Make sure your new investors are legit
- Jason called and emailed ALL the time. Way too much for Drew’s comfort level. Other times, when Drew emailed him for help or advice, Jason didn’t reply for weeks.
- Jason had promised to introduce Drew to other angel investors but never fulfilled that promise.
- Jason said that he didn’t think Drew was ready to raise another round, but never explained why.
Meanwhile, Drew’s founder friends saw Jason’s name listed as his investor on Crunchbase. They went out of their way to share unflattering stories of their experiences working with him.
It was too late for Drew to reverse his decision to work with Jason. But he could have avoided the drama if he didn’t skip a critical part of the fundraising process.
In episode 8 of Uncapped Notes, Eric and Janel share how to do investor due diligence before you commit to the wrong people.
It only takes 10 minutes
It’s normal for early-stage startups to grow for 7-10 years before getting acquired or creating an IPO.
This means that founders will interact with their investors for a long time. As Eric puts it, you’re “growing old together”, and most of us want to grow old with people we like and trust.
Before you accept any investment, make sure the investor is a good human being by conducting investor reference calls.
These are phone calls with other founders who have worked with your prospective investor.
Reference calls don’t have to be long. A 10-minute call will probably tell you everything you need to know.
And putting in the time will help you avoid toxic investors and save you years of pain.
How to find investor references
First, ask your investor for two references. If Drew had received this advice before taking Jason’s money, he could have asked:
“Hey Jason, are there two founders that you’ve worked with that I can speak to? I want to learn more about the relationships you have with your founders.”
Next, we recommend finding two more founder references outside of the names that your investor gave you.
Why? Because an investor will give you the names of two founders that he feels confident will give him a good review.
But you want a less-biased source.
So, how do you find the two other founders? Here are two methods that we’ve seen work well:
At the end of your call with the first referred founder, ask them if they can refer you to another person who has worked with the investor. This is the easiest way to get a sense of who’s within the orbit of the investor that you’re considering taking capital from.
Look at LinkedIn and other investor databases and reach out cold to related founders. You’d be surprised at how effective a cold outreach is when you’re doing investor due diligence. Founders are eager to help other founders when they can.
What to ask in your reference calls
You’ve now set up several calls. What should you ask them?
Scott Cook, the founder of Intuit, recommended two questions that founders should ask in their investor reference calls.
“On a scale of 1-10, 10 being perfect and 1 being catastrophic, how would you rank this person?”
Expect the founder to say an 8 or a 9. They will likely list a canned response of how helpful or awesome the investor has been so far.
Founders want to be cordial and not speak poorly of anyone’s character. This is where our next question is extra critical.
“What would this person need to do to become a 10?”
Most people aren’t prepared for this introspective question. That's when you’ll hear more honest answers.
“I wish Quinn was a more strategic thinker.”
“I wish Mohit was more responsive.”
“I think Tyler goes on vacation too much.”
When to conduct investor reference calls
Do your investor reference calls AFTER the investor commits and BEFORE you accept.
This is important.
Do not waste your time doing investor reference calls before they’ve even committed because it might be a wasted effort.
Don’t do it after you’ve accepted because once you’re locked in, it’s important to honor your commitments.
This is why doing your investor due diligence between these two stages is ideal. Any good investor will give you enough time to conduct these calls because that is what a responsible steward of capital should do.
Don’t skip the references as Drew did.
You’re starting a long-term relationship with your investors. Spending a little extra effort at the beginning may save you a lot of pain down the road.