VC’s Doing the Work to Build Investment Conviction

I once had a VC mentor (only) half tongue-in-cheek tell me that “all investment diligence is merely an exercise in confirming what you have already decided during the initial pitch.” Diligence validates your gut to invest or (hopefully quickly) kills an opportunity that sounded reasonable but you just didn’t like.

I’ve come to believe a much less cynical view of investment due diligence, that, especially at the seed stage, it’s is best when followed the 80–20 rule.

I’ve found that with just a couple phone calls and/or a little research work, you’ll quickly learn if your initial hypothesis was correct with an over-the-top-positive backchannel personal reference, a strong customer call, positive indications from careful analysis of a dataset… or lack thereof.

The challenge for some VCs is that real, deliberate diligence like that, takes actual work. And work is, well, hard.

So instead, VCs often “outsource” that work to others. Most often, VCs ask founders to pitch another member of partnership. And then another, and sometimes another.

This endless string of meetings can be helpful in validating an investment idea, but too many is just abdicating responsibility of building conviction through peers’ consent. And that doesn’t typically yield successful end-results.

Other methods of outsourcing work include assigning founder “homework” or having junior staff run some analysis, make phone calls, or write up a report.

Venture capitalists are used to meetings.

In-person meetings, phone meetings, portfolio meetings, new company meetings. And it takes time out of an (intentionally) over-scheduled VC’s day to stop, sit down, and critically think about what has to be done to build conviction around an opportunity. Notably, it is a change in the typical rhythm of a day.

The decision for VCs to partner with an entrepreneur to take on a project where the odds are stacked against it is not one which can outsourced to others, but rather a VC partner has to “feel” the validation first-hand.

So this notion of “doing work” (and friction towards it happening) yields a couple takeaway for entrepreneurs:

  1. In most cases, progression towards a potential term sheet isn’t really happening until a VC partner is doing work.
    Meetings and other people doing work (often) signal genuine interest from a firm, but until a specific VC partner experiences third-party validation first-hand, a founder’s fundraising process with that firm can get stuck treading water.
  2. It’s OK to ask what diligence steps will be made in the course of the current meeting and the next, as well as suggest a task if it’s not clear.
    There’s an art to this communication, but it can be extremely productive to subtlety nudge VCs about a simple diligence task beyond another meeting with the firm. For example, offer to intro the partner to one customer — fit the “work” into a discrete time-period which slots perfectly into a VCs calendar. What’s a strong validating third-party touch-point which will help them build more excitement about the company?

Investment due diligence can both address outstanding questions or clarify risk areas for a VC looking at a potential new investment. More importantly, it can solidify the excitement coming out of that first pitch into conviction and commitment required for making a new investment.

Real work here takes effort, so founders understanding what actually has been completed in this regard gives them an edge into prioritizing the multiple conversations when running a fundraising process and nudging potential investors along.