VC Due Diligence is a two way street

Borrowing an enterprise sales term, the “funnel” for startup opportunities at a venture firm starts very wide and ends up extremely narrow, and there are numerous stages along the way.  From initial call or email to actual funding, there is a massive filtering process.  The magnitude varies amongst firms, but to give you a sense, at Ascent, we see roughly 1,000 B2B business proposals throughout a given year, we meet with between 100 and 200, initiate diligence on 20 to 25, get really serious with a handful, investing in 3 to 5.  Yes, an extremely tight filter by the end.  Even enterprise tech sales people doing true “whale hunting” see better conversion ratios than that.

Most of the companies we spend time with are interesting and likely have the potential to build a good business, but only a few fit our specific investment strategy.  In this piece, as a follow up to our post covering how to get Series A investors engaged, I will share thoughts on what to do once you have us interested and what it takes to get through our process.  I hope it will be helpful in working with us as well as other potential investors.

How long does it take?

Let’s start with timeline.  Overall, it is wise to allocate about six months for a full fund raising process.  This is to be safe and make sure you have enough time to meet with the right groups, get them engaged, and work through a process.  It may go faster, but you need to ensure you don’t run out of capital before the process is over.  With any given firm, the diligence part of the process is about four to six weeks, followed by another four weeks for the legal process and documentation.

What are the stages?

At Ascent, if you have made it to the meeting stage, that means that you fit our basic criteria and are likely in an enterprise technology sector that we have identified as attractive.  We have a small team, so we must be ruthlessly efficient with our time.  We despise the “slow no/maybe” as much as you do.  If we are not interested, we aim tell you within a week.  If we are interested, we will talk to our team, and start to test the waters a bit, speaking with relevant industry contacts.  I refer to this as the initial “lite diligence” phase.  We may also request a few pieces of follow up materials from you.

If our team is generally supportive, and the feedback from industry sources is encouraging, we set up a follow up meeting at your office, with a specific agenda that will always include meeting more of your team, going through the sales process and pipeline in more detail, and covering any areas of specific interest or concern based on the unique aspects of your company.

After this meeting we will talk in more detail with our partners and make a collective judgement call regarding whether we are going to prioritize the opportunity, dedicating two people to work on it, and coming up with a specific diligence plan that includes a comprehensive evaluation of the business and a full partnership presentation from you and your management team.  We will likely request a larger set of information such as org chart and hiring plans, cap table, prior round term sheet, product details, financials and budget, customer contacts, management references etc.  Our goal is to get to know you and your company extremely well so that we can advocate (or not) for an investment. Assuming we proceed we will be knowledgeable and valuable partners to you from the start.

What materials to prepare?

Once you get past the initial overview deck, there are a lot of different items that may be requested depending on areas of interest or potential concern.  The obvious ones are sales pipeline, customer segmentation analysis, full organization chart plus hiring plan through next 12 months, detailed capitalization table, detailed financials and growth plan (budget), CAC, Churn and LTV analysis, references (management team, customers, partners), legal docs and term sheet from prior round and any important employee contracts.  The best advice here is to get your house in order to provide this information quickly, and to be completely transparent.  The diligence process is as much about building trust as it is about convincing us to invest.  The best experience I’ve had is when a CEO literally gave me access to the company’s Google drive and told me I could look at everything.

When does a term sheet come?

This does differ by venture firm, but beware those that give them out too early in the process – they may be trying to lock you into an exclusive period (meaning you can’t talk to other investors) and will decide later if they really want to do the deal or not.  At our firm, we typically wait until we are well into the diligence process and have a high degree of certainty before we issue a term sheet.  A very high percentage of the term sheets we issue end up closing.  We will write more about the actual term sheet in a subsequent post.

What about the lawyers?

It likely makes sense to touch base with your counsel when you start funding raising, and you should certainly consult with them on the term sheet – you typically want to get all material points covered prior to agreeing to terms.  Once signed, documentation is very important but should be mostly a formality and not reveal any new surprises.

Do your own homework

We will want to spend a lot of time with you and your team, and we will be asking for lots of info and references.  You should do the same.  Take the time to ask your own questions and then talk to the CEO’s we have worked with directly.  Make sure you get comfortable with us through this process as well.

What to watch out for

Timeline and process do vary by firm, and it can be hard for entrepreneurs interpret and influence at times. Examples of VC firm dynamics which can dictate timing include:

• Decision-making capability of your main contact at the firm
• Pre-existing knowledge/experience of your business or industry
• The firm’s investment committee process
• The phase of the actual fund that the firm is investing
• General internal politics and firm dynamics

Given that these factors are largely out of your control, it’s important for you to openly communicate with the VC, making sure you have a good understanding of their process and feedback on your business, and do reference checking as much as possible.   If the process is unclear or you do not really know where you stand, that is a bad sign and you probably want to focus on other potential investors.

In summary, you want to be prepared for a thorough and open investigation of your company and the opportunity going forward.  Good potential partners will add value during the diligence phase by making helpful introductions, offering insights gained from working with other relevant companies, and perhaps even force some deep thinking about important topics going forward.  Raising the capital is important, but your real goal should be to find the right partner to help you build your company.