How Much Information Should you Give VCs for Due Diligence?

Posted on Aug 27, 2012 | 32 comments


This is a hot topic I’ve been asked a lot about recently.

  • You’re on a first date with a VC – how much should you tell them?
  • You’re heading into a full partner meeting and you’ve been asked for a full data pack before – should you give it?
  • When is it appropriate for a VC to call your customers?

There is no universal answer and my discussions with various VCs on these topics have yielded many differing opinions. Having been on both sides of this sensitive topic, the following is my personal advice.

The First Meeting
I have seen some entrepreneurs go into first meetings willing to share almost anything about their company. I have seen others who seem guarded and cloaked about what they’re working on. There is certainly a delicate balance between these two extremes.

I often caution entrepreneurs about seeing too many VCs when you’re beginning your fund raising process both because information tends to leak and because if you see too many people who talk with each other you’ll soon have whispers amongst all of the VCs who “passed on you” and your deal will seem over-shopped and lacking in momentum.

On the other hand, if you’re in a meeting with a VC and you’re overly guarded it will be an immediate turn off and it begs the question of why you’re even talking with VCs in the first place. I’ve seen this back fire on entrepreneurs who say things like,

“Well, we’re not talking financials with investors yet.”
“Why not?”
“We’re not really fund raising yet so I’m not prepared to have that discussion.”
“So why are we here?” (which really means, are you really so naïve as to have a discussion with a VC and you’re worried about sharing your high-level financial results and forecasts?)

The best advice I could give you for first meetings is that you should have a limited number of discussions until you’re pretty sure that you’re likely to have positive results in fund raising and you should be open in the meetings that you do have. There’s no sense in having an investor meetings and turning them off (permanently) in the first meeting.

But you can engage in a serious discussion about your business while keeping your financial projections high level and not immediately talking about your most sensitive plans. There is nothing in revealing your past performance that should impact your ability to execute going forward so that’s not an area to be sensitive in my opinion.

The main thing to guard is an strategy direction in your future that you feel is proprietary. Since the game of competing is always “where the puck is going” you can have a detailed conversation without completely letting on what your future strategy will be.

Don’t mention that you have strategic initiatives that you can’t talk about. You’ll just sound cagey. Simply don’t bring them up. Don’t allude to them.

Now, I’m not saying you shouldn’t share any strategy with potential investors. That would be dumb and you would sound unplanned and uninteresting. I’m simply saying that if YOU feel there is a certain part of your strategy that you feel sensitive about – don’t mention it.

If you show a list of key customers or key business partners and if this list is sensitive (READ: If you don’t want VCs calling them) then you need to make it explicit with the VCs.

I personally believe it is appropriate to say

“We are sharing with you our list of key customers / biz dev partners. Obviously if we continue in discussions with you we would be more than happy to organize reference calls for you to validate our success.

PLEASE do not call and enquire about us without checking with us first. These relationships are sensitive and we don’t want to bombard them with unplanned VC calls.”

Please know that of all of the areas that VCs are poorly behaved this is the number one area. It drives me freaking bonkers.

When I was raising money I pitched to several VCs. I instructed each one as above. I specifically asked them not to call Salesforce.com – my largest customer. They knew I was fund raising but I didn’t want to annoy them with unnecessary calls.

One VC (I won’t name but with whom I still won’t work  today) called Marc Benioff directly. They somehow figured I wouldn’t find out. What did he do? He forwarded an annoyed email to my main contact at Salesforce. He contacted me annoyed that I was encouraging people to contact Marc. Shit rolls downhill.

Another VC called the co-founder & tech head – Parker Harris. Another called one of the top biz dev guys.  So I have taken to recommending to some of my portfolio companies a small addition to my statement above to say, very casually

“Obviously if we did get feedback VC calls were being made it would affect our decision of which VC we would likely work with.”

But very few companies can get away with this. It’s certainly hard in the A round when you’re scrapping to get your first institutional dollar. It’s easier when you have traction and a competitive process for your funding is likely. So if you add the addendum use it wisely and carefully.

