Over the last few weeks I’ve had the very cool opportunities to give a University lecture and write an OpEd piece for an Aussie magazine, on the topic of raising capital. This has had me thinking about how to even concentrate this vast topic into some key points….but I’ll attempt to write a blog post about that later. But last night, I fielded a Q&A post lecture at the University of Newcastle and a couple things seemed to resonate in particular with the audience 1) questions you should ask VC’s when you are capital raising; and 2) debunking a few myths about capital raising, and I thought they might be worth sharing. Today, a few musings about number 1 (although I recognise this topic has been done, but the questions last night made me realise it probably needs to be said again).
But, let me first say that I’m totally aware that writing posts like this come across like “we are sooooo self aware and confident in our ability to answer these questions that we are happy to share them” and “we are suuuuch great guys and gals its simply our duty to pull back the curtain and share it with the masses ”…its basically a humblebrag, which makes me sound like a asshole. But hopefully I can be a useful asshole.
1. How big is your fund, and how much money do you have left to invest in your fund?
This is a crucial question because it will tell you straight away if the VC is just taking a meeting with you because they are genuinely interested in investing in you, or just want to keep their finger on the pulse/have FOMO/don’t want the market to think they are out of the game. It will also tell you if this VC is capable of financing the whole round, capable of financing future rounds, or whether you will need to build a syndicate. There are some circumstances where an investor can still invest in you even if they don’t have capital left in a dedicated fund (through co-investment or special purpose vehicles), but asking the question should allow you to flesh this out. Capital raising is a labour intensive process and you want to make sure you are concentrating your focus on the investors who are genuinely willing and able to invest.
2. How much time do you have left in your fund?
This will give you an indication of what their likely hold period expectations are. If the investor only has 4 years left it heir fund, this means that their hold time expectations are likely to be less than 4 years. If this aligns with your plans for the Company, or you are comfortable that a shareholder may sell out separately ia a secondary sale, then, happy days. If not, then it allows you to make an informed decision about taking on that investor at the outset or allows you to manage expectations of the exit process via language and provisions in the transaction documents.
3. What do you bring to the table (apart from money)?
Not all investors will claim they add value, and some definitely oversell it, so determining what sort of value you are looking for is the first challenge, then finding an investor who fits that need is the second challenge. Most smart founders, if they are seeking VC, are seeking more than just capital from their investors. Be wary of the investor who uses vague statements like “our proprietary networks” or “broad domain expertise” this is bullshit for ‘we can’t actually articulate how we add value’. Ask them for specific examples of how they have added value to their portfolio companies. Then go crosscheck with those portfolio companies on whether that’s true. Validate.
4. How many portfolio companies do you manage?
If you are choosing a specific investor because you believe they will add value or at the very least contribute time and attention to helping you or your business, then it’s important you understand how much time and attention you can expect from your investor. If a specific investor manages a portfolio of 25 companies, its simple maths to infer they can’t dedicate the same time and attention as the VC who manages 6 companies. Now, there are always exceptions to this rule, and ‘active investor’ does not always translate to ‘better investor’. But, if you are seeking active investors and their skillset, its best to determine upfront how much of their help you will actually get.
5. What are your investment returns?
Track record. It’s one of the few objective measures to validate how good a VC is….in returning capital to investors, that is. Now, the caveat of course if that historical performance is not necessarily a predictor of future performance…but then again, Josh Lerner from Harvard showed me a graph once about how performance actually tends to augment over time. I think it was called persistence of performance. That is, fund managers who are in the top quartile of fund managers globally, have a greater likelihood of remaining in the top quartile of performance with future funds, and performance tends to improve (such that they move up into the top decile etc). This also works for the bottom quartile, but there is a natural attrition of this group over time for obvious reasons. So maybe in VC, we can say that historical performance is a pretty good predictor of future performance. The reason this should be important to a founder is that great VCs who deliver good returns to investors overwhelmingly do so because the portfolio company/companies has/have been a success — not because they have screwed over founders (those ‘wins’ for a VC fund a very, very few and far between, and it is not a sustainable business model for a VC either, just quietly). Great VCs structure transactions so that everyone is aligned, so if the VC fund returns have been good, then likely the companies have been successful, and the founders have also had substantial returns. Whether those returns have been because the VC fund has added real value or they just happened to pick amazing companies is kind of irrelevant. Knowing the track record, shows at some level they know what they are doing and it should give you comfort in choosing them. The one caveat being that you should also ask is what the volatility of returns is/ has been. If the VC fund has had one screaming success and 23 failures in their portfolio (high volatility of returns), it’s hard to argue they have a robust investment strategy, and it’s pretty easy to argue they got lucky and I would question whether this gives you any validation about their ability to pick winners, or their ability to add value or be a good partner.
6. Can I have the names of every founder you have invested in?
If they don’t do this. Run. Don’t let them give you one or two names that they’ve cherry picked as the ones who will only say good things. Transparency is key in this game (and this works both ways by the way), and if they are not willing to defend some possible negative feedback, run.
The caveat to this is to be discerning on what feedback you get — some founders who fail despite having good investors as partners will sometimes use investors as scapegoats and will want to bring them down with them. There can definitely be shitty investor partners and there can also be founders that despite best efforts, refuse to be protected from themselves or blame others for their failure, learn to work out the difference.
6 questions you should be asking VC’s when you are capital raising was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.