Raising VC money: how to handle VC due diligence?

This is the fourth post in a Friday series on “raising VC money.” For the list of topics we are covering, click here. In this post, we’ll focus on the topic: how to handle VC due diligence.

So, you’ve come up with a short list of VCs (more here), you’ve asked for the meeting (more here), and the first meeting went well (more here).

Now what?

Unfortunately, this is the most challenging step an entrepreneur faces in the VC fundraising process. It’s quite unpredictable in terms of outcome, and there’s a wide range of time associated with it.

A VC after the first meeting may move quickly, slowly, or not at all. He may invest, but may not. His activity may have a stop-start-stop-start rhythm. And, many VCs keep their cards close to their vest and aren’t very up front about feedback. In other words, this process may make you go insane, or at least, make you very cynical.

Let me try to clarify this situation by mentioning a few things. Here are the cold, hard facts: 1. VCs are paid to make money for their investors, not to be business plan reviewers—that doesn’t explain away rude behavior, but that’s the reality of what their “day job” is; 2. Some VCs will not provide honest and direct feedback—they don’t want to insult the entrepreneur; and, 3. VCs are busier today than they’ve ever been since the 1998-2000 Internet Bubble (more here).

The good news is this, however: VCs are paid to invest—they are looking for reasons to say “yes” to your financing. It’s a myth that VCs enjoy taking up entrepreneurs’ time and then declining financings. Instead, VCs are paid a lot of money by their investors to find great new ideas and create new companies. Their funds have to go somewhere. Why not to you?

So, with that, here are some suggestions for entrepreneurs.

Advice #1: ignore what the VC says, and focus on what he does. If a VC is interested in your idea, he will act. The VC will propose immediate next steps. Your colleagues may get a call to check you out. He will be in sell mode.

If a VC politely says your idea is interesting, but takes no action, then that’s what I call “the California no.” For some reason, your business idea wasn’t enough for him to change his schedule and do work. If he’s slow to reply to your follow-up emails, it’s not going to do much to email him a dozen more times, or to start calling.

So, actions speak much louder than words.

Advice #2: don’t stress about what you cannot know. A savvy entrepreneur I know once told me: “I never stress about what VCs are thinking after I pitch them because it’s impossible to know.” His point is that a VC who doesn’t respond strongly to his pitch may be ambivalent for a lot of reasons—and, you will never know why.

Some possible reasons are:

– The VC took the meeting as a favor and was never interested in investing
– Your pitch or delivery was bad
– He doesn’t believe in your space
– He is on too many Boards and is holding out for a later-stage investment
– He is secretly thinking of leaving his firm
– That VC has limited power to influence his partnership
– He wants to see if other VCs show up and validate your idea for him
– He reference-checked you with someone he knows—and, it was negative
– His partners really didn’t like the idea
– He is a new VC– the senior partner supervising him isn’t interested

The list is endless. The point is this: it’s near impossible for you to know what truly happened at that VC firm. So, don’t stress about it. Move on to the other VCs on your list.

Advice #3: understand the VC firm’s decision-making process, triggers, and timeline. Each firm has an explicit process for screening investments. At large firms, there’s a gradual process of escalation. You may start with one partner, then have to pitch two to three, and then, all partners. The VC may have to write an investment memo at some point in the process. At other firms, there may be no written correspondence, but there may be a clear decision-maker. The point is this: every VC firm has a process, and you need to know what it is.

You want to know the process and the steps in the process to gauge where you are. You also want to know what triggers movement from one process to another. For example, at our firm, we have three partners who have to meet with every new investment and sign off. This happens after the partner working the opportunity has done diligence and recommended the investment to the team. We call this “having conviction.” What this means is that it is very hard for us to invest after just one quick meeting, but when we commit to your company, you have the partnership’s full support. It also means that you’re asked to present to the Kepha team, your VC sponsor has already bought into your business idea. That’s all good news. Very few teams pitch to our full partnership, and you’re in the 7th inning with us when you’re asked to do so.

Advice #4: do what you say you will do. During every interaction with the VC, you are being evaluated. The VC is looking to see how you handle yourself, how prompt you are with follow up, and how organized you are. The idea is that if you’re organized and “on point” with VCs, you’ll be the same way when you’re recruiting impossible-to-get employees and strategic partners. The diligence process is a great opportunity for you to shine.

Finally, I will conclude with this: the process is a great way for you to get to know the VC. Is he straight-forward in his communications? Is the chemistry good? Does he display value-add? Does he have time to work with you?

Well, that’s all for now. Next week, we’ll cover the topic “how to handle the partners’ meeting.” A Happy Passover and a productive Good Friday to all.

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