Why it’s Critical That you Reference Check Your VC

Posted on Dec 14, 2010 | 20 comments

Why it’s Critical That you Reference Check Your VC

I was recently speaking with some founders about their fund raising process.  They had received a term sheet from a VC and were wondering whether to work with this firm.  I personally had three separate data points from entrepreneurs who took money from the firm that said “never again.”


I really try to stay out of the middle of these things so I softly said to the team, “maybe you should contact these companies and see how their experience went?”  From there I figure they can both figure out what to discuss – or not.  One bad comment doesn’t always scare me as there’s often two sides to every situation.  But three from different, independent sources?  Pattern, me thinks.

This experience made me want to dig into my archives, re-write & publish this piece.

I often tell people that raising venture capital is more difficult than getting married.  In marriage if you’re unhappy you can at least get divorced (in most countries).  Not so in venture capital.  You’re tied at the hip to your VC.

And worse still, your VC will have certain controls in the company that don’t make it simply a matter of a “wasted opportunity.”  They’ll likely be influential in future financings, in major economic decisions, in executive hiring / firing, annual business plans & ultimately in M&A discussions.

So my first advice is not to rush in the fund raising process.  Get to know VCs over a long period of time so that when you’re ready to get engaged you feel you know their character.  As in real life – those that rush into marriage often find out what their partner is really like after the fact.  I wrote a post about how to build relationships with VCs over time and about investing in lines & not dots (which cuts both ways).

But what about once you have a term sheet?  How do you then reference check your VC to be sure that you’ve chosen a good firm and partner?

1. Get a reference list –  Most entrepreneurs do almost no reference checks or at least do them very informally.  Don’t let that be you.  Most VC’s will happily supply you with a list of CEO contacts of the people who will speak to you about working with them.  Don’t be afraid to (politely and respectfully) ask for this.  In fact, they will think better of you because you’re demonstrating that you’re the kind of thorough person that they wanted to invest money into in the first place.

2. Don’t stop at the list they give you – This list is the equivalent of the reference list that you’d give your VC (or any other potential employer if you’re interviewing for a job).  What I mean is that this is the “friendly” list.  The one where they HAD BETTER say good things about you because if they don’t then you’re really messed up for not suggesting the right people and calling them in advance to control the process and make sure that they say good things.  Good recruiters never stop at the official list and neither do VCs.

3. Focus on the companies that went through tough times – For some reason most entrepreneurs do.  I always tell entrepreneurs, “if a company only went through good times then for sure they loved their VC.  They made great introductions, they helped you get financed, the put in more money themselves, they helped you strategically and they helped you with your exit.  It’s a two-way love fest.”

But what was the VC like when the chips were down?  When the world was ending?  After Sept 11th?  After Sept 08?  How about when you missed your revenue targets, when your product didn’t ship on time, when your co-founder quit, when you ran out of cash and didn’t have strong options, when Facebook announces that they’re going to compete with you or when Steve Jobs says that your company pisses him off?

Don’t take my advice, take Eric Clapton’s.  Nobody Knows You When You’re Down and Out.

nobody knows you
When you're down and out.
In your pocket, not one penny,
And as for friends, you don't have any.
When you finally get back up on your feet again,
Everybody wants to be your old long-lost friend.
Said it's mighty strange, without a doubt,
Nobody knows you when you're down and out.

Make sure to call the companies in that VCs portfolio that didn’t succeed.  Feel free to ask the VC after they give you the official list for a list of 3 CEO’s where the company stumbled.  Do a web search to find companies that they didn’t give you.  Ask the CEO’s about the VC when the chips were down.  Do research and find some CEO’s who were fired by the VC.  That would be instructive.  I’ve met some that actually say positive things about the VCs.  I’ve heard others that say the opposite.  You’ll have to sort though how much is sour grapes versus reality but … wouldn’t you rather have all data points?

Some VC’s will go out of their way to give you all their references as Fred Wilson says in his post

Encourage the entrepreneur to get feedback on you and your firm. Instead of references, I like to give a list of every entrepreneur I’ve ever worked with and an email address. I tell them “throw a dart at that list and talk to four or five of them randomly. you’ll hear the same thing from everyone.”

I’m the same.  I list all of the companies (except one in stealth) on my blog and this includes both VC investments and angel ones.  I play open book.  I’ve had to have hard conversations with entrepreneurs when things aren’t going well.  But I think most would tell you that in tough times I tend to roll up my sleeves rather than head for the door.  When companies have been in a vulnerable position I haven’t taken advantage of the situation.

These are the circumstances that will never be written about publicly by me or other other venture capitalist.  But they’re the ones you can find out with reference checks.

4. It’s the partner, not the firm – Firms have brands but brands don’t attend board meetings – partners do.  And in each firm you have partners who are different.  It’s true that “institution” VCs do get value out of the partnership and not just the specific partner but at the end of the day, you still have the one person you’re going to work with.

You’ll want to know:

  • How knowledgeable / active is the partner in your specific space? (obvious)
  • How much political capital does the partner have to get deals through?
  • How willing is the partner to fight for you in tough times?  They will be in a partners meeting one day as your advocate.  Or not.
  • Are they an egg breaker or are NINAs? I only like to work with egg breakers?
  • How well do they play with the other kids in the sand box?  You’re going to build a board and you want people who can work well together
  • Are they willing / able to roll up their sleeves and help you?

