You can imagine a venture capital investment as a dance between the entrepreneur and the investors. Much has been written on this end from the entrepreneurs’ perspective: how they can best perfect their pitches and fine-tune their approaches to win investment from venture capitalists. But from the venture capitalist point of view, especially as a small fund that invests in pre-seed to seed stage rounds (like we do at 301 Ventures), unique challenges abound that make this “dance” hard to finish.
Since I have noticed a growing trend in small, early-stage venture capital funds, I’d like to detail some of these challenges and how we’ve learned to approach them in order to serve both our and the entrepreneur’s end goals.
As a small venture fund investing less than $50k per deal, you find yourself in the peculiar position where you notice mostly Angel Investors participating in the round alongside you, but your responsibilities lie with your own investors (LP’s) who have put their trust in you to make the best decisions possible with their money. From our experience, many Angel Investors (and of course, not all) approach deal diligence with a different mindset than traditional funds. Since most of the deals are so early, they like to invest dollars into the best idea or a story an entrepreneur has started to lift off of the ground. Of course, as a fund, we look for these brilliant ideas too — however, we need to dig deeper into the financials and projections of a company, their marketing & sales plans, and develop an understanding of why a particular founder has the skills necessary to fend off competitors.
This leads to some of our largest challenges during our diligence process: as a relatively small investor in rounds, we need to develop a clear picture of a company and its founding team extremely quickly, balancing the need to do right by our investors with ensuring that an entrepreneur raising a $500k seed round doesn’t spend an unnecessary amount of time working through diligence with a small piece of their investor pie.
This constraint forces us as a small fund to quickly develop an understanding of the business in order to ask precise questions around the industry, the product, or the end user.
Obviously all venture funds need to ask the right questions, but as a (relatively) extremely small fund, we do not have unlimited opportunities to land our questions. We have to get it right the first time in order to move quickly and remain mindful of the time of the hustling entrepreneur. As mentioned before, usually, checks in these pre-seed/seed rounds come from Angel Investors who do not have the same diligence duties that a fund will have.
We’ve made these mistakes before: spending too much time asking subpar questions with an experienced founding team, ultimately creating a bit of friction and losing out on the deal opportunity. Over time, developing an ability to ask tough, thoughtful questions immediately has allowed us to rapidly develop an understanding of a company and their unique space, enabling our fund to either pass or give the stamp of approval on a given deal.
Some of the questions we like to ask during the initial stages:
Tell us about why you decided to start this company, and how you chose your co-founders.
This gives us insight into the founder’s goals, passions, and their ability or willingness to surround themselves with the right people.
What’s your competitive moat, and why will you win even in the face of competition?
Asking this helps us to understand what the infamous “secret sauce” of the company is and why they’re going to win in their space.
How will our money advance your company?
Of course, you need to understand where your dollars are going. Ideally, our money helps establish a strong base that a company can quickly build upon.
Besides your product / service now, how are you planning to develop additional revenue streams?
Not every revenue source works as intended, or a major customer might not bite. So we need to know how a company can diversify their product/service offerings to both mitigate risk and create new opportunities in potentially new categories.
Who are the key people or decision makers you need to sell your product/service to?
This helps me see if a founder understands who their target market actually is and who they need to win over in order for their offering to be adopted. This is especially important for B2B companies
While it may seem obvious that it is important to ask the RIGHT questions, these can make all the difference between participating in an exciting company, or missing out completely, especially for a small fund. Venture capitalists operate in an unusual world where they need to make big decisions with limited information; however, developing the ability to quickly understand the few crucial components of a deal can lead to you a decision that works for all interested parties: the entrepreneur, your LP’s, and you.