How to Conduct Due Diligence On An Investor

3 Questions To Ask Before You Take The Check

We live in frothy times in the early stage market. From the SEC loosening their grip on the accredited investor laws, to AngelList democratizing the access to start a fund, to the internet proving it can take on hedge funds, there are A LOT of new investors entering the arena. This a great for many reasons, but if there are many investors, many don’t have a reputation or track record yet. It may be hard for founders to differentiate the good investors from those who may derail them. It is key that founders understand that not all capital is equal and they should actually be aiming to get capital that is from good investors, not just any investor. Here are some of the things to look at when meeting a new investor to evaluate if they are “good”.

Also note, these points apply to pre-seed and seed investors, but some of these rules fall apart once you get the the Series A and later. With that said, let’s get into it.

Do they actively write checks?

If they’ve written a a ton of checks in the last 2 years, then great. You’re dealing with a pro. If they’ve written 2-5 checks in the last few years, you’re dealing with an angel investor, which can still be very good (not always, though). If they sporadically have been writing checks or haven’t written one in 3-4 years, you know there’s something probably up here and you should assume this isn’t a professional or even a casual investor.

You can tell how often they write checks by checking out their Crunchbase or simply asking them. If they wince at the question, consider this a red flag. If they are actively writing checks, you can infer that:

  • They are thinking critically about markets and the future

  • They are getting a ton of reps talking to founders, so they know the latest trends in the fundraising process

  • If you wanted to take their money, you could do a reference check on the VC first from one of their more recent investors

Are they a neutral value add?

I actually ask this by trying to evaluate how much of a pain of an investor they will be, but before taking a check. Most investors think they are value add, but as a founder, you should optimize for neutral value add. Sure, it’s nice when an investor helps but all they really are obligated to do is move money and provide access; You shouldn’t expect them to do anything but that, but be pleased when they do. For investors who:

  • Need more than 2 meetings to make a decision for a check under 100k

  • Prides themselves on value add, but can’t give concrete specific examples from their past experiences when asked to prove it,

  • Won’t sign the same docs all your other investors signed

  • Have a longer than average due diligence process (2-3 weeks or more)

…it can be assumed that they may provide negative value add in the relationship with you too. So if you’re getting any of these vibes as you’re meeting with them, pass. Gut feelings about investors are usually right. Optimize for neutral value add and try to filter out if you see someone going too heavily on either end of that. Note, there are enough investors out there that check off these boxes, so may as well not risk it with the one that don’t.

Are they insiders or outsiders?

When you take money, you’re really getting two things. Capital and access. The highest value is when they invest, your company gets more valuable simply because they are on the cap table. It’s obvious this is the case if it’s Jason Calacanis or Eric Ries, but what if it’s someone less known? Well, you still want to make sure they are connected. The benefit of having an insider on your cap table is that they can intro you to other insiders who invest downstream. You will have a clear path to a tier one firm for a seed or series A. I don’t agree with this method, but it is what it is for the current moment in time.

If they claim they are an insider, how can you believe them? Here are a couple tricks you can use:

  • See their follower/following count on Twitter. Do they have a fair amount of followers? Do other influential people follow them? People you look up to? Twitter is the virtual Sand Hill road, and any insider knows this.

  • Can they introduce you to other investors? If so, they may be able to help you raise capital or introduce you to a lead for the next round

If they actively write checks, don’t come off as too positive or negative value add, and they provide access for you, then take the check. If you have 2/3 of these, then maybe still take the check. 1/3? Ehh. 0/3. Run away quickly.

This is obviously not an exhaustive list of how to due diligence an investor. There are tons more questions you could ask around fund size, ideal ownership %, control terms, etc. The idea behind this post is that these three points are in some ways functions of the truth. If they actively write checks, give off neutral value add vibes, and are insiders, you can infer that many other things will line up. If they are missing those points, then you can also infer that they will likely bring a lot of headaches.

It’s a jungle out there, hopefully this short stop helps inform you on how to spot the “real” from the “fake” out there. Good luck and let me know how I can help! —> Mat@matsherman.com