Q&A: How to Choose Great VCs, Red Flags, Reference Checks & Capital Optionality - E258

· VC and Angels,Q and A,Southeast Asia,Founder



“Building a great business with product market fit gives you a lot of capital optionality. You don’t have to build a billion-dollar company in order to raise millions of dollars. It means if you're trying to raise from angel capital, then you should de-risk. You have to be thoughtful about strategy. You should think about how you're bracketing the set of de-risked experimental progress milestones that help you understand the business model in a way that's proportionate to what the capital is looking for.” - Jeremy Au


“I had an experience with a great VC. We told each other what we wanted because we’re both going to gain if we hit a certain level of outcome. If we don't get there, we won’t get an outcome. We have a conversation about what the parameters are and the reasons why they are important. We build trust because I'm going to have to fundraise from the next investors. I have to trust this guide explaining the financial terms because it's a long relationship.” - Jeremy Au


1. Founders should build capital optionality proactively. Fundraisers don’t get to choose unless there are multiple VCs bidding based on the strength of the business & team. Focus first on building a great startup with strong product-market fit and methodical experimentation.

2. If you can successfully position yourself for multiple term sheets, founders should “hire” for great VCs with the same high standards they would have for an executive job candidate. Focus on vetting the VC who would join the board, rather than the firm-wide brand. Review their individual professional track record, personal reputation, network, founder compatibility and passion for the business. Conduct direct and indirect reference checks, and see how they work with both “winning” and unsuccessful portfolio founders.

3. VC red flags to watch out for: History of absence or disengagement for board meetings. Exploding term sheets that have insufficient time for the founder to make a considered decision. “Blitz” conversations that are focused on salesmanship rather than building the future together. You can intentionally choose to waive them, but at least now you know the seed crystal of your business relationship.

Watch, listen or read the full insight including considerations before signing a term sheet, the importance of relational trust in fundraising and capital sourcing opportunities at https://www.bravesea.com/blog/choosing-vc

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Jeremy Au: (01:43)

Hey, morning, Adriel. Another week, another Q&A.


Adriel Yong: (01:49)

Yeah. Good to see you, Jeremy. This is a question from founders that both of us probably get a lot as VCs. How do you pick a good VC, especially when you're talking to multiple VCs in Singapore, across the region, and in your local market for those that are not based in Singapore? What are your thoughts on this as someone who has founded companies and is now a VC?


Jeremy Au: (02:14)

We got asked that question pretty much last night as part of that process. I thought that was something worth answering again and sharing broadly. So, at the end of the day, why do you want to pick a good VC? You want to pick a good VC because you are looking to build a large company and building a large company is very hard because there is a 1 in 40 chance of becoming a billion-dollar company. There's a 2 or 3 in 40 chance of becoming a large company that's there, and then pretty much 35 out of 40, which is most of the time, the company's going to wind down. There's a large spread of outcomes. It's very scary. The true enemy is not the VC, not the founder, it's not the customer. It's about the reality of the status quo and the reality that it's a tough business to build, which is why I think everybody's working so hard.

You have superstar founders, superstar coaches, and superstar VCs, all working together very, very hard, to build something amazing. That's why we celebrate them when they do succeed, so picking a good VC is part of that recipe, part of that magic that happens when a great founder meets a great VC. Fundamentally, when you're picking a good VC, what you're looking for is that you are trying to get better odds. So the odds are 1 in 40. That's already assuming, based on the data that you raise money from a reputable VC, but the truth is there are lots of different VCs out there, and you have to be thoughtful about the process. So, let me walk you through the chronological approach of how to pick a good VC.

The fact of the matter is that, first of all, you've got to build a great business with product market fit. That gives you lots of capital optionality. What I mean by that is that it doesn't necessarily mean that you have to build a billion-dollar company in order to raise millions of dollars. What it means is that if you're trying to raise from angel capital, then you should have de-risked. For example, in some of the product market fit, you have demos, and you have MVPs. You're actually very thoughtful about strategy. If you're trying to raise Series A, you should already achieve full product market fit. You should quote metrics. You should have revenue numbers. You should be growing very nicely. So you should really be thoughtful about how you're bracketing the set of de-risked experimental progress milestones that help you understand the business model in a way that's proportionate to what the capital's looking for. What that means actually, and is how I try to think about it a little bit is, from capital processes, if you build a good business, you get lots of capital options.

Of course, the best source of capital is always your customers and your partners because if you're building something that people want, your customers are going to be very happy, pre-paying to invest in you to give you debt. I think they're excited to work with you and help source capital. So customers and partners are great. That's layer one.

The second, next layer is your friends and family, and former colleagues. These are people who know you. They trust you. They know who you've been, and they know and believe in who you're going to become. They're willing to put money now to share and be part of that journey, and so that's another capital option. Third, of course, you have angels and syndicates who are also there. They are professional, they're individuals, and they're there out of passion. They're there because they care, they're there because they want to earn a return. But these angels and syndicates actually form quite a significant form of capital, especially for early-stage founders who I find normally tend to skip this stage of capital and try to go straight to more of the later forms of capital.

