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How to reference check your prospective investor

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Of all the advice I have given founders over the years, one of the most important ones is to make sure they do reference checks on their prospective investors. When founders do their homework on investors, they make informed choices about who they will be working with for many many years to come. As the saying goes, you’re literally getting married to your investors. Well, here’s the rub, some marriages can be dissolved more easily than getting rid of an investor you may not like or have soured upon over time.

I’ve seen and heard of enough cases of when founders didn’t do their homework and ended up committing themselves to an investor relationship that was in some cases either a drag on the company or the board dynamics, or best case a net neutral. The real value of having a positive investor/board relationship is very hard to quantify. In fact, a lot of first-time founders don’t really recognize if they have good investors or not as they don’t really have enough data points over the life of the company to compare working with different types of investors.

If you’re looking at raising a round of financing, you have a choice. You could either go with the highest offer on valuation that gives you the lowest dilution, or you can choose the partner who you’re going to be working with. I always recommend to my portfolio companies that they should be focusing on the latter, as getting the right partner and firm behind the company can make a massive difference in how much time the founders spend on managing their board or on everyone working together and focusing on optimizing for the success of the company.

Here are some tips for founders when making this tough choice:

  • Check references on your prospective investors. This is an obvious thing to do, but you would be surprised by how often founders are swayed by the perceived brand over the substance. VCs know that brand matters when it comes to winning deals and so they make a concerted effort to manage that brand. But the true measure of an investor is not what their perceived brand image is, but what their founders say about them. The best time to do investor references is when the investor has made an offer and before you make your decision on whom you’re going to work with.
  • Ask investors if it is okay for you to check references on them. Asking the question itself is somewhat telling. Some investors may be offended by this and that in itself is a red flag for you. That just means their ego is too big. Others will welcome you checking up on references and see it as a positive indicator as it also reflects how you will behave when you’re hiring key people or setting up key partnerships.
  • Be sure to do some off-list references. Every partner/firm will have at least a few good references they can offer up. A good tell here is if they give you a curated list or ask you to choose who you would like to speak to. But you should be able to work your network to reach out to founders of companies that may not be on the reference list to see what those founders have to say about the investors as well.
  • Know how to ask the right questions. If you’re taking with a founder who has the investor on their board right now, then their first priority is to protect and preserve their own relationship with their investor/board member. So they’re going to be cautious in how they address any questions. But there are ways to get the information you need without putting the founder in an awkward position. I’ll address this further below.
  • Use your best judgment. It is unlikely that any investor would have 100% positive glowing references. In fact if you haven’t encountered some negative feedback then you probably didn’t dig hard enough. A large number of venture investments do not pan out. Companies end up going through rough patches and several end up in the dead pool. Whent hat happens, emotions run high and the experience can leave people holding grudges. It’s your job as a reference checked to be able to separate the wheat from the chaff here and be able to almost forensically piece together what may have happened. When you do get negative feedback on an investor, one of the best options (provided you can do so without compromising the source) is to actually ask them about it and discuss it. Hear both sides of the story before reaching your own conclusion.

But how do you conduct a investor reference call? What questions should you ask? Here are some of my favorites. Your mileage may vary.

  • How long have you worked with this investor?
  • Are they on your board? How often are your board meetings?
  • Do they come prepared for board meetings?
  • Are the comments and discussion in those meetings productive/constructive?
  • Do you engage with this investor in between board meetings? How? Why? (What you’re trying to get here is whether the investor asks for the engagement or whether the founder reaches out to the investor because the founder wants to.)
  • What is this person’s style? (This is an open ended question, so you may get different answer. The things I look for are are they trying to hold you accountable to a plan, or are they trying to help come up with the plan? Are they proactive, or reactive?
  • What is the most helpful or value-adding thing this investor has done for you or your company?
  • Have you ever had a disagreement with your investor? How did he/she manage themselves in during that disagreement? How did you resolve the disagreement?
  • Compared to other investors in your company, how would you rank this person in terms of their helpfulness and attitude?
  • Once your company is massively successful and you’re independently wealthy, would you want this person as an investor in your next company?
  • How does this person interact with other board members and/or with members of your executive team?
  • When something bad happens or when you have a burning question who do you call?
  • Does the investor respect your time and qualify any introductions before making them? How useful have these introductions been?
  • If you had to give this investor feedback on how they could improve, what would you say to them?
  • What tips do you have for me for working with this person and building a strong relationship/partnership?

These are just some of the questions I can think of, but I’m sure there are many more. If you have any good ones that you really like to use, please add them in the comments below.

 

  • djglasco

    Very good advice. One thing I would add or clarify about doing reference checks is whether the term “investor” which I assume from your writings means the partner or individual representing the fund? As you know there are some good partners whose fund may not be that great and vice versa. So they might want to do some due diligence on the fund as well. E.g., I would add how much “dry powder” or capital they have remaining in the fund for follow on investing if needed and what is the decision making process at the fund. A bonus would be knowing who the LPs are in the fund – that might be useful to know if they could be potential customers. Just a few thoughts. Thanks for putting this together.

  • The whole attitude of the article, tips,and list of questions is very useful. Thank you, Manu!

  • Mark Arnold

    Great article, thanks. Mark

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