And I should tell you that some VCs with whom I’ve debated this topic think it’s always fair play to call your friends at Facebook, Google, Salesforce or wherever to get feedback on you early. Summarizing their feedback?

“If you’re not ready for that kind of scrutiny you’re not ready for fund raising and wait until you are.”

I’ve had to politely agree to disagree.

Follow Up Engagement

By the time a partner shows you some interest and has take 2 or more meetings they are probably beginning to ask you for more information. It is always appropriate for a VC to ask you for your past 12-month financial performance and your going forward forecasts. Quoting my friend above, “if you’re not ready for that, you’re not ready for funding.”

If you like the partner and imagine you could work with them then I would slowly reveal more of your strategy and ask them to debate it with you. Nothing tells you more about whether they would be good to work with then hearing how they debate your strategy. After all, one of the most important roles of a VC is as a sparring partner.

I often coach that this period is often when you can engender great confidence from the partner. If they ask you for a certain type of analysis (cohort analysis, margin analysis, competitive assessment, whatever) it’s a chance for you to turn it around quickly and do a thorough job in answering their question and with professionally produced materials. It’s the best way to give them confidence that you’d be a good partner to work with.

There are some partners that after the first meeting ask for belt-and-braces document exchange. They want to see your cap table, your legal documents, your major contracts, your full financial model, etc.

In my opinion that is totally old school. There is no reason to part with your cap table or legal docs until you’re convinced that they’re actually committed to doing work with you in due diligence. The only real benefit of their having this information is in preparation for a term sheet. They can get at the most important information early on by simply asking you :

  • How much of the company do the founders own?
  • Have you invested money directly?
  • What was the post money on the last round and how much did you raise?

Fair questions, all.

The Partners Meeting

Going into a partners’ meeting you want to know whether your lead partner is really a champion or not. They ought to be preparing you for the kind of meeting you’d expect. They ought to outline who will be in the meeting and what their likely responses will be. Any great champion would do that for you if you’ve spent tons of time helping them get up to speed on the opportunity.

And if they do seem like they’re championing you and are engaged, I would certainly allow them to make some careful calls into customers or partners. This not only helps them to be more bought into the opportunity but it also provides them necessary ammunition to lobby their partners before and after your meeting.

It would not be uncommon for partners to ask after you’ve left the full partner meeting, “have you spoken with any customers? What did they say? What competitive products did they consider? Why did they select company X, etc.”

Heading into a Term Sheet – Final Due Diligence

Obviously once a partner seems inclined to work on a term sheet you can expect a proctology exam and this gets even more intrusive after the term sheet. Here you need to line up customers calls, discuss all future strategic plans, redo the financial model if they felt it wasn’t complete and so forth.

Make sure to disclose anything major that you believe would seem disingenuous to tell the after the term sheet. You’d be surprised the stuff that comes up:

  • Major lawsuits
  • Founder friction / departures
  • People who were convicted of felonies
  • Major firings from previous companies (as in a reference call that isn’t going to go well)
  • etc

All of these things – major disclosures – are overcomeable if disclosed at the right time and the right way (Obviously circumstances matter, too. For example, a felony for financial fraud and I can assure you that you won’t raise VC under any circumstance.)

I always tell people, you need to disclose to champions before they ask for final approval because they can’t go back after they get approval and say, “oh, and one more thing.” They’d sooner drop you than tell their partners that they found about a major mishap AFTER they submitted a term sheet.

Dealing with VCs can be a time consuming and trying process. If managed correctly you can limit the downside while picking up a lot of new relationships that can benefit you in your future. In my next post I’ll discuss some of the techniques I’ve used to also make sure I was getting back from the VCs with whom I was speaking.

What have been your experiences? Any tips to pass along? Or war stories to share?

  • http://www.binpress.com/ Eran Galperin

    Hi Mark,

    Great article and very relevant for us right now as we’re starting to organize a round.

