Choosing from The Dark Side

If there is one thing I’ve learned after pitching to VCs, it‘s that not all of them are made equal. It might be counterintuitive for some founders to think of being selective on which VCs to go for. After all, the investors do provide money and a lifeline for your unprofitable startup. But do remember not all money is equal and some money is even counterproductive for your company. I recommend every startup going through a fundraising journey to create a priority list of VCs as a first step and then approach the investors from highest to lowest priority.

The biggest criteria in my opinion for making a decision on which VC you want on your cap table depends on how active you want them to be. If you feel you need help in strategising, building up the business model, choosing the pricing, or other such challenging tasks, try to go for a VC who will be more active and be a sparring partner for your thoughts. VCs see a lot of companies and have a good understanding of what businesses work in a particular market and what do not. However, if you think you have an understanding of EXACTLY how to build your business, have little to no doubt on the execution, and need just a bit of cash to extend your runway, stop reading this and start pitching to passive investors.

The obvious question that arises from the above statements is how to find out who is active and who is passive. A very good thumb rule for estimating this is by calculating what I call a Portfolio Activeness Ratio or PAR value of a fund. Please don’t get excited by the terminology, I just made it up.

PAR = Fund Portfolio Size/Fund Investment Professionals

Consider some examples.

GREE Ventures has a portfolio of 9 active companies in South Asia (psst two are in stealth-mode) and being active investors is our number 1 priority. We have two investment professionals managing these 9 companies, giving us a PAR value of 4.5. This is quite a healthy ratio in my opinion. It is relatively easier for an investment professional to manage 4–5 companies at a time, especially if they are in different life stages. Some will require more work and some will require less.

After having worked in this sector for the last couple of years, I have come to terms with the fact that a good fund manager can actively manage a maximum of 6–7 companies. Hence, I would create a very subjective benchmark of 7 as the active PAR value. The lower the PAR of a fund the more active it should be with its companies. Please note the use of the word “should” rather than “would”. There are a few funds in the region who have the bandwidth to spend time with their portfolio but end up not doing it. This is usually because they either don’t consider it a priority or are just not interested in the whole fund management process and will likely end up becoming “tourist” VCs.

I’ll now give examples of some passive VCs. Please note, I am not saying that any passive investor is “bad”. It’s just a different style of investment and you need to choose which one is more relevant for your company. Not you. Your company.

Let’s take 500 Startups (they are very upfront in saying they are not active btw) as an example. 500 Startups Durian has invested in 119 companies in Southeast Asia from its first fund. They have listed 3 team members on their website as investment professionals. This brings their PAR value to a whopping 40. There is no way in hell that an investor can be an active mentor/investor with this ratio. Sure the passive investors can still open up their network for you, but that’s about it.

A contrasting example of an active micro VC would be KK Fund. They have invested in 13 companies and have 3 listed investment professionals, PAR = 4. It’s a very healthy PAR for a small fund and frankly means they are all taking big pay-cuts, but doing it for the long term.

After you have done the calculation as above, there is another thing you must do to be sure of the activeness of your potential VC. Just ask their portfolio. Connect to a few founders in the existing portfolio of the VC via LinkedIn and ask them out for a coffee. Understand how their relationship has been with the investor and try to find out whether the specific professional who is working with this portfolio has the right skill-sets you think you need for help on your own startup. This is usually a much more intensive process and I would only recommend doing this once you have sufficient interest from the said investor in your company. I’ll also recommend talking to 3–4 startups in each investor’s portfolio.

After all this research, you should have a good idea of whether this VC is some one you’ll like to work with or not. But wait a minute, shouldn’t you be thinking from the other side’s viewpoint also? How about which VC will like to work with which startup? It turns out that there are ways for you to figure out which VC is more likely to take more interest in you. But the post is becoming lengthy, and I’ll cover this in the next week.

To be continued…

Note: Any feedback from your own experience, for or against, is appreciated