Startups that get a Series A term sheet can consider themselves lucky but, before startup founders sign the term sheet they should do some diligence on the fund. Here are some things to look out for.
A good series A investor will bring clear value. The series A investor with its capital injection should increase the financial return for the founders and accelerate growth of the company. Value should be long term beyond the capital injection itself. Bringing value means the investor will collaborate with the founders for the next years through the ups and downs. Bringing value can include capacity to bring on board additional investors, help recruit people or drive a successful exit. A meaningful way to look at value is to create a value spread sheet where you list value criteria that are important to your startup.
Background of your VC is very important. Background translates into Series A terms sheet. A lot of VCs start out in investment banking or private equity or become VCs after a run as successful entrepreneurs. VCs with i-banking background tend to be heavy on startup metrics and information rights. VCs that have transitioned from private equity tend to draft term sheets with extensive down side protections. Entrepreneurs that have turned into VC have control heavy TS. In my opinion best VCs with principals that have been angel investors and translated their investment success into a fund.
Before you sign you should look if the fund has done any recent investments. It is a red flag if the fund has not done any investments in 1–2 year period. This could mean that the fund ran out of money or there is some other issue. We were on a deal where a VC signed the term sheet and then half way through got cold feet and left. If the fund is new you should look into the track record of the principals in previous funds. A red flag is also when the investor is prolonging the negotiations and not closing. The term sheet should specify the date of the closing.
Talk to Portfolio
Founders should also talk to portfolio companies of the fund. A good fund will want to share its success stories and give access to previous investments. Founders of portfolio companies will tell a lot of interesting stories. For example, if the VC is active or passive on the board or has ever threatened to replace founders with hired management.
The VC fund should have at least one success story with a meaningful exit from its investment. Meaningful translates into a new fund.