    The question that always bothers me is whether its a good idea to reveal initially how much money we put out of our own pocket to bootstrap the startup. The number is substantial and might be considered a seed round for other ventures, so I’m wondering how investors look at it –

    A. It’s a good sign that the founders are this invested in the project
    OR
    B. They haven’t made that much progress with this amount already put in. Are they going to do better with the money they’re asking from me?

    It could also be a combination of those, naturally. I’m interesting in hearing your thoughts when you hear the founders already have substantially money (relatively) in the startup.

  • http://twitter.com/brandwinn Brand Winnie

    Great post Mark! These tips will come in handy down the funding trail.

  • Matthew Bellows

    Great advice on a difficult and important topic. In general, the downside of being closed/cagey/paranoid (not getting funded) is worse that the possible benefits of not revealing a secret or of annoying a customer. Your mileage may vary.

    But the key quote from above is “If you like the partner and imagine you could work with them then…”

    It’s not possible to overstate how crucial this is, especially for salespeople-turned-entrepreneurs. Raising VC is not like selling a product. You can’t pass them off to Account Management afterwards. These people will be a major part of your life for the next 5 to 10 years.

    As important as the first term sheet is, you should absolutely, politely, decline to get more involved with any investor who you would hate working with. Slow playing the requests for more information is an easy way to do this, but the direct (polite!) route is sometimes necessary.

    Life is too short and your business is too important to saddle it with a terrible relationship.

  • http://arnoldwaldstein.com/ awaldstein

    Surprised about one thing.

    Sure there are VC and people generally who just do what they want, such as call your customers when you ask them not to.

    I would think that this gets around and unless they are the only or the best money in town, who really wants to work with them. Due diligence goes both ways,

    Seems like a trust break and at any stage of the relationship is just a bad thing.

  • edzimmerman

    Bad news isn’t wine, it does not improve with age. There’s a huge pause point when your sponsor or deal champion at the fund is socializing the deal with her colleagues before the partner meeting. One good test for founders is to try to put yourself in the shoes of your sponsor at the fund and ask whether she is going to need to go back to her colleagues and say “hey, I either didn’t do my homework or the founder didn’t have great judgment about what and when to make disclosure but here’s something we need to consider before we invest…” Investors will feel embarrassed and burned if they receive material bad news after they’ve greenlighted a deal. As an angel who has championed deals and brought others into a syndicate, I certainly am sensitive to having egg on my face because it looks like I wasn’t thorough or the founder didn’t trust me enough to share potentially off-putting news. Sure, as angels we can ask the really hard questions, but we worry about giving off a bad vibe and our own reputations. My view, as an angel, is that the founder should be forthcoming about negative info rather than waiting for me to ferret it out. How would you feel as a founder if, as an angel about to make a small investment and bring in a bunch of my friends, I asked you whether you had declared bankruptcy or been convicted of a crime? I think that burden should fall on the person with that in his or her past. Of course that is something the lawyers will need to tackle in legal diligence, which comes after there’s a signed a term sheet but I’d argue that is way too late to first be learning about those two types of disclosure.

    There’s a pause point before you sign the term sheet and again before the company sends the investors the first draft of the disclosure schedules. The disclosure schedules get attached to the purchase agreement and modify the representations and warranties in the purchase agreement. For instance, “there’s no litigation except the matters listed on schedule 3.7.” If there’s anything embarrassing (criminal, bankruptcy, resume inaccuracies) those usually get disclosed before the schedules go out either in a call or face to face – you don’t really want your investor to read about the fact that you went bankrupt, tell her in real time. The diligence process is an important prelude to setting the tone for a relationship in which bad news will inevitably get shared (even at great companies), usually in both directions. Set the tone for honesty and openness earlier. This also holds true for personal things (a dissolving marriage could, for instance, impact your whereabouts during the day and your focus at work; it could also impact stock ownership, and it has).

