One of those most difficult things for a VC to do is to pull out of a seemingly attractive investment. What’s even worse though is pursuing an investment longer than you should have, only finding out later it was all a waste of time. But the worst thing of all is missing out on a great investment.
And that’s where this article comes in – we want to arm you with a set of questions you can (and probably should) ask ahead of every investment opportunity. They'll allow you to start discarding those investments that won’t work and diving deeper into those that might pay off spectacularly.
It doesn’t mean you can avoid proper legal and financial due diligence – you can’t. An effective VC valuation method means investing armed with the facts and having those facts independently verified. It’s easy to be temporarily blinded by great narratives and sales pitches, but a thorough due diligence process will remove any smokes and mirrors.
The due diligence involves detailed checklists, lawyers, accountants, industry experts, financial projections and much, much more. It also typically comes a little later down the road than the initial questions a VC needs to ask themselves before considering an opportunity.
So, before you take that first step, here are some questions you can ask yourself before deciding on pursuing a deal.
Does anyone want what they’re selling?
The top reason startups fail is quite simple – they make products nobody wants. A survey by Forbes found that 42% of startups identified the ‘’lack of market need for their product’ as the biggest factor in their failure.
While a fancy new gadget or product may solve a problem for a niche audience (often the niche that the founders themselves would fit neatly into) if there is no evidence it would be desirable at scale, then the investment ends right here.
Is there more than one voice at the top table?
There's a lot of reasons startups fail - although sometimes the answer lies at the very top
Occasionally – very occasionally – a fully formed idea is released into the world. An individual has a lightbulb moment, creates something they can sell, and the world loves it. More often though, that first idea is half-baked at best, and often well past its expiry date.
Great ideas need questioning. They need to be probed, prodded, encouraged, changed, reiterated and believed in, all at once. When there is a single co-founder or single voice at the top, these ideas can too often go unchallenged.
If you are looking to invest in a start-up, lean towards those with a diversity of voices at the top.
Does the investment fit your philosophy?
Corporate philosophies can look great on the page (and even better on a fancy sign outside your HQ) but can quickly become something to hide when potential profits are on the table. When sourcing dealflow, investment opportunities will come along that is outside your comfort zone in a multitude of ways – including ethical concerns.
It’s all too easy to weigh up the factors and conclude ‘yes, but the money’ and dive into an investment, but that decision has to be balanced against your long-term strategy. If one of your aims is to attract great talent, will this investment hurt that? If you're investing in a sector or location you’re not familiar with, are you underestimating the challenges? Will, it set up competing factions within your own company?
While a philosophy looks great on a page, its real effectiveness is cutting out unnecessary work and giving the company focus.
Do you know who the founders are, really?
Getting to know the founders of the business is crucial when deciding whether to invest or not
People can make great first impressions, especially when you’ve got a large wad of cash and are considering investing in their business. There is also a tendency to want to have a favourable impression of the founders, and then change the facts to fit this desire.
So, doing your due diligence on the people running the company is just as important as the company accounts. There are the obvious points of reference - are they second time founders, ex-big tech talents etc.? Then simple techniques (but often skipped over) like simple Google searches or looking at websites such as Glassdoor (allowing for a certain number of disgruntled ex-employees), to accessing your network to find mutual connections, will give you an array of information on people before deciding to invest in them.
Do they care who you are?
The opposite is also the case – they should want to know who you are. Watching how they carry out their due diligence on you can be very insightful. If they are purely looking at you in terms of the monetary size of your investment, and not what extra value you can bring to the table, they may have their eyes on the wrong prize.
Have you asked their customers?
Depending on the stage that the start-up is at, there may be a wealth of customer data and feedback available to you.
What type of customers they will be will often be dependent on where the company is - are they a seed-stage company with some early adopters using the platform for free (or using a community-led approach) or are they at the series A stage with some early paying customers or even have some good traction and are generating MRR/ARR (Monthly Recurring Revenue/Annual Recurring Revenue)?
No matter the breakdown and type of customer, if the company has fundamental issues, that will manifest themselves in the customer experience; it just takes skill to connect the two. Beyond that, talking to people you know and telling them about your potential investment and whether it would solve any problems for them is another avenue to pursue.
A question of risk
Investing is inherently a game of risk management, and every VC valuation method will have its strengths and weaknesses. By reducing risks on one half of the ledger though, and then leveraging risk for returns on the other side, a VC will have a long and healthy balance sheet. However, to successfully do this over time requires more than instinct; it requires a process to follow that will remove bias and focus on facts.
By asking these simple questions, every time, you’ll be able to stop spending mental energy (and financial expenses) on unworthy investments, getting you to that next great deal quicker than the competition.