Venture Capital diligence varies from firm to firm, a fact that frustrates founders seeking investments. Making it worse are those urban legends of founders meeting an investor in a parking lot . . . and getting a million-dollar check after a twenty-minute conversation. If only it went that way (and if it did, that wasn’t so much an investment as a gamble).
Compounding the frustrations for founders, VC firm diligence also varies from stage to stage.
The diligence process that supports an investment in a startup without customers (very early stage) is quite different than the diligence process a VC firm would use for a company north of $20 million in recurring revenue. That said, here are highlights from Valor’s venture capital diligence process to help you get a mental template of what you could expect from us.
We are sharing this because we believe it’s just as important for you to diligence your first institutional investor as it is for us to diligence you.
The start of our investment process is sourcing. We know you can’t invest in the cream of the crop if you aren’t seeing a large section of the crop. So if you’re a founder, ask yourself how VC firms are going to find you? What’s your strategy to attract a great VC firm at the sourcing stage? It’s literally the first step in diligence. If we do this wrong—founders and VCs—we end up with bad matching. One of the things we do is benchmark our pipeline at regular intervals to make sure what we’re seeing is in line with what the market reports.
We are aware that <5% of venture capital funding goes to startups led by women or people of color, for example–and work to make sure our own pipeline is representative of the facts: 40% of startups are led by women and people of color.
Our next step is qualification. Each fund will have its own qualifications.
For us, those that are too early for us (pre revenue, pre product, just one big customer, etc.) go into a nurture bucket in Mailchimp for a drip feed of invitations to events, blog posts for founders, and a quarterly follow-up from an analyst outbound call.
Those that are qualified—which for us means they’re ready for their first institutional check, have growing revenue, eager current customers, and a software product that plays to our investment themes of financial inclusion—our analyst collects a certain amount of information on their traction, operating docs, and previous fundraising history. This is a Due Diligence Request where we formally engage in reviewing that company–it’s gone beyond an intro call for us.
If a startup hits our competitive benchmarks around growth, traction and funding, then the analyst sets up a meeting with the general partner. We try to do this at the company’s offices if possible. We have also made investments via Zoom and never met the founder in person. Founders always want to know what competitive benchmarks ARE, but the fact is, it changes quite a bit quarter to quarter relative to dealflow. Bottomline, we love to see companies that can grow at least 20% quarter over quarter in customer-driven revenue.
We are aware how critical it is to build two-way trust with an entrepreneur. If we can add value through our platform and “add rocket fuel” to their journey, and have confidence in that journey from a business planning standpoint, we proceed to early diligence. This is probably what you mean when you think “investor diligence,” but actually, diligence does start at sourcing.
We share the startup with potential customers in our Innovation Council, to get feedback on other startups that strategic is speaking with that solve the problem. We develop a list of comparable startups in the past, so we can see what the valuation, round size, and acquisition history is, and what the competitive landscape looks like. We provide the founder with some of our feedback on the company and how it could grow, usually from a sales and marketing lens, and also from an inclusion lens, and see how they react. We are testing for coachability but also “productivity” of the dialog. If we share 5 good ideas, is one of them good enough for the founder to adopt? This helps us develop a conviction that we are the right firm for their first institutional round. In this way, diligence is a two-way street. We are under our own lens as well.
If we get positive signals in early diligence, we then go to our technical review.
Our technical team reviews their code and their dev team. It’s not just the code and how it’s deployed, but who owns pieces of it, etc.
- We collect standard information including your backup procedures, github or other code repositories, and your thought processes on scaling the dev team from here.
- We look at everyone who has ever contributed code to the solution as it stands today. This helps us decide if you are visionary builders or more incrementally innovative on a technical level, so we know how to best support your growth.
- We look for single points of failure too. Is the code written by one person with a major health risk and no team mates or backups? We’re practical about wanting to make sure we invest in companies built to scale.
- At this level, we develop hypotheses about which major tech companies you could integrate with, too.
All firms tend to review your financials, operating docs, and run background and character reference checks, and we’re no exception. We also ask to understand the race and gender of your team, including your first investors. Valor is known for one of our core beliefs–that inclusion is a risk factor controllable by the investor. We believe inclusive teams are tough to build, but like all things of value, it’s worth it. As so much research and practices proves, diverse teams solve problems in an anti-fragile way and deliver greater financial performance.
Our final diligence is legal—making sure we have all representations and warranties in place, employment agreements, strong operating docs, and other items on the legal diligence worksheet.
This seems like check boxing, but let me assure you, there are some fascinating things that come out in legal diligence. One of the best things you can do before you seek funding is make sure your company’s paperwork is in good order first because a first institutional investor absolutely will.
Once we have everything together in that process, we proceed to funding. The one point I like to make here especially with founders is that funding is just a next step in a process. It’s not actually a climactic event. A lot more comes after, too.
The final phase of diligence is continuing the diligence into adding value.
The themes and learning we had together in diligence create our go-forward plan to help the founder create more value, usually on the board but always with:
- Customer introductions
- Ongoing product reviews from a major technology integration and acquisition lens
- Support hiring talent, including hiring inclusively for the team and the board
- Being an ear and a mirror for the founding team
- Access to our recruiting platform
- Connections within our Innovation Council
- Media coaching via our partner Write2Market
- Product roadmapping sessions with Robin Bienfait, general partner, former CIO Samsung and Blackberry
- Investor lists and support finding your next investor from our analyst team
- Adhoc support on founder Valor slack channels and weekly Zoom calls
To share with you more about diligence, I have to mention what happens when we say “no” at some point in the process. We invest in fewer than 1% of the firms that contact us, so learning how to say no quickly, directly and positively is a practice at Valor. I cringe realizing we don’t always do this beautifully and yet we do get a lot of practice–a few dozen no’s every week.
One of our core beliefs is that the entrepreneur is always right in their instinct to reach out for help, so we never want to disrespect that valuable impulse. Most founders hear from us in 48 hours, and at most a week, even from a pure cold inbound inquiry and even over holidays. When the answer is no, our goal is to share why we are not a fit for them briefly, not why they are not a fit for us. If there is fault to assume in rejections at the sourcing level, the fault lies with us. If there is a no in the investing process, it’s often because we know our platform is not yet robust enough to carry them to that next major milestone. Knowing what our platform can do, however, allows us to say confident yeses for those startups where we can add value.
Curious if we’re a fit for you? Share a little information here and we’ll be in touch.