Finding Your Optimal Investor – Due Diligence for Entrepreneurs

I’ve seen the venture capital due diligence process from both sides of the table and I know how comprehensive and exhaustive it can be (sometimes to the chagrin of the entrepreneur).  But it’s a critical part of the process, ensuring that the venture investor is fully bought into the team, product, market, etc.  A typical venture capitalist makes only a couple new investments per year, so a mistake is very costly.

Entrepreneurs understand the importance of the VC diligence process and they put in the effort to make it go smoothly. But what isn’t discussed nearly as much is that the entrepreneur needs to put the same effort into researching and vetting his/her potential investors. Selecting the wrong investor can be just as catastrophic for an entrepreneur as it is for a VC to invest in the wrong company.

This was the subject of a presentation I gave earlier this month at a 128 Innovation Capital Group meeting.  In my talk I shared some thoughts and advice on how to find the optimal investor.  A critical first step in this process is to define goals, both for the entrepreneur and for the business. What’s your desired exit strategy? Will you aggressively invest for growth, or grow at a steady pace? Will you be CEO for the life of the company or will you bring someone aboard?  The answers to questions like these define the makeup and needs of the company (such as capital requirements, management needs, and preferred governance) and have a tremendous impact on defining what the optimal investor looks like.

Once the goals and needs are defined, now the research begins. Before signing a term sheet, entrepreneurs should be absolutely confident their investor:

1. Understands their business
2. Shares the same goals for their business
3. Is a valuable, constructive partner to the entrepreneur

If you’re an entrepreneur and just beginning to research investors, start with the web. Visit VC firm websites and read partner bios, press releases, and blogs. Check out LinkedIn connections and see where VC’s show up in web searches.  With this basic research, you will get a good sense of who is investing in your area and who is having success.  This will give you a short list of VC partners with whom you will want to meet.

Next, once you’re meeting with a particular partner, make sure you get to know them as well as you can.  While the bulk of your meeting will be spent talking about your business, make sure to carve out some time to ask your own questions.  Ask questions about their goals, investment experience, thoughts on the market, and investment capacity. And perhaps most importantly, before signing a term sheet, ask for references – including from entrepreneurs who had negative outcomes – and diligently check them.

If you’re getting close to signing a term sheet, spend some quality time with that investor. Take them out to dinner. Make sure you’re comfortable with their personality and working style. This is critical because taking investment from a VC is almost like getting married – you will spend a lot of time with this person and will be confronted with many challenges that you’ll need to overcome together.

All of this effort getting to know your potential investors will be well worth it. We all know how hard it is to build a company.  When faced with that challenge, it’s critical to go to battle with the best team possible and that includes your investors – whether they be angels, VC’s, a bank or anyone else.  Do your homework and you’ll get the right set of investors – and it will save you many headaches down the road.