Counter-diligence

Eric Wiesen

I’m enjoying this series of posts, inspired by Matt Blumberg’s list from a few days ago, so here’s the next of Matt’s characteristics of great investors. This one is specific, pre-investment suggestion Matt makes about how to do due diligence on an investor.

Great investors invite you to do diligence on them by giving you a list of every CEO they’ve ever worked with and asking you to pick the ones you want to talk to.

I don’t disagree with Matt that this is a worthwhile thing to ask for and something a potential investor should be willing to provide, at least as you get quite close to a signed term sheet. From my perspective, if a company came in and pitched and immediately demanded a contact sheet for every CEO I’d ever worked with, I’d say no. But if I was planning on investing in the company and was getting close to proposing terms, I think it’s quite reasonable for someone on whose board I’ll sit to ask about others who have worked with me, and not just a cherry-picked subset of those I know will say good things.

A couple of additional points here.

1. Talk to at least one CEO who was replaced, if you can get in contact with one.  Every venture firm has CEOs who are replaced and most well-networked founders know several who have been as well. There are longer posts to be written on this topic, as the notion of founding CEOs being replaced is nuanced, complex, and can be for a variety of reasons. For purposes of this post, if you want to do full diligence on an investor and what your expectations should be for that investor, talking to someone who was replaced may be helpful.
2. In addition to CEOs the investor has backed, talk to a couple that the investor hasn’t backed. You can ask for a list of a few CEOs whose companies the investor chose not to fund (I keep a short list of this type of reference handy for potential investments looking for this type of conversation), or if you want to be a little more signal to noise ratio, talk to people around your space and see who might have pitched this particular investor. Chances are if an investor is seriously interested in your company, that investor saw pitches from a variety of your competitors or those in adjacent spaces as well.

Hearing the experience of those who may have pitched this investor, but in whose companies s/he chose not to invest is a potentially valuable source of data. As both Stuart and I are fond of saying – if a guy is nice to you, but nasty to the waiter, he’s not a nice guy. Similarly, if you find that an investor is on his best behavior to you but learn that he was dismissive or rude to others in whose businesses he was less interested, that tells you something about this investor.

Lastly, I want to make a point that also emerged in the comments to Matt’s post. Being open to this type of diligence request is only indirectly related to being a “great investor”, as great investors are measured by their returns, not by how well they are liked. It’s important when evaluating investors to think about how they are also being judged.

That being said, this type of openness builds a long-term reputation among the entrepreneurial community as someone who believes in respect and takes each interaction with a founder or CEO seriously. I think it’s a worthwhile exercise, and likely tells you something valuable about an investor with whom you’re about to spend a lot of intense, challenging time.

Put me in, Coach

Eric Wiesen

Continuing my walk through some of the characteristics that make a great investor (courtesy of Matt Blumberg’s thoughtful post on this topic), today’s topic is:

Great investors get to know whole management teams, not just CEOs — in fact, great investors become part of the extended management team of their portfolio companies

This is an interesting topic, and one that I recently covered with the founder of a company in which RRE recently invested. Again, I think there are two separate claims being made here about what a great investor looks like.

Great investors get to know whole management teams, not just CEOs.

At one of our Kauffman Fellows modules in Silicon Valley earlier this year, we were joined by a panel of four CEOs of VC-backed companies. We covered a variety of topics, one of which was this very question – should a VC on the board of a company have separate relationships with other members of senior management besides the CEO. What I heard there (and what I’ve learned working with our portfolio companies) is that there is a broad range of perspective on this question depending on which CEO is asked.

Some CEOs (like Matt) want investors to get to know the other members of management. I generally prefer this approach – I can get a better sense of a company’s sales effort if I have a separate relationship with the VP of Sales (not to mention I take up a lot less of the CEOs time asking questions about sales if I can go straight to the VP). If I want to have a discussion about a product choice or an engineering issue the company is having, I can have it on a more tactical level with the person directly responsible for that area. I’ve found some CEOs like this approach, and just want to be kept in the loop on what we’re talking about.

