For startups raising institutional finance, the balance of power typically sits with the VCs. They have the capital, you need it. According to the latest data, market competition is intensifying as VCs remain hawkish with their dry powder. 2,400 companies that raised seed funding in 2022 will be competing for Series A investors when they next raise. They’ll be joined by another 2,000 startups that raised Seed in 2021 and have yet to raise since.
Facing the realities of these tough market conditions – VC funding fell at all stages during Q1 of 2023 – can inevitably make raising a venture feel like a one-way street. Now, more than ever, founders don’t feel in a position to ask too many questions of their prospective VCs, or go deep on the investor ‘due diligence’.
But having good investors around the table can make or break a start–up. Many founders with sharp minds and exceptional ideas have signed term sheets with people they wish they hadn’t, or with clauses they went on to regret. To avoid being one of them, conducting due diligence on your investors can’t be overlooked, whatever stage you’re raising at.
Learning from experience
The first time I raised venture funding, back in 2016, I’d been a full-time doctor in the UK’s NHS until just a few months before. Navigating a VC raise felt far scarier than facing down a ward of sick patients during a night shift. I remember how grateful my co-founder and I were for every glimmer of investor interest. It didn’t cross our minds during pre-seed conversations that we should be assessing the VC in the same way they were assessing us.
Having now raised several rounds, including a Series B last year, doing our due diligence on potential investors is a critical part of the raise process. Here’s how we’ve learnt to navigate it:
Check the chemistry is right
Making sure you genuinely like and respect the investors who are set to join your board is a must. Those people will be sitting across the table from you at critical junctures for your startup; if there’s friction or misalignment there from day one, things won’t end well.
If a prospective VC is set to take a seat on your board, have a chemistry meeting with them. Not a Zoom call, or a pitch, but real time spent together as humans. When I was getting to know David Foreman, the Managing Partner at Praetura Ventures, we went for several coffees and talked about things outside of the startup world. I felt I could trust him. This foundation has served us well and Praetura has gone on to be an invaluable partner over the years.
If you can’t imagine turning to that investor in a moment of crisis, or find yourself consistently on the back foot or anxious during your interactions with them, it’s unlikely to pass the chemistry test.
Get evidence of their ‘beyond the cheque’ position
The best investors offer a lot more than cash. The websites of most funds will proudly tout their commitment to supporting their portfolio, but this can sometimes simply be lip service. To identify those who really practise what they preach, have a set of questions for all prospective investors about their approach to portfolio relations.
Ask for tangible examples in areas such as:
- How have you previously stepped in to support your portfolio in times of crisis?
- How does your fund support startups with their scaling plans, such as international expansion or growth hires?
- What’s your approach to bridging investment or round extensions?
It’s also important to assess how VCs support the less hard-nosed side of the founder experience. That might be lending their ear when you have a tough decision to make, or introducing you to executive coaches who can help you improve your leadership skills or resilience.
Understanding what you believe you and your company will need over the coming years will help you pinpoint the VC’s best set-up to help. And having a clear idea of how different investors will be able to support you with these areas of your start–up journey is incredibly important. Strong VCs should be able to point to multiple examples of where their support has added value to their portfolio.
Talk to other founders
Speaking to fellow founders about prospective VCs is a very effective way to spot red flags. Schedule reference calls with founders who’ve accepted or rejected terms from the VCs you’re in talks with. Find out what drove their decision. And, for those who signed the deal, what it’s been like since.
Centre these questions around two areas:
- What’s the VC like in the good times?
- And what are they like in the bad times?
In the good, are they cheering on your success, supporting growth, and enabling scale? And, in the bad, did they genuinely step in with meaningful support and impactful action?
When the SVB ship was sinking earlier this year, certain investors were incredibly proactive with their communications and advocacy. Yet from the chatter on Twitter and founder WhatsApp groups, others were remarkably off the pace. In one notional instance, a journalist claimed that a VC didn’t have time to discuss his plans for the impending SVB explosion with him because the investor was about to hit the slopes in Aspen.
These are the concrete examples of how VCs behave when the boat starts to rock, and which differentiate those really worth having around your table.
It’s easy to be a good VC when things are going swimmingly, but great VCs who are true partners to their founders tend to shine brighter when times are tough.
Reclaim power in the VC-founder dynamic
The founder-VC relationship is subject to a clear-cut power imbalance. But don’t let that put you off conducting any due diligence on them. Good VCs will be happy to take the time to answer your questions and help confirm that this is a relationship that’s going to work for both sides. Bad ones might push back. And that’s probably all you need to know about them.
