Diligence Your Next Investor

Selecting your next investment partner is a big deal, arguably the biggest deal you will ever sign as a SaaS business. You are bringing a new institution, and person into your home and into your business “family”. For high performing companies, it may feel like draft day (you may have your pick of investor!). You have formed relationships with several funds, learned about how/where they can add value, met the investment team who will be responsible for your portfolio partnership, gained an appreciation for their valuation and terms, and with that, the investor’s expectations (HOPEFULLY you have learned these things! But more on that below). Maybe most importantly, you should have spent ample time getting to know the person that is going to join your board as this decision is even harder to reverse than a marriage!

I am going to repeat this because it’s important, hopefully you have spent AMPLE TIME WITH and have REALLY GOTTEN TO KNOW the person that is going to join your board and whom you will be interacting with weekly for the next five to ten years.

I love the movie Draft Day, in particular this scene, where Kevin Costner’s character, the Cleveland Brown’s GM, goes against the grain and selects HIS player. The world had decided that Bo Callahan was the #1 pick in the draft class, but as the movie goes on, we learn that Bo has several critical flaws — including not being a good teammate, lacking passion for leadership and losing his composure in high-pressure situations. These are detrimental traits for a franchise quarterback to have and Kevin Costner dodged a bullet by spending the time to do his homework, understanding his prospective players as individuals and forming his own perspective. Ultimately, he signed Vontae Mack, an electric linebacker played by Chadwick Boseman (RIP).

We far too often see founders rush into relationships with investors, that they are then stuck with for the rest of the “season” (perhaps after being enamored by commercial terms and attractive valuations). However, unlike in professional sports, you cannot trade away a board member/investor. Once you’ve submitted your “draft card”, you are truly stuck with it. In this regard, draft day is also the trade deadline since there are no trades or changes allowed.

Given the finality of this decision, nobody wins when an investor and entrepreneur rush into a relationship. We’ve compiled some thought-provoking questions that we hope you ask before handing in your draft card!

1. Exit Expectations:

a. What are the investor’s exit expectations? Have you had an honest discussion about what you are both “in this for?” Does one party want to sell and the other IPO?

2. What’s the plan?

a. Have you aligned on what a good operating profile looks like? Is one party conservative while the other wants to “go for it!” Have you discussed whether future financings will be required down the road?

3. Tough Conversations:

a. What is the investor like during difficult discussions? These will occur at a high frequency in any investment partnership and thus any difficult conversation prior to signing a term sheet should be analyzed with a fine-tooth comb. Last thing you want is to invite ego onto your board.

4. What have you learned about their fund?

a. Have you done your homework on the investor’s fund? Who are their LPs? What are their return expectations? What is their typical holding period?

b. Ask what the fund’s average returns are, as well as their capital loss ratio to get a sense for how often their portfolio companies fail.

5. Domain Expertise:

a. Does the partner and team you are speaking with know your sector? Have they shared their own thesis ahead of time? Have they demonstrated passion for what you are building? Or did you have to convince them?

6. Value Add:

a. What tangible work product has the investor produced for you? Not what they “say,” but have they actually helped you in any way prior to signing a term sheet (practice how you play!). Moreover, have they demonstrated they’re willing to go the extra mile for you?

7. References:

a. How referencable is the firm and partner you are speaking with? Have they offered references and have you asked for references? Two references prior to signing a term sheet is a no brainer.

8. Have you met in person?

a. This isn’t 2020. It makes no sense to sign a term sheet without meeting face to face! Is the firm you are speaking with willing to get on a plane and see you? If not, we would question how serious they are.

9. Do you know your partner?

a. Do you know the person you are about to partner with? What are their interests? Do they have children? A dog? Is the person’s demeanor one you can work well with? How do you gauge their responsiveness and is that okay with you? Every data point, even knowing what type of cereal they eat for breakfast in the morning, is important here!

10. Dig deep!

a. Do you have a good read on the person’s character? Are they transparent? Kind? Do they play games?

This “next level” analysis on the prospective board member, as demonstrated in the movie Draft Day, is essential. Valuation and terms are important, but in our experience, the term sheet content hails in comparison to the importance of the partner and individual. Remember, this draft pick is massively important to your business and once you make your selection, there are no trades, no take backs, all investment partnerships are final!

At PeakSpan — we would urge anyone looking to bring on a growth partner to put us through the ringer. Ask us for our thesis, ask us to assist (we would be delighted to help!), ask for references and lastly, let’s spend as much time as feasible together such that you know exactly who we are as people and what you are getting in this partnership.