Reference Checking: How to Vet Potential Investors

Foreign Hi, I'm Richard Delude, one of the co founders and partners of Underscore vc. Today we're going to talk a little bit about how to vet investors. So first and foremost I would be thinking about, before you even approach investors, think about fit. Do they fit your area where you're building your company? We often think of those through a couple of lenses. The first is through geography, right? So are they investing in the United States, are they investing in Europe? If they're investing only in Europe and you're a United States based company, not worth spending your time there, then you can think of domains, right? So if it's a consumer investor and you're an enterprise software company, you're probably going to waste your time, their time, everybody's time. Additionally, you should think about stage focus, right? So stage is another important consideration in that there's early stage, there's growth stage, and then there's later stage financing. It's often, if you're an early stage company, not worthwhile to speak to growth or later stage investors. And so you don't need to spend time there. You can do all of this work up front, qualifying geography, domain and stage far ahead of having any first conversation. So you've landed the first meeting, you go, you have your first zoom or in person meeting with the venture capitalist and the prospective partner for your business. The most important, the single most important question that you can ask is how does an investment get made at this firm, Inventor? There's a lot of people in this industry who will say, skip the associate, don't ever have that conversation, just go talk to a partner. That's a really dumb idea. And here's the reasons. Because partners are really busy and you're not going to get the time of day. In fact, you probably get ignored because they're working on a lot of portfolio companies and others. And so often the gateway and the intro to a lot of these organizations is talking with some other team member and then kind of understanding how to have that conversation through the rest of the organization. One question that I always ask to tease out what the most important questions are for the firm is can you come back to me with a list of what the most important questions are that you guys are hung up on as you evaluate this opportunity, people don't often pause to just say, where are you hung up? And being able to just simply ask that question and then get an answer, ask actually helps focus how you can have the next levels of the conversation and triangulate into, okay, they're uncomfortable with market size, I need to spend a bunch of time talking about market size. Otherwise you'll spend a bunch of time talking about all the other pieces of the business and it may not necessarily move you far. By far the most important thing any entrepreneur can do before taking an investment from any venture capital firm or investor broadly, is to go to your references and do them extensively. And what that means is going to talk to three, five, potentially 10 founders who've worked not only with the investor that you're working with, but also the firm more broadly, because it's going to tell you a lot more than any marketing collateral on their website is going to tell you. You got to do references. I cannot say this more clearly. You got to do references. You got to take references of the good and the bad scenarios that happen with all of these phones. Go talk to all the most recent portfolio entrepreneurs, potentially some who are a little bit further along in their journey, I often think spending time with people who are at the same stage. So let's say you're seed going to series A, what's that experience like? Or if you want to look even a little bit further, go down the financing route and say, if you're a seed company, talk to the companies that are at series B or C, how do they operate at that moment in time? And the best way to do it is you can ask the VCs directly, who have you worked with? Often it's in their LinkedIn or the like. And you can go just say, who are the CEOs in those firms? And reach out to them directly. You'd be very surprised at how often they're going to pick it up. Because entrepreneurs are always in support of entrepreneurs, right? Especially when they're at this critical moment of financing. You can often reach evangelists, people who are going to be super excited that, geez, I work with this firm. It was probably the best experience. Those are equally important, actually. Hearing when somebody's really delighted as a customer can actually be one of the most important references to. And then you want the exact opposite. Go find a company that failed. So look at the list of companies that this firm had backed. What are the ones that are no longer in existence? And then who are the CEOs or the founders of those companies? Go talk to them too. Because when everything's up and to the right, generally people behave really well. When everything's really in a tough spot where it's really difficult, you get to see how these firms really work. And it can be a really critical piece of diligence in understanding what their experience was. Because you learn a lot more. The must ask questions, if you're doing a reference would be who makes the decisions at the firm regarding follow on financings, Specifically, what did that process look like? How early did they communicate? Another key question is what value do they add? I think asking questions that are a little bit more broad actually can help let them navigate the discussion to the parts that they want to talk about and potentially the parts they really want to talk about. Because it didn't go as well or it went particularly well. I think both of those are really equally important. At the end of the day, this is a relationship and you have to trust your gut when it comes to relationships. Either you're going to have a basis of trust to work with this firm and this person, or you're just not. And you learn a lot in the process. It's not going to be the individual deal or the term sheet. Of course, those can tell you a little bit about an investor, but it's actually more about the process. What did you learn from them in that experience or from other founders who've had had that experience with them? Are they going to be making you jump through a billion hoops and those hoops are not useful? That's a really important part of the diligence process that you can see. Trust me, they're probably going to be about the same on the other side of that. Or if they believe they have a bigger vision of the market than you do. Right. You know, again, you're probably going to have a partner that's going to be trying to steer the company later on. And again, I personally don't think that's a company I would want to go build. I think the red flags that I'd be watching for were, number one, you gotta trust your gut. So if there's kind of things that are harder to label, but your gut just says probably not great to be working with this firm, go think about that, go validate it, go talk to a bunch of references as part of it. The second is think about the term sheet. It reflects a lot of what's working with this firm. And then third, it's really what has the process been, has been a positive working with this firm. Do you feel like the business has already increased in value that you're working with somebody who's going to be able to get you to the next place? Or is it somebody who's just, you know, going to provide capital, which can be, of course, important, but it's not going to necessarily come with the advice or help or relationships that are going to pull you forward beyond the capital.