In October, we published The Operations of Fundraising (Part 1 and Part 2). One small section of the series covered how to identify the best potential investors for your startup. These posts covered the basics like:
1) Average check sizes
2) Industries of interest
3) Understanding fund lifecycles
4) Portfolio construction
5) Building an investor funnel
With all of the revelations coming from Silicon Valley, it’s more important now than ever to research investors more deeply. The last thing any founder wants to do is give influence to an investor who creates more problems than they help solve.
There are two simple, but important, questions that can be answered just by checking a few references.
Are they good partners?
It’s always a smart move to ask potential investors to speak with the founders of their portfolio companies. However, similar to reference checking employees, it’s important to call the references that aren’t on “the list”.
Don’t be afraid to find the companies they’ve turned down. The incentive to complement a current investor is high, while companies that have been turned down can sometimes provide better insight into the process. Other avenues for vetting include lawyers and accountants that have worked with the investor in the past.
Obviously, firms that have been turned down by the investor could have a potential bias. However, the quality and transparency of the interaction is often a leading indicator for decision-making and integrity which become crucial when faced with the inevitable challenges of a growing business.
I’m not suggesting that checking investor references should be only about finding negatives, but it’s important to get a sense of what a future partnership could look like. This requires having a sense of both strengths and weaknesses of potential investors. The more information the better.
How will they add value?
Capital is a commodity. Early-stage startups should look for investors with operational experience. Find investors who know how to build a team, product, or help with business development; things like finance often rise to importance later on, and even then operational finance still takes precedent.
It helps to know what your needs are, and what parts of the business are easily outsourced without sacrificing quality. The only exception is when the investor will add value simply by association.
Pay careful attention to what’s not said by CEO’s of portfolio companies when attempting to answer this question. If the investor has added value regularly and in a multitude of ways, it’s likely the CEO can offer specific examples of when they really made a difference.
Referencing is often tough and time-consuming which likely explains it’s not done more often. However, learning the strengths and weakness of anyone who will play a major role in the company including investors is well worth the time.