Qualifying a VC Investor

As the portfolio I’ve built in the past two years continues to mature, I’m spending increasing amounts of time helping founders navigate the fundraising process. The first step of that process is creating a target list of potential VCs to approach. We usually do this with a google doc that the founding team share with their investors and advisors so that they can easily track progress, action items, and responsibilities. The first step of the process is often building the target list. This list tends to come from a lot of people (founders, VCs, angels, advisors).

Typically, when qualifying and assessing potential investors, I tend to advise founders to think about this along several orthogonal dimensions:

  • The individual partner. At the end of the day, the individual partner looking at a deal is the most important determinant of relevancy. The “wrong” partner at the best firm is probably a bad fit. But a great partner at an average (or even below-average) firm is often a great choice. The fit between a founder and a specific partner is always the most important thing.
  • Reputation (perceived “greatness”). The reputation of a VC firm typically has to do with two things: the ability to invest into “winners” and the ability to “add value.” We all know there are firms out there with tremendous reputations and firms with less stellar brands. I’ve been around the VC game long enough to know that these reputations don’t always match with reality. Many of the firms with great reputations have earned those reputations with years of consistent hard work that continues to drive performance. But sometimes, a firm’s reputation can take years (decades) to adjust down to reality after performance starts to slip. That said, the reputation (perceived “greatness”) of a VC investor is an important consideration in selecting an investor. Raise from a well-regarded VC and other investors, employees, customers will take note which can ease sales, hires, or additional fundraising. Raise from an investor with a questionable rep, and all those things can get a bit harder. In today’s environment, with many rounds being led by “venture tourists” (firms or corporates with little to no VC track record), I’m actually much more interested in the identity of the investor than in the amount raised. When people see a large round led by a firm they’ve never heard of, they tend to assume that a lot of other (better? more experienced?) investors looked at the opportunity and passed.
  • Actual ability to add value. This dimension refers to an investor’s actual ability to add value to an investment. It can be (and often is) completely divorced from reputation. There are a growing number of highly specialist firms out there with specific focus areas (commerce, design, product, finance, IoT, industrial). Often, these firms have large networks in a specific domain or partners with directly relevant experience in specific areas that can help founders in pretty tangible ways. Of course, founders should approach claims of “future value add” with caution — and, wherever possible, should expect to see some “actual value add” in the course of a fund’s due diligence. (For example, if a VC claims to have a network of potential customers for your product, you should expect to meet a few of them in the course of diligence. If not, watch out.)
  • Likelihood to invest. Founders’ time (not to mention cash runway) is the most precious resource that a company has. If you are based in Helsinki and still at seed stage, the “perfect” VC in California may not be so perfect if they have never invested outside the US. On the other hand, if your company fits perfectly the investment thesis and profile of a less “perfect” local Finnish seed fund, you should probably bump that Finnish fund up in your ranking. While optimizing investors is always an important goal, making sure you have the cash to survive and live to fight another day is even more important. Likelihood of investment is not a particularly exciting dimension, but it needs to figure into a founder’s thinking.

These four dimensions capture most of the dynamics for how to rank VCs as a founder considers approaching them. Typically, I’ll work with founders to rank VCs by these dimensions (usually informally, sometimes formally) as we work together to prioritize who to reach out to, why we are reaching out, and in what order. Once we’ve determined an order, we’ll then decide who within the company’s network is best positioned to make the initial approach, and we’ll get to work. At a minimum, when a founder talks to me about a VC he or she is thinking about contacting, I want to understand what the motivation is. That is, which of the four criteria above does that potential intro meet?

At the end of the day, however, any VC’s decision to invest in a startup (and any founder’s decision to accept a term sheet) is best thought of as a love story. Try as we might, it can be hard to predict which company will resonate with which potential investor. The point of this post, however, is that the process can be made more efficient (and more effective) with a little bit of structured thinking.

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