How to Pick a VC
Advice for Founders Raising Capital
Just as venture capitalists diligence investments, founders should diligence potential investors.
The primary job of a venture capitalist is to increase a company’s odds of success. There are a number of ways VCs can do that – and identifying how each investor can effectively support one’s startup should be the core of a founder’s diligence process. Here are the things I’d screen for if I were in a founder’s shoes.
First, Can VCs Actually Improve the Odds of Success?
That is, do investors provide any value beyond pure capital?
I think so. From discussions with founders, these are the most commonly mentioned ways that VCs can truly help.
#1: Brand. Getting backed by what’s seen as a “Tier 1” VC often (at least temporarily) elevates the brand of the company. This most directly aids with recruiting talent, especially at or after a company has reached the Series A stage. The brand halo effect is a little less relevant for the first 10 or so hires – founders should ideally attract these folks from their network, given the outsized impact each early hire can have on the company’s trajectory and culture.
A strong brand means the firm or partner is known, respected, and viewed as associated with success. Success is the best brand.
#2: Knowledge and (learned) insights. Has the investor either seen or been in situations that they can draw upon to give entrepreneurs useful advice? Are they particularly adept at identifying factors that influence the market or business?
There are really two points in one here: 1) the repertoire of relevant knowledge a VC may have from seeing other companies in their portfolio succeed (or having been in similar situations as a founder themselves), and 2) the ability to provide a scope above water on broader market dynamics and how they may impact the company 6-12 months from now.
#3: Network. Sometimes VCs can help get the founder (or other functional leaders) in rooms with the right people. “Right people” might include other executives with relevant experience or prospective customers. Founders still need to stand on their own – a customer is rarely won because of a VC’s influence. But investors can certainly help get builders at least a foot in the desired doors.
#4: Distribution. Some VCs command an audience and, consequently, being an “influencer” is part of their value add (even if they don’t associate with the stereotypical “influencer marketing” persona). This is observable today: many VCs are trying to build owned distribution engines via podcasts, newsletters, X profiles, and more. Sometimes these can truly act as effective means for generating awareness about and interest in a new startup.
You Have Investment Offers: Now What?
First, congratulations! The opportunity to choose from an array of competitive investment offers is both an accomplishment and a privilege. Take a moment to enjoy the process.
It’s likely you already have some intuition about whom you want to partner with. The diligence process is often revealing – via the types of questions people ask, the insights they share throughout the process (and the degree to which it feels like a conversation vs. an interrogation), how responsive they are in following up, whether it feels like a cultural fit, and more.
Time to validate that intuition. These are the pieces of the process I’d follow, in no particular order:
Run references on the investor. These references should be with both companies in the VC’s portfolio that have succeeded, as well as ones that are either struggling or recently shut down. It’s important to know the type of partner an investor is in both successful and stressful situations. And, ideally, these references are with companies that also work with the specific investor with whom you’d partner.
Check for conflict risk. Does the firm have a history of investing in companies that compete with each other? And more importantly, are they invested in any companies that could theoretically compete with your company?
Consider how long the partner may remain at the firm. Often, you’re picking an individual to partner with just as much as you are a firm. I’d encourage more founders to ask their prospective partners about their aspirations and future plans. A related thought experiment is to ask yourself: if this partner left tomorrow, would you still be excited about the firm?
Determine if the firm has fund-stage fit. Whether a fund consistently invests in companies at the same stage as yours can impact the usefulness of its resources, the degree to which your company’s needs may be prioritized in the resource queue, and the relevancy of the advice an investor can provide. A $5M seed check from a $1B fund is only 0.5% of the total allocation. Put frankly, it just makes the economics of winning internal mindshare or help harder if the fund is putting $50-100M into later-stage companies.
Learn how the firm thinks about exiting. This may feel like a weird one. But in the current era where IPOs have been less and less common, knowing how investors think about the attractiveness of acquisitions or selling secondaries can save you a lot of headache down the road. Similarly, within crypto, understanding how investors think about selling tokens can be a useful input to the token design and launch strategy.
Choosing a partner is often a one-way door. Selecting the right VCs will never “make” a company, but it can improve the company’s odds of success and make a founder’s life at least a little easier. Spending an extra few days doing diligence on potential investors can pay dividends for years down the road.
These are solely personal views and do not necessarily represent those of any specific investment firm or employer.
Great writeup.