What are the best practices for conducting background checks on potential investors?

Asking a VC for intros to startups in their portfolio is a good first step. You can typically find these startups on the VCs website, the ones which are within your field are perfect to ask for an intro to. This shows how open the VC is and trusting in their investments. Startups will then tell you how the VC is on their cap table, going directly to the source can avoid potentially painful relationships. Especially within the bio/deep tech world where things take many years.

Understanding an investor's history is not just about numbers. For instance, a startup founder could share how delving into the past investments of a potential investor revealed their preference for rapid scaling, aligning perfectly with the startup's aggressive growth plans.

Most VCs will harp on about their value add but the majority don't deliver on that promise. Speak with as many founders of previous investments as possible and find out what their experience was. Founder/Investor relationships last on average longer than the average marriage so do whatever you can beforehand to make sure it's the right match!

When it comes to funds, look for mutual connects and take feedback from peers and other founders. However, when it comes to angel investors, it becomes a bit tricky. You might not find mutual connects and at the same time, lot of people like to present themselves as an angel investor, simple because they think it is a top of the food chain position and commands respect. Ask some important questions: - What are the other companies in which they have invested? - What is their preferred mode of vehicle, do they come directly on cap table or they come via a syndicate/network? - What is their ideal cheque size? - How have they helped their other portfolio companies succeed?

Assess not only the quantity of investments but also the size and sectors in which the investor has been active. Understanding their preferences in terms of investment size and industry focus helps determine compatibility with your venture. An investor with a successful track record in a relevant sector is more likely to bring industry expertise and connections.

This step goes beyond mere online searches. A case in point might involve a founder who, through diligent research, discovered discrepancies in an investor's claimed achievements, averting a potentially detrimental partnership.

Perform a comprehensive online search using search engines like Google. Look for any articles, press releases, or mentions of the investor's name in reputable publications. This can help corroborate information about their professional activities, accomplishments, and any potential red flags.

As tempting as it may look, no matter how substantial a check an investor is dangling in front of you, you shouldn't accept it if you don't know them or, at the very least, have a few close connections who can vouch for their legitimacy. Getting into business with someone you can't trust is a much worse problem than having a short runway. Fundraising can be challenging, but don't let desperation lead you into making bad decisions.

It's crucial to confirm the identity and credentials of potential investors. Utilize tools like LinkedIn, Google, or social media to review their profiles and connections. Request official contact details and visit their website to ensure authenticity. Verify their accreditation status, demonstrating they meet specific criteria for private investments. Online platforms like VerifyInvestor or AngelList Verify offer convenient ways to confirm accreditation. This step ensures transparency and safeguards against potential scams in the investment process.

An online research can only be a very first step. Founders should dig much deeper and ask their potential investors about other companies in their portfolio. Any reliable investor will make intros to their portfolio companies. By that, founders can speak with peers in companies their envisaged investor has already invested. They will hear about the experience other founders made with the investor and about any pros and cons of such investor. That′s a true due diligence. If an investor is not willing to disclose the portfolio the investor already invested, founders should be alert. There might be reasons to not disclose, but in my experience any VC is happy to make intros.

This is about more than shared goals; it's about shared vision and approach. A useful anecdote here could be a startup that chose a smaller investment from an investor whose past involvement in similar industry startups proved invaluable in navigating market challenges.

This one should be the first step before founders even reach out to an investor. Find out if the investor has actually expertise in your vertical AND stage. Find out if the investor provides more resources than just capital, who is in their team you could potentially reach out to once you have questions, etc.

I highly recommend interviewing a VC's portfolio company founders to determine the investor's potential fit and alignment with you and your business. Don't just interview the founders they list as references. Identify other founders they've supported and interview them, too! If the VC is earlier in their investing career with fewer founders to source for investor due diligence, I recommend identifying entrepreneur support organizations they support (accelerators, incubators, pitch competitions) and interviewing operators and entrepreneurs in those communities to obtain answers about the investor's background, approach, thesis commitment, and similar.

After verifying credentials, assess alignment with potential investors. Seek those who share your vision, values, and can provide strategic guidance. Understand their investment criteria and how it aligns with your stage and goals. Pose questions like: Why invest in your company? What are their goals and timelines? How do they evaluate your market and product? Clarify their level of involvement and communication preferences. Inquire about challenges they've navigated with other portfolio companies. This ensures a harmonious partnership conducive to mutual success.

The devil is often in the details. A relevant story could involve a founder who narrowly avoided a bad deal by closely scrutinizing term sheet clauses that initially seemed standard but had long-term adverse implications.

If an investor presents you with a term sheet, most of the terms should be rather straightforward. For any other legal agreement (SPA = Stock Purchase Agreement, etc.), involve a lawyer. There are many fantastic startup lawyers out there who represent founders in their earliest stages.

We investors show our best face during the "courting" process. The due diligence process doesn't always represent how VCs will really act and specially how they will act under pressure or when interests are not 100% aligned. During the terms negotiation you may get a glimpse of how they are and how they treat you. Never accept the first offer (dah, obviously). Always push back a bit, this will allow you to see how they react and will of course likely get you better terms. VCs don't offer their highest offer first, so you have some wiggle room usually.

When reviewing an investment offer, don't apply the 80/20 rule. Before signing the dotted line, make sure that you understand 100% of what's written above it. Often these days, early-stage investments are made with a boilerplate SAFE or Convertible Note. These agreements are typically founder-friendly and don't include any special provisions. However, if the terms of the agreement are complex and include special provisions, it is highly important to get proper legal advice.

After assessing alignment, thoroughly review the investment offer's terms and conditions. Scrutinize the term sheet, understanding implications on valuation, equity, governance, and obligations. Seeking advice from professionals is prudent for nuanced negotiations. Be vigilant for red flags like unrealistic valuation, excessive fees, inflexible terms, or lack of transparency. Background checks on investors can ensure a secure partnership. By adhering to these practices, safeguard your interests and enhance the likelihood of a successful collaboration.

One of the best ways to conduct a background check is to get in touch with other founders from their portfolio, particularly seasoned ones and ideally those with a diversified captable that have interacted with VCs in the past. If they have launched >1 startup and have experienced failure, their feedback is even more valuable as they would be less romantic about the relationship altogether and their management of the expectations will be more aligned to reality. Then, I always find it useful to meet them outside of a business context and take them out for lunch to a restaurant far from fancy to check how do they address the people around. Ask them about their motivations and dreams as well as the things that keep them awake at night.

Beyond these steps, it's crucial to understand the investor's network and influence. For example, a founder might recount how they prioritized an investor not just for the capital but for their unparalleled connections in the industry, which opened doors that were previously inaccessible. Another aspect to consider is the investor's involvement level. A scenario could be presented where a founder initially sought a hands-off investor but realized the immense value of an engaged, mentorship-oriented investor, altering their selection criteria for future funding rounds. Lastly, understanding the investor's exit strategy is vital.

Founders shouldn't underestimate the severity of bringing an investor on board. From my experience, many founders take this too lightly and simply want/need the capital and don't screen for anything else. Untangling a bad fit is close to impossible, extraordinarily expensive for everyone involved, and often simply impossible.

As a leader, I strive to ensure our practices maintain fairness and ethics above all else. While tools can provide signal, the ultimate decision relies on our deep domain expertise and understanding of each situation's human factors. Partnership here is key.

Try to find founders they rejected or didn't invest in. Learn not only why they passed but how they behaved when they did it. You'll learn a lot more about their character from how they treat those they don't invest in.