How to Diligence a VC
Plenty of posts have been written about the process VCs use to diligence startups. Heck, I’ve written a bunch myself. Like this one. And this one. And this other one. But what about the inverse? As a founder, it’s easy to get so caught up in the ultimate goal of fundraising — to raise money — that you forgot or run out of time to learn more about the source of the funding.
But it’s essential that you diligence potential investors before they end up on your cap table.
If things go well, you’ll likely interact with them week-in-and-week-out for 10 or more years. Even more significantly, you’ll have to work with them when things aren’t going smoothly (something that’s guaranteed to happen). Your choice of investors will impact the direction of your company and your journey as a founder, so it’s essential that you understand who they are and how they conduct themselves.
Here are 5 tactics you can use to diligence a VC:
1. Ask for References
The bare minimum you should do in terms of diligence is to ask potential investors for references from founders they’ve previously backed. Of course, this is like asking a potential hire for references — they’re only going to introduce you to people who will say amazingly positive things about them.
You should still talk to those founders and ask them about their experiences. You may be surprised by how candid they are. Then take it one step further: ask the VC for references to founders of companies they previously backed but which ultimately shut down.
The goal here is to understand not only how helpful the VC is when times are good, but how they work when things get tough. Pay attention to how an investor responds to this request. The best VCs will gladly make such introductions. The worst will make excuses.
(Note: The absolute best VCs will offer an introduction to any founder in their portfolio. Don’t be afraid to take them up on it.)
2. Talk to Former Founders
You wouldn’t be doing your diligence if you only talked to the references that a VC gives you. The next step is to find your own. Luckily, there’s an app for that.
Imagine if the next time you considered getting into a long-term relationship, you had a list of every one of that person's ex's and could call any of them to ask anything you wanted to. That's what Crunchbase is for founders.
You can literally go online and find each and every company an investor has previously invested in. Look for companies that not only had success, but also shut down. Then reach out to the founders.
Fun fact: while investors typically use warm introductions as a way to filter requests, 99.99% of founders will respond to a cold email titled “Founder Looking for Diligence on <X>” (if <X> was someone on their cap table). Every founder who’s ever raised capital understands the information imbalance inherent in fundraising and are more than happy to help even the odds. They’ll sing the praises of the investors who helped them the most, spill the tea on those who wronged them, and help you to understand the nuances in how a given investor operates.
To this day, I get cold emails from founders asking about investors in my previous companies (and that was more than a decade ago).
3. Ask Your Existing Investors to Backchannel
Getting the real story on a VC is one area where your existing investors can help. A lot.
Both angel investors and VCs spend a considerable amount of time meeting and getting to know other investors. So even if they don’t have first-hand knowledge of a particular VC, they should be able to get multiple points of reference for you.
Your existing investors have a vested interest in helping you to bring the right partners on board, so leverage each and every one of them to backchannel on your behalf.
4. Reach Out to Later-Stage Investors
In the course of your founder journey, you’ve likely come across investors that you were too early to raise from. In some cases, you might have had multiple touch points and have started to develop a relationship with them (aka a “dotted line”).
If they’re genuinely interested in your company, then they’ll also have an interest in seeing you raise from strong early investors (albeit not as significant an interest as your existing investors).
If you’ve started to build a relationship with one or two later stage investors, don’t be afraid to reach out and ask, “We’ve got a term sheet from <X>. Curious what your thoughts on them are?” The answers can be enlightening.
5. Trust Your Gut
Above anything else, trust your gut. If something seems off about your interactions with a potential investor, don’t be afraid to call them out on it. Or add it to the list of questions to ask other founders about.
At the end of the day, if something feels like a red flag, it probably is. This is your company. And your future.