There are many sites with lists of initial questions to ask startups before you invest (e.g. why now, what’s your competitive advantage, what customer problem are you solving, why can this team execute better than the competition, what’s your month-over-month growth, how big is the total addressable market, etc. etc.) They vary somewhat based on stage and sector, but in general they’re about filtering out companies that don’t have a good fit between market, product and team. I don’t have a lot to add on this topic, so I’ll refer you to Y-Combinator’s pitch deck template which answers many of the top questions.
Once I’ve had a first call with the founder(s) and they’ve passed this first screen, I’ll want to dig deeper. I cannot spend as much time as a VC would on due diligence, and I don’t have support staff for it, so I have to triage. Here’s how I focus my time:
TANGIBLES (necessary, but not sufficient)
If the company is willing to give me their actual financials (income statement, cash flow statement and balance sheet) for the current and past year, it saves time vs. doing follow up calls with long lists of financial questions. Some won’t be comfortable with this though, and it’s not a deal breaker if they can answer the questions I care about and if there is a notable lead investor in the deal.
I ask for a pro forma financial projection, not because it’s going to be accurate as a prediction, but because it shows me how the founders think and what inputs they’re focused on.
I ask what KPIs and metrics the company is tracking internally, and if they can share any recent reports. If the company had prior investors, sometimes this info is already available in a recent investor update document so it’s an easy give.
If I’m investing in a convertible note such as a SAFE, I want to see the cap table to find out if there’s an employee options pool yet, and I’ll ask the company about the amount of prior convertible notes outstanding. Pre-money SAFEs dilute each other, but aren’t diluted by a new employee options pool, while post-money SAFEs will be diluted by a new employee options pool in the later conversion round. More on this here and here.
I mostly ignore LOIs (letters of intent). They’re a slightly positive indication that the company is talking with actual customers and getting some feedback. But the financial amounts and timing in an LOI have no real legal weight and I don’t anchor myself to them for purposes of predicting future revenue. I also generally don’t aim to review customer contracts for a B2B company - the contracts are going to be one-sided because the small startup has no leverage, and they’ll improve at later renewals if the startup grows.
I usually don’t care about patents, and I definitely won’t spend time or money getting an expert to assess their value. There are a few sectors where they might matter down the road for exit value, but generally, a startup can’t afford to be suing for patent infringement while they’re pre-IPO, and VCs usually aren’t betting on patent licensing revenue.
If the company is a US-based C corp, I won’t spend time to review the articles of incorporation, bylaws and other corporate formation documents. If it’s a foreign corporation, I might or might not - if there’s a positive precedent (i.e. a startup exit) in the marketplace with the same structure, I probably won’t worry about it. I stay away from LLCs, partnerships and other corporate structures because they can have complex tax consequences and can be difficult to scale due to how employee compensation works.
Reference checks are helpful as a filter for downside risk - if I can reach somebody they worked with in the past (investor, co-worker, customer), I’ll try to get some quick feedback.
I send follow-up questions in email to dig deeper on details of their product roadmap, customer feedback, traction metrics (including how those are going to change over time, which often isn’t addressed in a deck other than for one or two top metrics like revenue or customers), competitive landscape, and future funding strategy. The last is rather important - I always want to know what milestones they need to hit to get to the next round of funding, and assess the odds that they can get there given their current runway.
INTANGIBLES (the key)
I almost never invest without a second meeting, and I want to meet another co-founder if there is one, so I can see how the founders interact with each other. They’re a team, and even if their resumes are individually impressive, I want to understand what “positions” they’re each playing in the company and how they complement each other.
The number one personality trait I look for is perseverance. I don’t think the importance can be overstated. I try to figure out questions about their past experiences that will demonstrate this quality. This is critical for so many reasons, including: (i) they’ll face a lot of hardship along the road to success that may tempt them to give up, and (ii) if they’re doing well they will likely receive acquisition offers long before they reach the size that portfolio winners need to be in order to pay for the investments that fail.
The number two personality trait I look for is confidence in a point of view about how the world is changing that is not obvious. Most startup founders exhibit this to some extent, but great ones are just about ecstatic about it, as if they have a secret they found in a crystal ball that they can’t wait to share with the world.
I always search for video of the founders talking online (e.g. YouTube), and try to find something other than a pitch at an accelerator demo day which is highly rehearsed and polished. I’ve found critical personality insights this way that I missed during my founder interviews.
I sometimes like to challenge founders on one of their assumptions, to see if they will engage in debate. If they shut it down by repeating an earlier stock answer rather than digging into the details, or get visibly annoyed, it may be a red flag. I don’t want them to immediately agree with me either. Great leaders stand their ground while maintaining a friendly tone, and often find a way to appreciate a different point of view even if they don’t fully agree with it.
I want to understand barriers to scalability, and whether the founders are thinking in terms of removing those barriers. Sometimes I ask: if you were raising 10x the amount of money right now, would you be able to scale 10x as fast? This may seem like more of a tangible question, but there are often signals of a mental focus on growth embedded in how founders talk rather than the substance of their answers.
Closely related to the last point, I look for evidence of processes that the founders use to improve their operational efficiency. I favor execution risk over market risk, and I’m looking for teams that can out execute the competition to the point that they don’t care how much funding the competitors have.
Integrity and honesty is super important because I have to rely on the founder’s word for a lot of data points. There may be no public data or third party data to validate or audit it.
To sum up my thoughts on the importance of intangibles, here’s a recent tweet from Harry Stebbings, who hosts the excellent Twenty Minute VC podcast:
Amazes me at seed, how much time investors spend on market, product, GTM, all transient things at this stage. Inversely, how little time is spent understanding true dynamic of the founding partners; ego, respect, truths, tones, ethics. This is what kills companies not GTM.
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