When you’re looking for a venture capital partner, there are five criteria that really should matter:
1. Domain expertise (such as Internet, software, cleantech) of the partner or firm
2. Quality of the partner’s character
3. Stage experience (seed, early, expansion or growth) of the partner or firm
4. Matching the investment amount relative to size of the fund
5. Clarity on expectations for your new partner
Unfortunately, entrepreneurs often get sucked into the venture world's brand and celebrity vortex rather than focusing on the real issues. The reality is that a venture capitalist’s brand and reputation will only get you so far. Investors who claim to be experts in every conceivable domain are very often masters of none.
How can you tell who you’re dealing with? Here are four questions every entrepreneur needs to ask:
Is the venture capitalist a battled-tested partner?
As all entrepreneurs know, building a company is exceptionally difficult. Some days you feel like a king, and on others you feel like a pauper. The ebbs and flows of startup life can be taxing. So before you pick a partner, you should spend a lot of time testing his or her character.
Start by asking for a reference from a CEO who has lived through less-than-glamorous times with your potential investor. I have heard too many horror stories in which a company missed a quarter or lost a customer, and the venture capitalist started acting irrationally as a result. Ultimately, you want someone with a steady hand who has the experience and temperament to bring a level head to the board room.
Does the venture capitalist understand your stage and industry?
As I mentioned above, many firms are trying to be stage- and industry-agnostic, and to be all things to all people. However, it’s virtually impossible for a venture investor to have an impact on companies across every stage and industry. In my view, those firms end up looking more like asset managers than true value-add partners.
The best investors are the ones who have been laser-focused on a specific stage and/or industry over a long period of time. Those are the folks you want rowing for you. Face it: the challenges a seed-stage company is likely to face are decidedly different from those that expansion- or growth-stage companies are likely to encounter. You need to understand how your firm--and more important, the partner you’ll be working with--has helped other companies at your stage in very specific terms. You want the muscle memory and pattern recognition that comes from fighting the same battle over many years.
Are you a guppy in the ocean?
The amount of money you raise should matter not just to your company, but to your investors, too. Raising $10 million from a $1 billion fund is not likely to yield much attention, nor is it enough to ensure that your interests and those of your investors are aligned. If the venture capitalist thinks that the best-case scenario is that his $10 million will turn into $50 million, his firm is unlikely to dedicate a lot of time or energy to your cause.
On the other hand, if you raise $10 million from a $200 million fund with the same expected outcome of $50 million, you are going to be front and center for that investor. You want to find a fund where the amount of money you are raising is meaningful to the VC, yet not more than 10 percent of the total fund.
What are you really trying to gain from this fundraise?
While there are some entrepreneurs who just want cash, most founders want something more than capital in exchange for their dilution. In practical terms, think about what you really are looking for from this new partner. Is it executive recruiting, customer introductions, economic model guidance, or product strategy?
If it’s any of those things, or some other form of value, then don’t hesitate to ask prospective investors for examples of how they have accomplished similar tasks with existing investments. Then validate their claims with reference calls to CEOs. I would also suggest you ask the venture backer how many boards he or she sits on. Anything beyond eight will make it virtually impossible for him or her to be productive.
Too often, entrepreneurs get caught up in the brand of the venture firm or partner, the valuation, and the speed of the process, and lose sight of the actual goal of the transaction: a partner to help grow the business.
Ultimately, the best advice I can give you is to be very clear on what your objectives are for fundraising and test those objectives with prospective partners. This is likely to be a seven-year partnership, so it’s important to choose wisely.