Four Ways to Evaluate a VC
“As much as the VC (venture capitalist) is doing diligence on you/your company, it’s important that you do diligence on them as well.” – Gadiel Morantes, EGFS President
Watch an episode of Shark Tank and you’ll see that the investor doesn’t simply choose the startup. Sometimes the startup has to choose between two offers, sometimes the sharks make joint offers, sometimes the startup walks away from an offer, and of course, some get no offer. Like an employee-employer relationship, a candidate is pitching their skills and talent, but ultimately both parties have to decide if there’s a match.
The amount of the offer is not always the deciding factor. Because if it were just about money, venture capital would be more like a glorified business loan. Investors bring different types of value to the relationship. If you’re pitching your startup to investors, you must understand the VC landscape and who will help you scale your business best.
Investing your time wisely
When you are getting started, it’s good to participate in pitch competitions and other events where you can talk about your business to a room full of people. There are many opportunities where VCs or angel investors will be in the room, but you may or may not get this information ahead of time. Take advantage of situations where the pressure is off because you are not pitching and get advice on how to develop your story. Building relationships with investors who can make introductions or help you prepare your pitch is the next best thing to receiving funding. Still, at some point you will want to target VCs instead of casting a broad net.
While you’re fundraising, you will also be working on your business. It is critical to be selective with your time when it comes to one-on-one meetings with investors. Do your homework before you spend time pursuing an investor who doesn’t invest in your space or with companies at your stage. The same way you target your customers, you can target VCs based on the value they bring to the relationship and the likelihood that they’ll invest in your startup.
Investors bring more value than just $$
- Expertise – Especially if this is your first startup, the insight from someone who’s been playing the game for a while can be invaluable. You want someone who can help you see your next move, because they’ve seen so many others traveling a similar path.
- Reputation – Even if the partners (individuals at the firm) are passive, you can benefit from the reputation behind the firm’s name. For example, increased media exposure and credibility in the investor community. This shouldn’t be the most important factor, but it may help you decide if you have it narrowed down to a couple of strong offers.
- Connections – The greatest value a VC can bring you (outside of capital) is connections. Beyond reputation, are they going to actively facilitate key introductions to partners, prospects, and other investors? Will their network help you grow your business?
Ways to evaluate VCs
How do you prevent over-investing your time pursuing a VC that’s not a good fit? We’ve outlined a few methods that can help you get started. Eventually you’ll develop your own vetting process. Start by not over-investing your time in this research! You don’t need to do an FBI-level investigation. You need to decide what your “must-haves” are before you initially pitch. Then, over the course of a few meetings, learn more about each other and determine if you’ll be good partners in scaling your startup. The dating analogy still applies.
- Tier 1: Typically, the top 15-20 venture firms — those who consistently raise large funds of $300-500M+, and have backed multiple, well-recognized startups and “unicorns” in the past.
- Tier 2: The next 20-25 funds — smaller with some moderate past success but not multiple “unicorn” exits yet.
- Tier 3: Everyone else.
Reach for the highest, but don’t discount the rest. Use this as one filter.
Continuing the relationship analogy, once it’s official, you might as well be married. Even with in-person meetings becoming a thing of the past, you don’t want to be too many time zones away. The challenges of setting meetings can be a big hindrance.
Look for someone who is based in the same region if you can. Keeping it local means you can catch up over coffee or meals, which is great for relationship building. As Marc Andreessen said, “Where is the startup located? Can it hire the right talent in that location? And will I as the VC need to drive more than 20 minutes in my Mercedes SLR McLaren to get there?”
It also means facilitating introductions will be easier. Being part of their network can never be underestimated or duplicated by the investment alone.
How diversified is the VC you’re considering and are they targeting your specific solution area or industry? If you are strictly a software solution, it is not worth spending time targeting a hardware-focused VC.
They should have a clear understanding, if not a presence, in the sector you occupy. If you have to translate too much information, it’s not the best fit.
At the same time, it is not wise to pursue VCs who are working with your primary or secondary competitors. Taking the chance of idea leak occurring – even with an NDA in place – is just not worth it. Plus, as entrepreneur and angel investor Dan Shapiro said, “Good investors feel a strong obligation to their existing portfolio.”
Talk with other companies working with your targeted VC to get a sense of what their dialogue style is. Often it takes one of three paths: the mentor, the observer, or the confidante. Get clear on how it will go when things get tough (and often emotional) in the business.
Mostly importantly, choose a VC that is aligned with your vision and understands (or wants to understand) your space, because they will become part of your company. Being well-aligned and clear on what each other’s expectations are key to a successful investor-startup relationship.
*Source: Battery Ventures
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