Why read this article
As founders seek out investment opportunities, it’s essential to flip the script and rigorously assess potential investors, ensuring that both parties align on vision and values before sealing the deal. This article underscores the importance of this reciprocal diligence, emphasising that understanding an investor’s track record, support mechanisms, and alignment with the founder’s ambitions is as vital as the investor’s diligence of the company. By approaching investor selection with the same rigour applied to evaluating a company, founders can ensure a well-matched, strategic partnership that facilitates long-term success.
A few key takeaways
To maximise the effectiveness of investor relationships and secure a mutually beneficial partnership, consider these essential points:
- Reciprocal Due Diligence: You should thoroughly investigate potential investors’ track records, values, and support capabilities. This ensures that their goals and methods align with the company’s needs and can prevent future misalignments and conflicts.
- Key Questions to Ask: During pitches and follow-ups, ask targeted questions about the investor's process, support mechanisms, and past performance. This helps gauge how well the investor’s involvement and support will complement your biotech’s growth and address potential challenges.
- Leverage Networks for Insight: Engage with other founders and industry professionals to gain insights into an investor’s reputation and past interactions. This external perspective can provide a more comprehensive understanding of what to expect and how the investor performs in various scenarios.
Essential Questions to Vet Your Investors
There is a clear expectation that a startup will be thoroughly investigated during the due diligence process by their potential investors; but it is equally as important that this process be reciprocated. Not only is this good business practice, it also empowers founders to make informed decisions and ensures that both parties are well-matched for a successful and collaborative partnership. By investigating an investor's track record, values, and the support they provide, you can assess whether the investor's goals align with your own and what that investor’s value add can be.
Questions to ask and research before the first meeting
It is very likely that you’ll do a lot of this research while building your investor database. As you’re collating your priority list of investors, ask questions such as:
What areas do they invest in? Does your company align with their investment thesis?
- VCs may look at thousands of pitch decks a year, and to clear the funnel, they’re looking for any reason to toss yours out. Make sure you’re aligned with their thesis to avoid wasting both of your time.
What is their ticket size? At what stage do they prefer to invest?
- Make sure your company aligns with what the VC is looking for and that they can provide (either on their own or within a larger syndicate) the capital you need to get to your next value inflection point and fundraise.
What type of VC are they?
- Are they a specialist or generalist VC? Are they an institutional or corporate investor? Knowing this will help you cater your pitch and can also gain insight into your alignment.
Will they lead? Who are their co-investors?
- Some VCs will lead, some will not or cannot. If there are investors a potential VC likes to co-invest with, that gives you insight into what a syndicate might look like, and also opens new avenues to warm intros.
How many funds have they raised? What is their track record?
- Perform some of your own competitive intelligence and compare their track record to their competitors.
How many portfolio companies do they invest in each year? How successful have the companies in those funds been in the past?
- This is a great starting point to ensure that they are actively deploying capital and manage expectations around timelines.
Questions to ask during your pitch
We’ve all heard the adage that you should go into interviews with some questions to ask your interviewer, and the same is true during your first pitch. You’ve already got your meeting and made your case for funding; now is time to flip the script and ask the investors some questions:
Why are you excited about us? What about the deck was particularly exciting?
- As a follow up you can ask if there were any orange or red flags. This allows you to address specific concerns with more data or rationale in your follow up messages, and pre-empt those same pain points in future meetings with other investors.
What is your investment process?
- Hopefully the person you’re speaking to is the decision maker who will be your internal champion, but it will also be helpful to know who is on their IC, (that is, who they need to convince). Understanding their internal process will also be helpful for setting expectations in regards to timing and the overall decision making process.
How do you support your portfolio companies? Can you provide an example?
- This may be in the form of strategic guidance and operational expertise, marketing, networking opportunities, or ongoing support around talent and mentoring ( 👋 Hi). These extra pieces may or may not be value add, but it’s good to know what’s on offer.
Questions to ask and research during the follow up process
You’ve made it through your pitch and you’re now in the formal diligence process. Now is the opportunity to ask the questions you may not have wanted to ask upfront. The investor/founder relationship is one that should be built on trust and communication. Remember: you are taking a long term view. Therefore be open with your investor about your intention to conduct due diligence on them. Investors will understand and appreciate your intentions, and if they push back then this can likely be a red flag that they themselves have something to hide. Ask for refences to their past and present affiliations; it’s also a very good idea to do formal fund manager compliance checks at this point.
Questions to directly ask your investors
Who are your LPs? Will they co-invest?
