New businesses need investment money to move forward; a great start-up idea or the next new tech innovation will never get off the ground without the capital to do so. And while it may seem that any money offered by a venture capitalist (or angel investor) is always a good thing, money raised on the wrong terms or from an investor whose vision for your business does not align with yours can sometimes be worse than not raising any money at all.
Just as your investor(s) will do their due diligence to ensure they’re making a sound investment, you too must do your due diligence to determine whether the investor(s) is the right fit for both your company and your business plan. For example, is the investor requiring the investment be used for a specific purpose (perhaps R&D) for its internal fund allocation reasons? If so, you may not be able to use those funds for another purpose (perhaps marketing) and you could end up overfunded in one area and underfunded in another. Or, is the investor promising a deep Rolodex that will enable you to put your team together? Can it live up to its promises?
In the first example, there is nothing wrong with the investor’s demands, and in the second example, the definition of a ‘deep Rolodex’ may be a question of interpretation, but in both cases it is important that you confirm what your investor brings to the table aligns with your actual needs.
Basic due diligence checklist
1) Review their investees. Visit the investor’s website and review their list of current portfolio companies. What sectors are they in? Are they all early stage? Do they list any home runs?
2) Complete reference checks. Call the president or CEO of several of the portfolio companies listed and ask for feedback (in an off-record conversation) on their working relationship with the venture capitalist. Try to locate the founders of the companies. Are they still active or have they been squeezed out?
3) Talk to peers. Ask questions of your own business peers as to whether anyone has had any previous experience with the investor. Steer clear of hearsay and gossip and stick to conversations with business peers who have direct knowledge of the investor.
4) Find their failures. Although this is more difficult to do, unearth previous investments that are no longer listed in their portfolio and attempt to uncover what went wrong and why. Failures offer just as much insight as successes into how an investor operates.
5) Look at the individuals behind the venture capital. Much can be learned by understanding the motivations and expectations of the individual or partners behind the corporation. What is their track record and industry expertise?
6) Ask direct questions. Be straight in your questioning during the interview process; ask your investor whether they intend to be passive or active at the board level or even in the business itself, what milestones may be attached to the investment, and what value (other than money) they bring to the table. And, if you anticipate raising more money in the future – find out if their fund is large enough to support their successful companies in future rounds as well as their investment timeline and preferred exit strategy.
A venture capital or angel investment is rarely a simple no-strings attached cash injection. Understanding the investor’s plan for their investment in your business and how it fits within your strategic business plan is key to your success.
As founding partner, Glenn Rumbell brings almost 30 years of business law experience, a distinguished top legal firm background and a passion for helping startups. Since the early 1990s, he has forged a successful and varied career as a lawyer, entrepreneur and investor in Canada’s legal, investment and technology industries.