Imagine that you’re entering a race and could choose any car. You’d probably pick the fastest sports car you could find. But what if I told you it was a drag race? Or the 24 Hours of Le Mans? Or something off-road in mountainous terrain? Each would require a unique vehicle and a driver with a specific skill set. And if you chose the wrong car for the wrong type of race, your chances of winning would diminish significantly.
For entrepreneurs selecting a VC, the same should be kept in mind.
While many founders view VCs as vendors of the same generic “product,” the reality is that the very best VCs differentiate themselves by delivering much more than capital. For instance, many firms boast robust networks that can open doors to new customers, strategic partners, or M&A targets, while other firms provide more hands-on operational help with internal consulting teams. But, that endorsement comes with one very big caveat: Unless a VC’s support services are sharply aligned with the business they’re helping, they’re mostly meaningless.
For a VC to Add Value, Sector & Stage Focus is Critical
Moving back to that race, you wouldn’t automatically choose the most expensive car or the most notable brand. You’d take the type of race into account.
Selecting a VC is no different. While choosing the biggest, sexiest name on the VC market might generate buzz initially, that momentum will flame out unless the VC’s value creation strategy is explicitly designed to handle the specific needs and opportunities of your type of company.
Why is that focus so important?
At the end of the day, the needs and opportunities of an early-stage consumer startup will invariably be different than those of a growth-stage B2B SaaS business. Operational challenges will be different. Hiring needs will be different. Market opportunities will be different. Expertise gaps will be different. So, if you’re going to select a VC based on its ability to provide more than a check, wouldn’t you want to also ensure its value-add services align directly with the unique sector and stage challenges you’re bound to face?
What to Look for When You’re Choosing a VC
With that being said, VCs are diverse and it isn’t always easy to decipher between when a firm is telling the truth or when it’s telling you what you want to hear. To help you separate the two, I recommend focusing your diligence around a few key activities:
- Current and former investments: The best due diligence an entrepreneur can perform on a VC is to call several of the firm’s investments and ask to speak with their CEOs. Most VCs will provide this information, but you can also look it up online and cold call. In order to truly get something out of the interviews, make sure to ask specific, fact-based questions about the types of projects and initiatives the VC worked on and the results that came from them.
- Market and stage focus: You’ll gain some clarity on this by studying the firm’s portfolio, but don’t rely only on that information. Instead, ask the VC to describe its market and stage focus, and drill into the specific backgrounds and expertise of its partners. I’d also suggest bringing up an issue or challenge your company is struggling with and asking the VC to give you an idea of how they might address it. The recommendation they give matters less than how intelligently they’re able to speak about your market and stage.
- Firm culture and mission: Outside of sector and stage, you’ll want to assess how well a firm’s culture, mission, and aspirations align with your company’s culture and long-term strategic goals. If a VC tends to push for quicker exits, but your management team prefers a longer, slower build, that’s an important factor to consider. Similarly, if the VC’s internal culture and belief system conflicts significantly with your own, be wary — that’s a recipe for disaster down the line.
The funny thing about the entrepreneur/VC relationship is that both parties inherently understand the value of specialization in their personal lives. No entrepreneur or VC partner would choose a general surgeon to perform a double bypass — they’d try to find the best cardiac surgeon with the most experience performing the exact type of surgery they need.
I’d push you to do the same thing with your business. I think you’ll find that most good VCs will accept — and even encourage — your due diligence effort because even they understand that a Ferrari is only as good as the environment it’s being driven in. If the fit isn’t right, it won’t work out well for anyone.