Founders Must Read: The 5 Rules of Reverse Due Diligence, Choosing the Wrong Investor is More Fatal Than Business Failure!

Written by: Alana Levin, Partner at Variant

Compiled by: Lawrence, Mars Finance

Just as VCs conduct due diligence on investment projects, founders should also conduct due diligence on potential investors.

The primary goal of a VC is to increase the chances of a company's success. VCs can achieve this in various ways, and determining how each investor can effectively support their startup should be at the core of the founder's due diligence. From a founder's perspective, I would filter VCs based on the following criteria.

First of all, can VCs really improve the chances of project success?

Can investors provide other value besides just pure capital?

I think it is possible. Through communication with the founders, here are some of the most commonly mentioned ways in which VCs can truly provide help.

Brand: Receiving support from "first-tier" venture capital institutions usually (at least in the short term) enhances the company's brand. This provides direct assistance in recruiting talent. The brand halo effect is slightly less impactful when recruiting the initial 10 employees, but it becomes crucial for attracting talent once the company reaches the Series A funding stage or beyond. Given that early employees have a significant impact on the company's trajectory and culture, founders ideally should attract this talent from their own network.

A strong brand means that the organization or partner is well-known, highly respected, and regarded as a key factor in the success of the project. Success is the best brand.

Knowledge and Insights: Do investors have experiences that entrepreneurs can learn from to provide useful advice? Are they particularly skilled at identifying factors that affect the market or business?

There are actually two points here: first, the relevant experience that VCs may accumulate from successful companies in their portfolio (or similar experiences as founders themselves); second, their ability to provide a clear understanding of the broader market dynamics and the potential impact these dynamics may have on the companies in the next 6 to 12 months.

Networking: Sometimes VCs can help founders (or other department heads) connect with the right people. "The right people" may include other executives with relevant experience or potential clients. Founders still need to fight for business on their own, as few clients are acquired solely due to the influence of VCs. However, investors can certainly help entrepreneurs at least open some doors they want to enter.

Promotion Channels: Some VCs have an audience, so becoming a "KOL" is part of the value they provide. This is very clear today: many VCs are trying to establish their own promotion channels through podcasts, newsletters, X accounts, and so on. Sometimes, these channels can indeed become effective means of enhancing the visibility and driving traffic for new startups.

You have received an investment invitation, what should you do next?

First of all, congratulations! You have the opportunity to choose from a range of competitive investment offers, which is both an achievement and a privilege. Take some time to enjoy the process.

You may have some intuitive judgments about the parties you want to collaborate with. The due diligence process often reveals certain situations, such as the types of questions people ask, the insights they share throughout the process, their responsiveness to follow-ups, and whether there is a feeling of cultural alignment, among other things.

It's time to verify this intuition. Here are the steps I will follow, in no particular order:

Conduct background checks on investors: These checks should cover successful companies in the VC portfolio, as well as those that are on the verge of or have already gone bankrupt. It is important to understand how investors behave as partners in both successful and stressful situations. Ideally, these references are companies that have also collaborated with the investors you are considering working with.

Check for conflict risks: Does the institution have a history of investing in competing companies? More importantly, have they invested in any companies that could theoretically compete with yours?

Consider the tenure of partners at the institution: typically, the choice you make is both an institution and an individual partner. I encourage more founders to inquire about the aspirations and future plans of potential partners. A relevant thought experiment is to ask yourself: if this partner were to leave tomorrow, would you still be interested in this institution?

Determine whether the institution matches the stage of your company: whether a fund continues to invest in companies at the same stage as your company will affect the usefulness of its resources, the degree to which your company is prioritized in resource allocation, and the relevance of the advice that investors can provide. A $1 billion fund provides a $5 million seed round investment, which only accounts for 0.5% of its total allocation. Frankly, if a fund invests $50 million to $100 million in later-stage companies, it becomes more difficult for the previous company to gain attention and assistance from the institution internally.

Understanding the institution's view on exits: This may sound a bit strange. However, in an era where IPOs are becoming increasingly rare, understanding investors' perspectives on acquisitions or the sale of secondary equity can help you avoid many troubles down the line. Similarly, in the cryptocurrency space, understanding investors' views on token sales is a useful reference factor for token design and launch strategies.

Choosing a partner is often a "one-way street." Selecting the right VC can never "make" a company, but it can increase the chances of success for the company and at least make the founders' days a bit easier. Spending a few extra days conducting due diligence on potential investors could pay off in the long run.