In my last post I shared the deck we used to raise Alpha Bridge Ventures Fund I with commentary from esteemed LP Chris Douvos. We tried to show how LPs think about picking VC fund managers. In this month’s post we are sharing some tips that founders can use when choosing which VC to partner with.
For first time founders, it may seem as though “money is money” and that securing funding is simply a means for their company to continue down its war path. However, in venture, money is never just money, its money and a long term relationship. It’s important to remember that the partnership with your VCs will last longer than the average American marriage and is infinitely more complicated to terminate. While not every founder has the luxury of interviewing their prospective investors in depth (sometimes you just need to get money in the door), whenever you are presented with an opportunity to choose from seemingly equal investors we recommend asking the following 11 questions.
Can you show me the deck you share with prospective LPs in the fund?
No founder has ever asked us how we pitch to our investors, but I believe all of them should. With the exception of a small minority of VC powerhouses who can afford to operate on reputation alone, 99% of venture firms have slide decks they use to pitch to LPs. These decks are a treasure trove of information that can be helpful to founders. Here are at least 3 things you should find and pay attention to:
1) Is the VC’s story to their LPs consistent with the story they tell you? Does it seem like its in integrity with itself?
2) How are the VC’s returns? If a VC’s returns are high it is (a) an indirect indication of how helpful they might be to you and is (b) definitely an indication of how helpful they can be in helping you fundraise in future rounds. If their track record is good, LPs and other VCs are more likely to want to co-invest with them.
3) Who are all of their portfolio companies (not just the ones they tout in their twitter bios and homepages). You can use this information to run “off list” reference checks (see below) and get a sense for whether they publicly “drop” the companies and founders that aren’t runaway successes.
Please share a list of founder references. Preferably founders you’ve worked with who have been successful and founders you’ve worked with who ultimately failed.
Its very rare for founders to ask us for references but its something every founder should consider doing. While its possible founders are using “off-list” references – as in references we do not personally provide, I doubt it because we usually hear about this through back channels anyway.
Why check references? You’ll learn how the VCs behave once the deal is closed. Do they add value or do they serve as a major distraction? Do they abandon companies when the going gets tough or do they roll up their sleeves and double down? The only way to really know these things is to talk with founders they’ve worked with in the past.
We’re of the position that “off-list” references are disproportionately valuable in this space. Fortunately, if you asked the first question we suggested, you have their deck which should serve as a wonderful source for these references. You’ll want to speak with founder’s they are currently working with, founder’s they are no longer working with, and founder’s on either end of the success spectrum. While we as investors will make reference calls at every step of the way, we consider it equally important for a founder to do the same.
Who are your LPs? Where does your money come from?
You might want to know if your VC's money comes from sources you might consider nefarious, ethically moribund, or otherwise troubling. Many founders aren’t too concerned as they’re unlikely to ever have direct contact with the LPs but if its important to you, than you should ask. The caveat here and where it can be critically important is if you are working on something in the defense tech / national security space in which case you should verify that there isn’t Chinese or Russian money in the VC’s fund as it may complicate your ability to do business with the government.
Who is a founder that doesn’t like you and your firm and why?
You might exercise some finesse in how you word this one, but the idea here is to test your investor’s transparency and continue developing a more complete picture of how they operate. Nobody can be in this business for long without pissing someone off. The larger and older the firm, the more likely it is they made an enemy somewhere down the line. Understanding how and why that enemy was made will give you key insights into how the VC “thinks” about the tricky decisions they have had to make along the way. Most importantly, do they hold themselves accountable in their retelling, or is the blame exclusively the founders to bare?
Have you ever made a decision that was financially good for your firm and LPs but not the founder? Why? How did you make the decision?
The most common scenario is a decision to sell, or not sell a company. In some circumstances, blocking the sale would benefit the LPs and the firm but not the founder. Understanding their thinking behind a decision like this (and of course conducting a follow-on, off-list reference call to corroborate their story) will give you a good idea of what you can expect down the road.
What types of signals do you read as a time to replace a founder as CEO?
Are there certain behaviors you won’t tolerate? Political red lines you don’t want to see a founder tweet across? More likely, what are your means for determining if and when its time to replace a founder CEO? Have you ever done so?
Not every founder CEO is equipped to or will grow sufficiently to lead their company across the finish line. Not every founder CEO wants to take their company across the finish line. Going from 0=>1 is not at all the same business or skill set as going from 1=>1M and there is zero shame in admitting it. There is no right answer here but you should know how your prospective investor thinks and if their thinking aligns with your own before you take their money.
How do you support your companies? Name a time when you think you made a real difference for a portfolio company or founder?
VCs are competing with other VCs for an equity position in your company. Many firms promise something valuable in addition to the capital they bring. Its hard to know up-front how valuable your VCs will actually be and the only way to get a sense here is to talk with some of their other portfolio companies.
What is your thesis on our industry?
Some funds are thesis driven. They've thought deeply about a space, and make their investment decisions around a potential future they believe is inevitable. Given this, what do they think is exciting about your company and how do you fit into their thesis? This question tells you why the VC thinks you are worth it and where they see you slotting into their portfolio. Knowing this information helps you determine whether the VC shares the same ideas as you about why you’ll succeed. Alternatively, it can be a fresh perspective about a different path to your success.
How do you like to work together? What cadence of communication? Official meetings or just pinging whenever its necessary?
What do your prospective investors want your updates to look like? Is working with them a chore, or a breeze? Will they text you everyday and demand a response? Like normal people, VCs have working styles of their own. Some want to know what you did that week. Some only want to know what you did that month. You’ll want to understand exactly how much time you’ll be spending with your investors and how valuable of a use for your time you think it will be.
What is your policy on follow-on investing?
Do they follow-on in all of their companies when there is a 3rd party lead? Do they try to take the whole round themselves? Do they never follow-on? Different firms have different policies and you should understand the policy of any firm you partner with. If they do follow-on, what is the milestone for a follow-on investment? Is it revenue based? The whispers of an exit? Something else? Know where you stand in their calculus for a potential future investment.
How long have you been at the firm? What is your ideal firm to work at? What would draw you away from your current firm? Have you left a firm before? Why? How do you relate to the founders you backed after you left that firm?
If your assigned firm partner/champion leaves the firm, what can you expect to change? Often, the partner you work with is the only person at the firm who knows your company and cares deeply about your success. If they leave, what sort of care and feeding can you expect in their absence? You do not want to be orphaned as it will make raising a subsequent round much more difficult.
We know that not every founder has the luxury of digging deep like this with their prospective investors. That said, some founders do and if that is you, than you owe it to yourself to take this seriously and to ask these questions of your prospective investors. The more informed you are the better relationship you will have with your investors going forward.
Thanks to Rob Sullivan for his awesome work on this post.