Top Questions That Don’t Get Asked When Raising Capital

by mike on January 20, 2010

questions

Most VCs have a standard protocol for evaluating investment opportunities, but entrepreneurs vary greatly in their evaluation of VCs. Experienced entrepreneurs have been through the fund raising process before and know what “potholes” to avoid. There a few questions that entrepreneurs should ask of their potential VCs and some do, but most don’t. (Note: I use the term champion below to represent the partner or other investment professional at the VC firm who is sponsoring your investment.)

Here is my list of top questions that entrepreneurs might want to consider asking when raising capital:

  1. What is the firm’s decision process? Every VC has its own process for evaluating investments, getting to a term sheet and getting a transaction closed. Believe it or not, some firms close a good number of their investments from opportunities junior folks drummed up (so much for avoiding Associates). The point is that it is important to get to know your potential VC’s investment process and your champion’s role in that process so you can measure progress towards closing the transaction.
  2. Who will serve on the board of directors post-investment? This seems like an obvious question, but the answer is not always straightforward. Some firms may staff the board with a different partner than the one who championed the investment. It could depend on anything from geography to operational experience to the number of boards your champion serves on. In fact, some firms may even change out their board member based on the stage of the company. There is also turnover in the VC ranks and partners do leave firms.
  3. How much of the VC’s current fund is invested? This question will give you an idea of how much money your potential VC has left after the investment in your company. Most entrepreneurs are so focused on the current fund raise that they don’t think about future rounds, which arguably are more important. The reality is that this fund raise probably won’t be your last. I’m in no way implying your VC won’t be able to support you in the future. There are plenty of ways VCs can handle these situations such as raising new funds, raising annex funds or making crossover investments. Regardless, this is a good piece of information to know particularly in the current environment where further VC consolidation is expected.
  4. How many investments will the VC firm make this year and how many is your VC champion evaluating? The goal of this question is two fold. One, it gives you guidance on how many investments your potential VC as a firm does in a given year. Second, and the harder one to gauge, it gives you an idea of where your company lies in your champion’s priority stack. Does he or she have three other companies with signed term sheets right now? How many investments does the champion look to do this year and out of those how many has he or she already done? Typically, most partners only make 1-2 investments per year. I truly believe the “cream rises to the top” and if you have a strong company you’ll be able to raise capital regardless, but it’s always good to gain insight on your funding competition.
  5. What are the barriers to close the transaction after the term sheet is signed? This is probably more relevant to late stage companies where a significant amount of due diligence is conducted by the VC. Signing a term and closing a transaction are two different things. Due diligence is typically conducted after a term sheet is signed and basically verifies everything you’ve told the VC up until then — technology/product, financials, management team, etc. If things don’t add up there is a chance you will be re-negotiating that term sheet. Some VCs do this and feel strongly about it and some don’t. Either way, it’s good to be aware of the possibility of it happening.
  6. How has your VC champion specifically added value to his or her portfolio companies? The key here is specifics. Don’t accept high level explanations. VCs almost exclusively operate at a high level and are mostly good at selling (they raised the fund after all). Just get the facts and verify with the VC’s portfolio companies.
  7. What does the VC like and dislike about your company and market opportunity? This might be a difficult question to ask, but it’s important to get candid feedback as early as possible. If there are challenges and concerns for your potential VC you need to address them upfront. Also, find out what the VC likes about your company and play to your strengths.

I’d love to hear from entrepreneurs on this one. Comments, thoughts and suggestions are welcome.

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