When first-time founders reach the point of pitching their company for funding, it can be a nerve-wracking experience.
In many ways, the future of their startup relies on these meetings and the potential to finance the next step of the journey. This leads to founders feeling as though they are constantly on the selling side, selling themselves, their idea and their vision.
However, this is only half true. Startups and founders need to understand that they are also on the buying side. Market dynamics have changed in favor of the founders — making it a seller’s market.
Founders have endless options of funding and potential investors which should make you, the founder, confident to conduct DD on the investors and ensure the right decision for you and your venture.
We tend to think investors make an investment decision based solely on what the startup presents and according to the findings of their internal due diligence. Yet the fact is that there are many external factors that come into play without any connection to the startup itself or to the DD results. As a founder, you can flush out some of those factors by asking very basic questions regarding the fund.
So, without further ado, here is a basic checklist of DD questions to consider asking when encountering a potential investor.
*The list below is more relevant for Venture Capital but can apply to other sorts of investors.
I invite all my fellow investors to add more relevant questions in the comments.
The fund status can be a proxy of how much appetite and resources the fund has for new investments. Are they at the beginning of the fund and feeling fresh and ready to take more risks? Are they at the end of the fund and very picky as to how they will fire their last bullets? Are they going into fundraising mode soon? Are they too busy with boards?
These are just bits and bytes of what different questions can contribute to your understanding of the people on the other side of the table.
Questions to think about regarding the fund’s status include:
- How many funds are they managing?
- Which fund are they investing from currently?
- How many of their companies are active? How many board seats does the fund hold?
- How many investments have they done until now from the current fund? How many to go? Until when?
- How many startups do they plan to invest in per year?
- When are they planning to start raising the next fund?
- How big were the other funds and how many investments per fund?
Strategy & Thesis
Understanding a fund’s investment strategy and thesis is very important to you as a founder. The data you collect here can help you qualify the investor and prioritize choosing the ideal partner for you.
The strategy will consist of fund allocation, average check size, size of the portfolio, follow on and pro-rata strategy, and their level of hands-on. The thesis reflects how the fund sees the future, which markets and technologies they are betting on, what is their domain expertise and more.
To find out their strategy, these are some questions to ask:
- Size of the fund?
- Average check size for first investments?
- How many investments in total for this fund?
*These first 3 questions give you an idea of how much money the fund is reserving for follow on investments and can indicate on how they plan to double down on the winners.
- Do they lead rounds? Follow?
- What is their follow on strategy? Do they lead? If not, how have their companies raised their next round? (this connects to the added value section)
- Do they take a board seat? An observer seat? How hands-on are they besides these official interactions?
- What does the fund invest in? What investments would they never do?
- What is their domain expertise? What kind of companies are they looking for?
- Have they invested in a company that is outside of their focus areas? Why?
This is a tricky one. Why is this important? Two reasons:
a) The fund has experience in scaling these so-called winners, which means they know that market very well. If you are building something in a similar market, you might seem more attractive to that investor and if you decide to work with them, you may benefit from their expertise and network.
b) Of course there are also write-offs in every fund which investors usually benchmark as markets to avoid. You might need to figure out how to de-risk this issue if you see a resemblance to a write-off they have experienced.
A VC’s track record also brings with it prestige and brand which might get you hyped up to work with them. This is understandable but might also be superficial. I believe in the holistic approach taking into account all factors (as detailed in this blog) before making a decision and not blindly following deciding based on this factor alone.
Questions to ask include:
- Who are well-known companies they have previously backed? Who led those deals and what did they learn?
- Was there a recent write-off? What was the reason? Does this mean they won’t invest in those areas in the future? What were the key learnings from that investment?
- How did you contribute to the success of the winners?
One of the most important things you need to understand is what exactly can the investors do for you? As a founder, your mindset should be that you are buying your investor’s money with equity.
When you buy something, don’t you want to know exactly what you are getting? What are the extra add-ons? What are those services that no one else can provide and why are they unique and better than the other VCs you are meeting?
To clarify this, you can ask the following:
- Do they know and understand the market you are operating in?
- Have they invested in this market before?
- Do they have a network that is relevant to your venture in terms of customers, advisors and talent?
- Are they connected with later-stage funds? Do they help or even lead the next financing rounds?
- Do they help with talent sourcing and bringing in strong executives?
- What is their main value add? Can they give a recent example?
*From my experience, most funds will give you the same kind of answers, that’s why point #6 (references) is so important.
No matter what a fund promises, no one is excellent at everything. Understand what will be your top two challenges in the early stages of your venture and optimize for added value there. Remember to be open and not to dismiss challenges you might feel are irrelevant — you don’t know what you don’t know and investors usually offer added value services for specific challenges for a reason.
Chemistry and Process
I like to compare the fundraising process to dating and the term sheet to getting married. In the book “Secrets of Sand Hill Road: Venture Capital and How to Get It” Scott Kupor mentions that an average marriage in the US lasts between 8 to 10 years. A seed-stage investor will be your partner for the expected time frame of 10–12 years. Take a minute to digest this :)
You will be spending a fortune of time in one another’s space so finding out if you and your investors get along is vital. When dating a potential partner you usually ask yourself — How was the chemistry?
Could she/he be the one? Can I imagine her/him as my life partner in sickness and in health? What is my gut feeling?
In the same way, post-meeting with investors you must ask yourself:
- How was the process? Transparent? Efficient? Fair?
- How do you perceive the fund’s team? Would you like to work with them?
- Do you see them as an extension of your team? Would they go the extra mile for you?
- Do you want this specific individual on your board?
Check out how well I can predict the future:
Every investor you will meet will ask you for personal references per founder. Why? Well if you go back to the previous point, they need to validate you before the put a ring on this.
But this isn’t a one-sided action. Once you feel that the investment process is going forward, it is time for you to launch your own background check on the investors. Ask them for a reference, this will usually be founders from their portfolio, but can also be other relevant industry figures.
Here comes another prediction — The VC will connect you with their top performers. This is totally legitimate but might not provide you with all the angles you need to get the whole picture.
Therefore, it’s on you to reach out to the lesser-known portfolio companies and get other perspectives and angles of how the investor interacts with their founders. Remember — you have to backchannel and not only rely on the references given.
Questions to cover include:
- How is the general work with the investor? Ask about the team also.
- Did they add value? How? What is the most impactful thing they have done for you?
- How do they act on the board? How did they act when things weren’t going as planned?
- Are there any red flags I should be aware of?
- What is the investor best at/worst at when it comes to working with you and your team?
Asking these questions and DDing your VC helps in more than one area.
Besides the obvious of finding an investor founder fit, it will help you gain points in the eyes of the investor as a true professional who understands their business and might even empower you to prioritize and choose the optimal investor in a case of multiple term sheets (the best problem to have).
Going back to how these questions are perceived in the eyes of an investor- for me, a founder that asks even a handful of these questions already gets major brownie points. It shows that you did your homework, understand how important it is to find the right investor, and proves that you fully comprehend the industry.
As a bonus, asking for references allows you to connect with the winners of a portfolio, which leads to building your network and can even lead to potential customers.
At F2, we urge the founders we interact with to ask us questions, talk to references, and truly DD us. We want founders to feel as comfortable as possible with us as a team and feel that they really know who we are and what we’re about.
We hope that this will lead founders to choose us not because we were the fastest or any other arbitrary reason — but because they view us as a true partner and are excited to build the next game-changing company together.
POWER TO FOUNDERS!