Other CEOs (including virtually all of those on the aforementioned panel) feel exactly the opposite. These CEOs don’t want investors “mucking about” with the company, and feel that investors should trust the CEO to provide updates and route appropriate requests and questions through to other members of management. I was a bit surprised to hear the fervor with which this point is sometimes made – some founders consider it an absolute breach of trust for a VC to interface directly with other members of the team.

All of which rolls up to – great investors find out what type of relationship their CEOs want them to have with other members of management.

Great investors become part of the extended management team of their portfolio companies

In a sense, this is the opposite of Matt’s original claim that VCs don’t get into the operational weeds of the company. By becoming extended management, investors are by definition going to take an additional level of operational involvement. That all being said, as I wrote yesterday I do think there are times when it’s appropriate for investors to get their hands dirty and get involved with various management functions within a company.

Yesterday I suggested that taking a more hands-on approach is appropriate when a company isn’t on plan. It might also be appropriate when the company is doing exceedingly well and scaling so quickly that management is overwhelmed. This is another opportunity for an investor who has the right capabilities (this is critical) to step in as a relief pitcher of sorts (maybe that’s a bad sports analogy – an extra blocker? Second tight end? I’m bad at sports metaphors) and provide support while the company staffs up toward a higher growth rate. You sometimes see VCs serve as interim CFOs for companies that are in this position.

Ultimately I agree with Matt’s basic point – great investors are members of the team, spend time on the company’s issues and don’t just wait for monthly updates at board meetings. But I’d include the caveat that great investors take the time to know what their CEOs want from them in this area, and interact with each company in a way that works for that particular CEO.

Great Investors

Eric Wiesen

Matt Blumberg of Return Path recently posted a list of Ten Characteristics of Great Investors. I like lists (don’t we all?) and read this post with interest. I agree with some of them, not so much with others, but in generally it looked like the table of contents for a great series of posts. So I thought I’d take them one by one. I had no hand in Matt’s post, nor did I comment on it, but it got me thinking about my work at RRE and how I can do my job well, and I think each of the points he raises deserves its own longer-form treatment, perhaps a post per.

Great investors know how to give strategic advice without being in the operating weeds of a company

There are two claims being made here.

Great investors know how to give strategic advice.

This is undoubtedly true – and in fact is true of board members generally (not just investors), since the role of a board director is not to run the company (that’s the CEO’s job) but to evaluate and assist with strategy, among other things. There is, of course, a secondary question – what constitutes “great strategic advice”? I would argue that venture investors in particular should bring to bear a broad perspective on the market and the sector in which a given portfolio company operates. If I invested in a particular company, it’s likely (if I’ve done my job) that I did research around the space, met the different companies and heard their stories, and (of equal importance) considered adjacent parts of the market.

Of course, a great CEO is also keeping track of the competition and understanding the value chain on either end of the product or service that the company provides. But the investor does this type of thing essentially full time. In the abstract, a good VC spends his/her day meeting companies, doing research and working with their existing portfolio. And in the abstract a good CEO spends his/her day on business issues strategic and tactical.

A great investor can provide strategic advice by bringing to bear a strong, informed perspective on the sector, the market and with a series of patterns recognized from other companies past and present. Great strategic advice acknowledges the position the company is currently in, is backed by a strong understanding of the competitive dynamics around the company, and (critically) is realistic.

Great investors stay out of the operating weeds of a company.

On Day 1 of an investment I absolutely agree with this claim 100%. And in a company that’s doing very well, it is equally true. (see Stuart’s post on this topic) But I think there is a large and important category of startups where this is not unequivocally true – companies where things aren’t going according to plan.

Many entrepreneur friends of mine routinely talk about how they want their investors to have operating experience. And this makes sense – someone who has run their own company or run a business unit within a company is capable of being operationally helpful when there is a problem and the CEO doesn’t necessarily know how to fix it. This isn’t to say that those VCs who aren’t career operators (as I am not, although I was an entrepreneur a couple of times) aren’t also capable of understanding operational challenges and helping companies think through them But in either case, rare is the startup that doesn’t encounter some form of ops problem somewhere along the way. I know from experience that in these situations founders and CEOs will turn to their investors for help if the investor has demonstrated a willingness and ability to be helpful on a tactical level.

So I’d modify the comment to be – great investors provide high-quality operational help when asked, and stay out of the way otherwise.