Entrepreneurs Don't Do Enough Diligence On Their Investors

businessinsider

“Think of him as chewing gum. By the end of the game, I want you to know what flavor he is.”

— Coach Norman Dale (Gene Hackman), Hoosiers

Entrepreneurs don’t do enough diligence on their investors.

As venture investors, we do a lot of diligence on you.

We call references, both on and off your reference sheet.

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In our partnership discussion, we talk about your strengths and weaknesses, your character, your ability to grow the business, your idiosyncrasies, whether you will want to sell too early, your willingness to take feedback, and everything else under the sun.

We are making a bet on you just as much as (or more than) we are betting on your idea.

As an entrepreneur, you should conduct an equivalent amount of diligence on your investors, but few entrepreneurs do. My experience has been that most entrepreneurs base their decision on one factor well above all others: price. Choosing an investor based on price is like picking a wife based on looks.

It seems like a good idea for the first six months until you hit a bump in the road and figure out you optimized for the wrong factor. I am not saying price isn’t important; it’s just not all-important.

Choosing an investor based on price is like picking a wife based on looks. It seems like a good idea for the first six months until you hit a bump in the road and figure out you optimized for the wrong factor.

The obvious caveat is that often entrepreneurs don’t have a choice in choosing their investor partners. Assuming the choice is there, below are seven tips/questions to help you think about your diligence.

1. Call references.
If you are deciding whether to accept an investor’s money, you can ask for intros to the CEOs that the investor works with most closely. Good investors often volunteer this information. Even better, find references you trust.

Talking with someone who will give you the straight scoop is much more valuable than asking questions of someone you don’t know and who is likely more beholden to the investor. Check out LinkedIn and Facebook for mutual contacts.

2. Ask the tough questions.
Don’t do perfunctory reference calls. Ask if that CEO would take the investor’s money again. Ask about strengths and weaknesses. Ask about how that investor reacts when times are tough. Ask if the CEO calls that investor when he or she is dealing with an important issue.

3. What did you learn through the negotiating process?
Your best indication of how you will interact with your investor during a more stressful time is the negotiation you just had. Maybe you didn’t get all the terms you wanted, but was the investor honest and up front? Did you feel good about the process? Was he or she responsive?

4. Think about the next round of funding.
If you are still an early-stage company, make sure you are setting yourself up for success down the road. What is the investor’s role in the firm? Is he or she respected among other investors outside that firm? Is there additional capital reserved for your company and how much?

5. What’s the track record?
By track record, I mean more than past successful investments. How has the investor responded in the tough situations that inevitably crop up in startups? Does this investor hop off boards the first sign of trouble? Does the investor attend board meetings in-person or phone it in?

6. Do you like him/her?
You may be spending 10 or more years with this person. Divorcing your spouse is easier than getting rid of a large investor, so don’t jump in willy-nilly. Do you respect this person? Would you enjoy talking to him or her over a beer? Try it out before the investment is closed.

7. Do you trust him/her?
Trust is the most important element of a successful relationship between entrepreneur and investor. Listen to your gut based on what you’ve heard and experienced. Prioritize trust over a couple pennies on valuation.

This article originally appeared on businessinsider

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