    It is important to know that you will be held to the standard of having needed to disclose anything a reasonably prudent investor should have known before she made the investment decision. This standard requires foresight and judgment, the kind of judgment that only comes from having considered these decisions and then lived with the results…for years and years. If you’re uncertain but think that disclosure might be necessary, run it by someone who has put a ton of miles on the odometer in these types of deals, there’s no substitute for experience in terms of whether, how and when to make the disclosure.

    As Mark’s post indicates, people don’t forget it when you’ve breached propriety in diligence, whether it was contacting people when you were asked not to do so or whether you shaded something the wrong way or exercised poor judgment about what and when to disclose. As a lawyer representing numerous venture funds, I’ve certainly spent time with clients noodling through whether I thought the founder who had messed up the timing, tone or decision to disclose was simply inexperienced and getting bad guidance or was not forthcoming. The first of those two categories can be a problem and requires fixing and the second can be worse. I’ve also spent way more time counseling founders on whether, how and when to disclose. It is I rant to note that lawyers shouldn’t just have a knee-jerk reaction saying “disclose everything” (I’m not suggesting that you hide pending lawsuits or felony convictions, but I’m not sure, for instance, that it is a good use of time and paper to disclose speeding tickets…that you paid; having been fired for cause may end up in that middle category where the reasons and timing may well be important).

    While the odds of a bad outcome (the thing to be disclosed may never come to fruition) may be low, the odds of the investor finding out either not from the founder or after the closing can turn an honest mistake into a failure to properly respect a relationship. These can be pretty subtle judgment calls more susceptible to being talked through than to a 5 Simple Rules approach.

  • MHSzymczyk

    Mark – great post as always. I think an additional point to make is how much ‘technical’ information on your product/technology you share in a meeting as well. This is where the NDA issue comes into play and I wonder where this could be leveraged for startups vs. VC’s.

    We had a meeting with a VC in October 2011. At the time, we thought it was unusual for the amount of information the VC was asking about – detailed information on how our technology worked, detailed information on our clients and so on. We never heard back from that specific VC but then saw that they had participated in a seed round with one of our competitors. To make matters worse, this competitor was clearly infringing our IP and the VC was aware of that during the meeting. The VC had invested in this competitor 2 weeks after the meeting we had and had proactively called us in the first place, so I’m assuming this meeting was used as competitive info gathering on an investment they were thinking of making.
    With all that said, it’s hard to spot when a VC is generally interested or just pumping you for information. That might also make a great blog post in the future as I have a feeling this occurs more often than discussed. It might help first time entrepreneurs to know what signals to watch for to avoid this.
    Matt

  • http://www.facebook.com/andrewbackerman Andrew Ackerman

    Very interesting post. Want to follow up on one point: customer calls.

    It feels like your post is written with B2B startups in mind. If you are a B2C startup, it would seem pretty odd to your customer to get a call from a VC. And yet the VC still needs to answer the underlying question: how does the market perceive this product?

    How do VCs handle this when looking at B2C startups?

  • http://bothsidesofthetable.com msuster

    It’s a great thing. It shows commitment.

  • http://bothsidesofthetable.com msuster

    “Raising VC is not like selling a product. You can’t pass them off to Account Management afterwards.” Classic.

    Or as I like to say, “raising money is harder than marriage. at least if you fall out of love you can get divorced.”

  • http://bothsidesofthetable.com msuster

    All I’m going to say is that it’s common practice. And I’m surprised there isn’t more entrepreneur transparency about this issue.

  • http://bothsidesofthetable.com msuster

    Perfectly written and agree totally.

    Key line for others to remember
    “Investors will feel embarrassed and burned if they receive material bad news after they’ve greenlighted a deal.”

    You don’t have to tell them you snore on the first date, but you do need to tell them before they’re committed.

  • http://bothsidesofthetable.com msuster

    I understand your concern. I think the case you point out really is an exception and rarely happens as overtly as you describe. Frankly, most VCs are unable to understand the deep technical information you provide ;-)

  • http://bothsidesofthetable.com msuster

    The reason I said “customer calls or biz dev calls” is that the latter is more likely in the case of a B2C company.

    re: how to judge how the market perceived B2C? Much easier. There ought to be tons of data to demonstrate this through engagement data.