5. There are online resources that can help – One small hack – go to LinkedIn and do a search for the company name.  You’d be surprised how many ex-founders and ex-CEO’s you can find this way.  Often ones that you didn’t know even existed.  Obviously TheFunded.com has a lot of proprietary information that’s worth reading.  Some of it you have to take with a grain of salt because it does skew toward the people who are more bitter about their experiences.  That said, it’s worth reading & processing.  And don’t rule out reading their Tweet stream (which is public) and finding out whom they’re connected to.  This can be a great source for reference checking.

Happy reference checking.

  • http://sisyph.us/ ErikSchwartz

    Awesome post. I made this mistake. Some money is not worth taking.

  • http://twitter.com/bjornhendricks Bjorn Hendricks

    Very good info Mark. Due diligence is important in all decisions of that caliber. It's not just about the money, it's about the accompanying relationship.

  • http://bothsidesofthetable.com msuster

    and in this case it's worse because the money comes with certain control. so you don't want to get it wrong.

  • Jason M. Lempkin

    To add to #4 bullet 2, I'd suggest that wherever possible, never ever take $$$ from a partner who doesn't have enough juice to do a tough follow-on round on his/her own. Most don't, even if they have partner in their name and have invested in a few cool companies. Doesn't matter how cool, smart or tunedin, or even pro-entrepeneur they are, if they can't actually help you.

  • http://weebehave.com Travis Ryan

    This is becoming a habit. Nice post.

  • http://bothsidesofthetable.com msuster

    True, that.

  • Russ Dollinger

    These are great. I assume you have thought of creating a collection of these in a book form. Let me know if I can help.

  • http://twitter.com/a0k Lexie

    I was just thinking that a book of these would be so useful. This is hard to remember wisdom and so important.

  • http://jaycaplan.wordpress.com Jay Caplan

    Besides CEO's and founders, you can also ping CFO's and CTO's (aka VP R&D) for useful references.
    I think it's the partner AND the firm. I have known some good partners who ended up leaving their not-as-good firms. In that case, the new director can be an issue.

  • http://twitter.com/ColinHayhurst Colin Hayhurst

    It's all about people again: Just as a VC will look at the entrepreneurs they are investing in so the entrepreneurs should look at the VC.

    Much of what you suggest should be applied in the case of angel investors too.

  • http://www.victusspiritus.com/ Mark Essel

    It's not hard for me to imagine circumstances where bad money is better than alternatives. If it's bad money or no money, what would you choose?

  • http://www.VentureDeal.com Don Jones | VentureDeal

    http://www.VentureDeal.com is a venture capital database where you can learn the investment history of individual partners…and not just the investments they list in their profile on their firm's website.

  • http://sisyph.us/ ErikSchwartz

    Bad money vs no money is rarely the choice except at a specific point in time. Given the choice between bad money and keep on bootstrapping for another 6 months, I'll keep bootstrapping.

    The problem with a bad investor is you cannot ever get rid of them. They also make it harder to raise the next round because no one wants to work with them.

  • http://bothsidesofthetable.com msuster

    great point

  • http://bothsidesofthetable.com msuster

    Thanks for adding the link to this useful resource

  • http://www.victusspiritus.com/ Mark Essel

    That rationale makes perfect sense to me, even if bootstrapping means working anywhere during the day to survive while working on your dream at nights.

  • http://hirethoughts.blogspot.com Donna Brewington White

    More and more, in interviewing and checking references in the recruiting process, I'm focusing on how a person has responded to failure. It really does tell you what you are dealing with. But, significantly, it's what the person has learned from failure that counts.

    How do you find out what a VC has learned from handling a situation poorly? Does the entrepreneur write off the VC based on a bad report, or is there a way to go back to the VC and talk this through?

  • http://hirethoughts.blogspot.com Donna Brewington White

    Wow, Erik, that's an important point — that choosing the wrong investor can actually deter future investors. I wonder how many entrepreneurs are aware of that factor?

  • Jon Callaghan

    Great post Mark! Seems we are both on the same theme of “choose your partners wisely.”

  • Jim Hayward

    It's great advice. There is a major problem. The assumption is that the entrepreneur has the luxury of picking and choosing. He doesn't. The typical VC firm looks at 40 to 50 deals before picking one to back.

    The other reality is that typically VCs are fair weather friends.And can be really ugly when things don`t work out as planned. Many funds describe entrepreneur forecasts as `promises`and you better not break your promise!!!

    The other reality is that the success ratio of VC investors is poor. In Canada, the returns of the entire industry over both the last 5 and ten years have been negative. In the US over the past 5 years, have also have been negative.

    VC money has dried up – except for the big winners and they all live in Palo Alto.

    VenGrowth are the biggest and oldest VC company in Canada. They have invested well over $1 billion of investor's money over the past 20 years.

    As you know, the Globe publishes each week the best 20 performing funds and the worst 20 out of the many hundred Canadian mutual funds. Just in case you missed it, in the summary of Fund Performance in the Nov.27 Globe, the three of the worst four of all the funds in Canada were VenGrowth II, Covington New Gen Biotech and Vengrowth Advanced Life Sciences with 5 year annualized returns of -19.9%, -16.3% and -12.8% respectively. Vengrowth also have the 8th worst performer with annualized losses of only -10.9%.

    I am sure you can do the math. Thery have lost 69%, 59%, 50% and 44% of their invested capital respectively over the past five years.Last month, VenGrowth announced they were selling the residue to Covington – The second biggest loser. The compensation to the VenGrowth partners is estimated to be $20 million.

    As an entrepreneur, getting money from a VC firm looks like the kiss of death. From the iinvestor`s perspective, it has been like throwing money down a black hole.

    It`s a long and sorry story and the article you sent on really misses most of the important issues.