Reverse Due Diligence

Many first time CEOs mistakenly think that due diligence (in conjunction with closing a round of venture capital) is a one-way street.  It is definitely not.  And if you, as CEO, are in the enviable position of having multiple term sheets, then doing some diligence can be the swing factor in deciding which investor(s) to invite into your board room.  With that in mind, here are a few tips on how to conduct what I call reverse due diligence:

  • Find out who you need to check out.  If it is not clear to you already, you should ask who would be the partner on your board.  While general feedback about a fund might have some value in terms of assessing an overall reputation, the most useful information is specific to the person you will have on your board.
  • Find out what boards they’ve been on.  Most likely you’ll be able to get a list from the fund’s website and a little Googling.  It’s also worth asking the VC what boards they have been on.
  • Ask for founder references.  You should ask for references and be specific that you would like to speak with founders (not CEOs who replaced the founder post funding).  I’d also ask directly, "what were the 2 or 3 worst deals you have invested in?" and then ask if they mind if you spoke to the founders of those firms.  If during this process you get a "no" or radio silence then you should be wary.  It might be fun to talk to a founder who had a hugely successful 20x return for the fund, but you will definitely learn more from speaking with someone who went through trench warfare.  As they say, crisis doesn’t build character, it reveals it.
  • Look for blind references.  Check out TheFunded.  If you’re not a member already, it’s pretty straight forward to join (I also have a few invites available and am happy to share on a first-come-first-served basis).  There are thousands of reviews on there, although it is still hit or miss on whether the fund you are interested in has been reviewed.  You can, however, post a "call for feedback" on the public forum which I suspect would get some useful feedback.  You should also go on LinkedIN and search for current or past management at companies on which the VC sits or used to sit.
  • Questions to ask references.  So now you should have a list of 10 or so direct and blind references…it’s time to make some calls.  In general, you want to ask short, open ended questions and then shut up and listen.  Each call is different, but here are a couple of questions you might consider:
    • How did XYZ prepare for board meetings?
    • How did XYZ contribute in board meetings?
    • What was XYZ’s biggest contribution to the company?
    • When it came time to raise another round, how supportive was XYZ?
    • When you missed your numbers (or had a major problem), how did XYZ react?
    • How did XYZ respond to compensation requests you made (for you personally as well as for your team)?
    • When you sold/shut down the company, how did XYZ behave?
    • Any tips on how XYZ likes to receive their board package?

Also, if the references are local, you should invite them out for coffee or a drink as you’re more likely to get candid feedback.

  • Get up close and personal.  After you have had a chance to make a few of these calls/meetings, go out to dinner with your prospective VC and ask them for "their side of the story."  This is a great time to have "what if" conversations with them.  For example, this is a great time to ask, "when do you expect to have the first serious review of my performance as CEO and whether or not I should continue in that role?" 

Most likely you will find that one of your potential investors will distinguish themselves during this diligence process.  Worst case, if everyone comes through with equally positive references, you will have some good information on how to work with your new board member.