Most entrepreneurs focus on the hard economics of the deal when they negotiate with investors: percentage ownership, valuation, preferences and other terms.
Those things are all important — but so is the soft stuff, especially in today’s volatile market.
Think about it. Taking venture capital funding is the beginning of an intimate, complicated and usually long-term relationship. It’s easier to get divorced from your spouse than get rid of your investors. (Seriously. And VC investments usually outlast the average time people stay married before a divorce — eight years in the U.S., according to The Economist.)
Particularly as valuations drop and markets churn, it’s tempting to grab whatever funding you can, from whatever partner you can. But a well-funded nightmare with the wrong partners can become disastrous.
What questions should you ask to figure out if you’re partnering with the right investor — one that will stick with you through good markets and bad? Put another way: How can you reciprocate all the detailed due diligence this person and his or her firm is doing on you before you both tie the knot?
Some of the questions are obvious: Has this firm done deals in your particular sector? Do they have a record of exits and a good reputation in the community?
But there are also less obvious — and telling — questions you probably don’t realize you should ask, particularly in today’s market. Here are a few.
How does this investor deal with stress?
Inevitably, companies hit bumps along the way. When the hard times come, will your investor grip the steering wheel too tightly, freak out completely or help you steer clear of a jam? Are they a yeller or a contemplative presence in the boardroom, no matter how tough things get?
Make sure your VC relationship gets off on the right foot.
It’s easy to be a great investor when times are great, but seeing how investors operate through adversity is probably more valuable information for you. Ask your VC to walk you through his or her philosophy on dealing with adversity, with specific examples.
What do CEOs whose companies didn’t work out with that investor have to say?
Connect with these people independently — don’t just call names your potential investor offers. Key issues to examine are: What exactly happened to your relationship when you hit that speed bump? Did the investor stop coming to board meetings — perhaps hand you off to a junior person at their? Was he or she slower to return phone calls, or just as involved in your company as before?
In my experience, communication between an investor and a CEO should increase when times get tough. Ideally, the VC should be talking to the CEO multiple times a week and focusing on taking decisive action. Under no circumstances should the VC step back and let someone else (such as someone junior) handle the situation.
How smart is their tactical advice — particularly on-the-spot?
Ask investors highly specific operational or finance questions relevant to your business. If you’re a B2B software company, one might be, “My VP of product and my VP of engineering don’t agree on product roadmap. How should I handle this?” Or, “I’m having a hard time creating urgency in my sales pipeline — getting customers to feel like they need to buy now. How can I do this?”
You could also talk about resource allocation, and ask for advice on how to grow your business faster without burning more capital. VCs also can offer advice about structuring future financing rounds (even though they’ll be self-interested, obviously).
All of these probing questions can give you a foretaste of your future investor’s philosophy about tackling important business issues. And if you don’t wind up choosing this particular VC, at least you’ll get some great free advice.
Do they have enough money to do a follow-on investment?
Don’t become so enamored with a high-profile VC that you forget to figure out if they can actually support you through your various stages of growth — which may take longer than you think if the company under-performs, or the economy is not doing well.
Don’t pick a seed-stage specialist, for example, if you need that investor to pony up $20 million of capital over the life of your company. That’s simply not a seed-stage VC’s business model; these super early-stage investors play a vital role in the VC ecosystem, but they do not have the cash to do very large, follow-on rounds.
Taking venture capital funding is the beginning of an intimate, complicated and usually long-term relationship.
Over time you’ll probably deal with multiple VCs, who often invest in rounds together in a syndicate. Make sure you’re in alignment from the get-go as far as how much each one will be willing to invest in subsequent rounds. Ask specific questions about how much money this VC has to invest now and plans to keep in reserve for future financing founds.
What blind spots will your investor bring to your startup? And are expectations aligned?
Are you pitching a consumer or mobile app to investors focused on SaaS and cloud computing startups? This is a bad idea — the lesson here is, know your audience.
VC investors are ruled by their brains and their guts, but gut instincts — whether acknowledged or not — are strongly colored by individual experiences. Get your would-be investors talking frankly about their own experiences and challenges with your specific space, whether it’s e-commerce or cloud computing. Investors want confidence that you bring relentless curiosity to understanding your industry, particularly when it seems you’re on the wrong track. Expect the same of them.
Also, talk to your VC about whether you are both in alignment on key business milestones and definitions of success. Find out which metric the VC would use to determine if this investment is successful: a 3X return, a 10X return or a 100X? Only an IPO, and not a sale to a larger acquirer? You’ll be a part of a specific VC fund, so you want to make sure you’re all on the same page.
I’m a firm believer that great companies can be created in any market environment. Now is no exception. But before you take the plunge and accept venture financing, I’d encourage you to ask potential investors these and other detailed questions. Make sure your VC relationship gets off on the right foot and, like a great marriage, matures into a successful and robust partnership.