- Sometimes LPs will co-invest alongside a GP, or will be able to invest at a later stage with greater amounts of capital. Particularly in the biotech space. many corporates act as LPs to get access to early innovations which they can then look at for M&A in the future.
How much of your current fund have you deployed?
- This can provide a lot of context for the VC’s risk appetite: a fund early in its lifecycle will have different investment hurdles to one in its final year or one in the middle of the deployment phase.
What is your follow-on strategy?
- Does their long term view align with yours? Biotech ventures are very capital intensive. Many early stage VCs will not have the capital to bring your product to market, therefore, what support can the VC provide to enable (either directly or indirectly) that long term vision?
How do you support your companies during conflicts, downturns, and other challenging situations?
- The journey ahead of you will be a long and bumpy one. If the market enters a downturn and it becomes very difficult to raise external funding, will they be able to help out? Ask for references and examples of how the investor supported a PortCo during a difficult time.
“How an investor acts during a bad situation is probably more telling than anything.” ~ Elizabeth Yin
Speak to other investors and brokers
What is this investor’s reputation in the industry?
- An investor's reputation, whether respected or questionable, usually precedes them, and feedback from other investors in the industry can provide valuable insights into their credibility and the quality of their support.
How have you found co-investing with them? How do they typically engage with the management team and board?
- This will help you gauge their level and quality of their involvement and their overall behaviour to pre-empt any potential impact to your company.
Can you describe how the other investor operates on a board? What is their level of involvement? How do they approach decision-making, and how do they interact with the management team?
- If the investor will be taking a board seat, this knowledge will help you assess whether their style and approach will align with your company's needs and culture and ensure that board dynamics will be collaborative and effective.
What are some of the strengths and weaknesses you’ve observed in the other co-investor’s board participation?
- This can offer a balanced view of their effectiveness and pre-empt any potential concerns or highlight areas of improvement.
Questions to ask other founders and operators
Your investor will likely provide you with a list of references; you do not need to feel constricted to that list. Utilise your own network to perform your diligence. Ideally find companies who joined the portfolio at a similar stage and in a similar thematic area.
“Don’t ask the investor for references to founders. Go to the portfolio list on their website and find a company that is no longer in existence and reach out to that founder on LinkedIn. A founder of a failed company is going to give you a lot more information on an investor than a founder of a company that is doing well.” ~ Mac Conwell
What was your overall experience with this investor? How were they to work with?
- This question helps gauge the general sentiment and overall effectiveness of the investor.
How involved was the investor in your business?
- This can help you gauge the level of engagement and support an investor provides beyond financial backing and determines the strategic value, operational assistance, and long-term partnership benefits they can bring to your company.
If you were to raise a similar round again, would you fight to include this investor over others? How hard would you choose to fight?
- This tells you a lot about that investor’s value add at a more holistic level.
How did they support your company’s growth? Did the investor facilitate valuable introductions or connections?
- You should be able to leverage a VCs network to your benefit, for purposes including BD, strategic partnerships, talent, and funding opportunities.
How did the investor handle challenges or conflicts that arose?
- A partner who’s there for the highs but not the lows is not a partner. Understanding how an investor manages difficulties and disputes provides insight into their reliability and commitment to the company’s long-term success. Effective investors actively engage in problem-solving, offer constructive support, and help navigate conflicts, demonstrating their dedication to both the company’s resilience and growth.
Were there any unexpected challenges or surprises with this investor?
- Uncover any potential red flags or issues that weren’t initially apparent.
Would you recommend this investor to other founders? Why or why not?
- Is it blunt? Yes. Will it give you a valuable answer? Also yes.
While due diligence typically involves evaluating a company’s potential, it's equally crucial for you as a founder to scrutinise your potential investors. This reciprocal approach not only aligns with sound business practices but also equips you to make well-informed decisions about who will be a strategic partner in your company’s journey. By investigating an investor’s track record, operational style, and the value they can add beyond financial support, you can ensure that you’re entering into a partnership with aligned goals and expectations. Additionally, this process can help avoid future pain points, enable alignment on long term vision, and clarify the terms of the investment, ultimately setting the stage for stronger, more collaborative relationships after the term sheets are in.
Sources:
How to conduct due diligence on investors (British Business Bank)
Due diligence: How to vet companies and investors (PitchBook)
10 questions to ask your investor during a pitch meeting (Octopus Ventures)
10 questions early-stage founders should be asking investors (TechCrunch)
How to do due diligence on investors (Creandum)
Diligence Deep Dives