How Should I Evaluate a Venture Capital Firm?

Evaluating a VC Firm

Q: I’m raising a seed round for a consumer web startup and I’m getting good interest from VCs. What questions do I need to ask of them to gain insight into how well we’d work together?

A: I suggest that there are two stages of research/questions to determine fit with you and your company:

  1. Prior to Contact: Research prior to making contact to qualify them in terms of the broader fit and,
  2. Prior to Commitment: Questions you want to ask once you’ve made contact to further qualify them since you will be partnering with them for years

Prior to Contact: These are the questions to find the answers to before you contact them so you don’t waste your time or their time by contacting them. Review the these items to make sure they line up with you and your business:

  • Industry or Type of Business – The firms will always have a specific industry or group of industries and/or certain types of businesses as a focus for their investments, such as “software”, “medical technology”, or “Internet”. Having a specific focus both reduces their due diligence time to investigate a potential investment and increases their ability to leverage their industry expertise and network.
  • Geography – Many firms also have specific geographic areas of focus for their investments – especially Venture Capital firms – that reduces their travel time to portfolio companies and increases their ability to leverage their local management talent and business network.
  • Size – Nearly all firms have specific investment amounts that they invest in any one deal, such as “$1 million – $2 million per company” or “up to $25 million per company”. This maintains a consistent thesis per their published investment strategy with their investors, maintains their risk profile and potential returns, and maintains a consistent process and staff leverage.
  • Stage and type of deal – Nearly all firms have a specific stage and type of deal focus for their investments such as “seed capital” or “growth capital” or “buy-out capital”. This focus increases their ability to leverage their business network and their ability to leverage their company stage expertise.
  • Syndication of deal – Most firms have a specific strategy for how they approach investments in terms of working with other investment firms such as “co-investor”, “lead investor”, or “controlling position”. This again helps them maintain a consistent strategy, their risk profile, their potential returns, a consistent process, and staff leverage.
  • Timing – All firms have timing cycles that they follow in terms of a fund life and stage that affects their ability or willingness to make investments. For example, if a firm is at the end of one fund life and is busy marketing to investors to raise a new fund, they will not have the time, willingness, or even capital to make an investment. Conversely, if a firm has recently closed on a fund, their willingness to do a deal will be high and they will usually aggressively pursue opportunities to build momentum.

Prior to Commitment: These are the questions to ask once you’ve met them to determine whether or not you really want to partner with them:

  • Firm Experience – Do they have experience with the exactly the type of situation you are facing and can they provide significant leverage for you to help you accomplish your goals in addition to the money? How connected are they in your industry? What is the quality of the ideas they are sharing with you for how you can improve your business model and your strategy? Is it a new firm with their first fund that hasn’t totally “gelled” yet, or is it an experienced firm with well-oiled processes and team members with a great track record?
  • Team Experience – Have they been entrepreneurs as well, or are they finance guys that will have a harder time empathizing with what you are going through? Will you get time and attention from the senior partners or will you be stuck primarily with inexperienced junior team members that cannot add the same value? Has the team been together for some time or are they still going through their own forming and storming stages as a team?
  • Personalities – Do you like them and their style? Are they humble servant investors that truly want to help you succeed or are they arrogant jerks? You are going to be stuck with them for five to ten years and you will want to be able to trust them through the inevitable ups and downs of the early stage.
  • References – Do they have good references from other entrepreneurs that have lived through all stages of a relationship with them? Can they provide you references from entrepreneurs that failed, but would still have good things to say about them and their character?
  • Process – Can they clearly explain their investment and due diligence process or is it more a “seat of the pants” process that defies explanation?

Recommended Resources

Document Downloads:

  • Startup Financial Model (to help you plan your startup or operate your business)
  • BizDevDocs (for a host of unique business development and planning documents, including a Capital Raising set of documents)

Ask an Expert:

Training:

  • Venture Academy (includes nearly 200 videos of entrepreneurship training)

About Wade Myers

Wade has founded or co-founded, invested in, and been a director of over 25 companies and has completed 55 financing and M&A transactions. His previous work experience includes the Boston Consulting Group and Mobil Corporation. Wade also served as an Airborne Ranger in the US Army where he was a decorated veteran of the Gulf War. He is a Baker Scholar graduate of Harvard’s MBA program and is married with five children.

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