  • http://www.justanentrepreneur.com Philip Sugar

    Spot on: I’ll address the address the call issue as I’ve had experiences there.

    First, I would be very, very clear that if an associate makes a customer call at any time that will kill the deal. I have nothing against associates, but when you are trying to make a name for yourself you don’t go: Yup that call went great. You try and dig and pick more than you should (same goes for legal associates). Remember the first rule of sales: once you have the sale stop selling, anything you say afterwords can only screw up the deal. You are getting somebody to say a bunch afterwords to your most important asset.

    Second, I agree any customer you bring up no matter what you say will be game. We in the history of our business had lost one customer and it was a complicated political issue. Their was some bitterness on our end and we assumed theirs as well. We disclosed the lost customer, made the VC promise not to call. Literally the second he got off the phone with the former customer, the former customer called to tell me what a great reference he gave. I guess the best thing about that was I learned they weren’t bitter, they knew we got screwed, and thought they made it up a little. I felt betrayed.

  • http://influitive.com/ Abdallah Al-Hakim

    a very good and detailed post about how to engage with VCs. The bottom line is that you should do it when you are ready for scrutiny and always do your homework on the VCs you are planning to meet. The rest will just improve via experience and by reading useful blogs such as this one :)

  • Richard Rosen

    Re: calling B2B customers. I would not want my customers discovering a fund raise via AngelList or TechCrunch. They need to hear this from me. While I would not want an “unannounced” call, I would also not hide the intention to fund raise from a major client.

  • http://twitter.com/chriskbrown Christopher Brown

    There’s an interesting thread on Quora now about lawyers asking for full access to a company’s email in diligence. http://www.quora.com/Due-Diligence/Is-it-normal-for-the-investors-lawyers-to-request-full-access-to-the-founders-email-in-a-due-diligence

  • James Neville

    I would of thought the whole point of a VC laughing at a founders request to sign an NDA is that they are offering implicit trust that what is shared in a meeting won’t leave the room. Why should a founder have to be guarded in a meeting if they can trust you?

    Due to the VC math being totally hits driven are we to believe that an investor who doesn’t get to invest in a round they wanted in on will keep their mouth shut to their portfolio companies and/or potential investments?

  • http://dissertationmonster.co.uk/ dissertations

    As important as the first term sheet is, you should absolutely, politely, decline to get more involved with any investor who you would hate working with.

  • http://bothsidesofthetable.com msuster

    Great input. I agree that VCs can have bad behavior on calls even when asked not to.

    Some additional thoughts:
    – on reference calls I always ask for permission. I try to divide the calls. I ask which the most “sensitive” calls are and I make those. re: associates – they are smart & disciplined and frankly sometimes we WANT the critical eye in our due diligence. That’s our job – to invest knowing the risks- I would also say that I’ve had some references call companies I was looking at and say “I gave you a great reference” and we didn’t perceive it that way. They may have been a cheerleader, but that’s not the same as a great reference.

  • http://bothsidesofthetable.com msuster

    Agreed. The challenge is when you see 5 funds and they all call the same people! And you don’t want VCs with whom you’re unlikely to work making those calls.

  • http://bothsidesofthetable.com msuster

    Wow. That’s unreal. Thanks for pointing out. I wrote a response: http://b.qr.ae/RmymFD

  • http://bothsidesofthetable.com msuster

    Most VCs are well behaved most of the time. Still, a degree of discretion is advised until you’re in deeper discussions. Same goes with biz dev deals with big enterprise customers. Even when unintentional, details have a pay of leaking out.

  • http://bothsidesofthetable.com msuster

    Amen.

  • http://www.justanentrepreneur.com Philip Sugar

    Agree on all points except the associates.

    When a VC calls a customer that is a really sensitive moment. Issues like competition and product holes have to be approached very sensitively or you can quickly unsell the customer.

    The customer is already on high alert because they have to be concerned if the round doesn’t go through the company will run out of money Associates are great to examine the market, but I am putting the company jewels in your hands.

    Yes like interviews people will say they gave a great reference when really what they did is just not bad mouth you.

    I’ll give the specifics in our case since it is always interesting. In this case we were providing software that interacted with slot machines. The state technically owned the slot machines and would pay for slot machines but not the software. One vendor figured out how to get a sweetheart deal on the slots and would build and give away the software. It was an inside deal like many that happened in that administration. Sucked for us, we accepted cancellation graciously, but were bitter.

    Turns out what we were doing was not nearly as trivial as they thought and they couldn’t get it done in time. The CIO wanted to extend our contract month to month. There was talk of letting him twist in the wind (every one of their customers would be affected) , but I said ok, full price, month to month premium, strict payment terms. It was a lot more than they were paying under a great deal we had given them. He went ballistic, about the most polite thing he said was I was twisting his arm at the top of his lungs. Not caring is a powerful position, and I didn’t care. They finally got it done 18 months later.

    I really didn’t want to dredge that shit up. We did close the deal, but it did permanently affect our relationship.

  • http://www.facebook.com/fdemmler Frank Demmler

    Great post!
    Regarding the number of VCs to contact, i advise no more then 3. Managing 3 high stress, quick turnaround relationships is more than enough.
    As to how much and what information to share, several thoughts come to mind:
    • Tell the truth, but you don’t have to tell the whole truth. Strategize as to when certain information can be shared and what context needs to be in place before such information can be understood correctly (as you want it understood).
    • Related, where you’ve got vulnerabilities or weaknesses, try to put them on the table and defuse them as soon as possible. VCs don’t like bad news that they believe they should have had before they actually got it.
    • All through the interaction with a VC, you’re going through a series of forks in the road. One fork is, No!” and the other is “Maybe.” Provide enough information to get that “Maybe” each time.

  • Greg_Gottsacker

    Good article. I think there is something similar between this and selling a business.

    When selling, after the suitor signs a non-disclosure agreement, we recommend providing a potential buyer with three years plus year to date recast income statements and a recast of the last balance sheet. Additionally, we recommend providing a seller’s disclosure statement that describes the particulars of the business without revealing the names of customers, vendors, employees or trade secrets.

    Suitors are then encouraged to make an offer with contingencies that the seller will provide full financial statements, etc., after the offer is accepted and due diligence begins. We do not offer the customer, vendor or employee lists until the deal closes, because if the deal falls through and the suitor is well capitalized, there is nothing preventing them from setting up shop and using your confidential trade secrets against you.

    A VC is buying into your business and they do need a reasonable amount of information to make their investment decision. There is also good reason to take some precautionary measures to protect your trade secrets until you know there is funding secured from that particular VC.

  • James Neville

    It is amazing to me that secret information can be passed from a confidential meeting and it is swept under the rug as “unintentional”. Atrocious behaviour. What good is it to say “sorry i let slip your trade secrets but it was unintentional”. The pendulum has swung too far to the “you can trust us” side when in reality you can’t.

  • Jeff T.

    re: how much of your own money have you invested? I’ve started a business and raised friends and family money about a year ago. Since then I haven’t paid myself, only my employees, admin/legal/etc.

    Should I consider my time an investment in the company, or living costs, or an hourly rate * x? I think this fact is important, and shows commitment, but should I, and how would you, quantify it?

  • Howard L Morgan

    Great post. If it’s consumer, make sure you and your colleagues try the product. Engagement data is important, but we always try to see if we can use it if it’s B2C.

  • http://imobilerescue.com/ iMobileRescue Inc

    Good thing to talk about – I’ve been thinking about this. Do we tell the investor everything? Etc. – My company (iMR) went to talk to an Angel a few months back. We told him the bulk of it, but as you said, left out some of the details we weren’t comfortable talking about. Intriguing read.

  • adam smith