And of course, the truth is if you're building a good business, at some stage, you're going to get bank debt and venture debt where there's going to be interest rates, there's going to be repayments, there's a loan, but these are all opportunities including government grants and government-backed loans that actually provide you with outsourcing of capital. Then, there are family offices as well as VCs which are more professional investors who are managing other people's money. They're trying to invest in a professional. Now when I say this, the reason why I'm saying build a great business is not because of that, but in order to pick a good VC, you need to basically have built a good enough business to be able to attract multiple forms of capital so that you have lots of capital options, and that gives you the confidence to approach the capital markets and be in a good negotiating position to not just attract VCs, but also to negotiate and have a good conversation for the future, because now you're thoughtful. You understand what the business actually is, and what the future looks like, so the team that you want to have.

And that brings me to the second piece, which is that you want to run a process that lets you evaluate multiple VCs in parallel. So again, you've got your capital for your customers, your friends, and family, your angels and syndicates, your bank debt and venture debt. Maybe some family office money from previous rounds or the part car round. You want to run a process that lets you run and evaluate multiple VCs. It's tough. These are 2A, 2B, and 2C. The truth is there are obviously going to be professional VCs and there are unprofessional VCs. What I mean by that is there're going to be VCs who, I remember when I was a founder. It's like they turn up on time, they write your materials, they understand something, and they ask questions. There are also people who are not professional because they're asking all kinds of random questions, and they're late. They're just not there. I think that's the minimum that you can expect because these are people whose full-time job is to be a VC, so you expect them to be professional versus unprofessional. That's something that's very easy to evaluate in the first interaction, the second, the third, and the fourth, right?

The second part, of course, is something that's a little bit less obvious, but also very easy to get, which is that there are some people you get along with and there are some VCs that you don't like. I think that's a bit of a taste factor. And I think sometimes some founders overweight it and some founders underweight it. But I think it's an important part of the overall formula, which is that you want to be working with someone that you like and who likes you because this is going to be a long-term working relationship. So you've got to get along with the person. Sometimes, if you can't get along, so be it. There's no point pushing on that relationship, but on the other hand, of course, there are some folks that you know are more direct, more frank, and then, maybe you don't like them initially, but eventually, you get along with them because you understand the relationship, you understand what it is. So I think you just have to be careful about that. There are some people you can't get along with, so be it. There's a question like who do you really get along with and who do you respect?

The third one is probably the hardest to evaluate and I've fallen prey to that as a founder, which is there are some that really understand your business and the future of your company and some that don't. And this is the hardest part to evaluate because the truth is, anyone who's professional and someone who gets along is going to be very agreeable. So the VC is going to be like, yeah, yeah, yeah, if you want to have this wonderful conversation about A or B or C, and you want to walk away feeling nice. When you go sit down with this, does this person understand the business? And if I was to boil it down a little bit further, there are different layers of that.

I think one part of this is this person, is curious about your business, about the assumptions, curious about experiments, and curious about the risk factors that are going to be happening in the future. The truth is, if you're building something that's never been built before, then there's no way. It's not like Google has it, ChatGPT doesn't have it. That has to be figured out together, right? So you need a layer of curiosity that you want from the other party, because nobody knows, right? So the curiosity is there. That's part of that understanding of business. Then two, of course, you want someone who's also pattern-matching and thinking a little bit ahead, which is based on that curiosity. Can that person push that conversation forward? If this is true, then is that true? And if that is true, how does that compare to perhaps another story in a different market or there's a certain article that reminds me of this, you want to have someone that understands that this is in the future.

What I'm trying to say here is that at the end of the day, two A to B two C here is as a founder, you end up in a position where you want to run a process where you can evaluate multiple VCs, it's the same way you would hire an employee. You wouldn't pitch 10 employees. Only one person wants to apply and then they'll get a person to the eye and say, yes, I will hire you straight away. That'd be crazy, right?Just because only one person wants to join my company doesn't mean that it's the right employee for it. You still have to do that thing.

You want to find somebody who is a professional, someone that you like, and someone that actually understands your business. That's the same criteria that you have to hire an executive in your company. I always tell founders, at the end of the day, you want to hire a VC. Don't let capital wag the dog, right? Don't let the tail wag the dog. Don't let capital wag the business. You are trying to hire an executive who's going to be on your board for a long time. At a minimum, maybe two years, maybe four years, six years, eight years, I've seen. You want to hire someone who you believe has your interests and understands the business and can execute. The fact of the matter is that you ran a process that only lets you have one offer. The truth is you didn't get to decide. I think you still get to decide to walk away and try again later down the road. But truth is, when you only have one offer, you can't really decide, so at the end of the day, you want to run a process that lets you evaluate multiple VCs the way that you would evaluate multiple executive hires to join your team.

The last thing is that after that, you picked your offer, you already built a good company, so you have multiple offers. Then you want to do reference checks. What's really important here is that you need to do reference checks the same way they are doing reference checks on you. They'll be doing direct reference checks that you provide them, and trust me, the VC, they're going to be doing indirect checks. They're going to ask their friends, their mutual friends, hey, is this person ethical? Is this person a good operator? Is this person someone that you would like to work with? Again, they'll be doing that to you. It is on you to do the same about them. You have to do the work because, and I say this because I can tell you that in my past experience, there were some VCs I didn't work with and some founders I didn't, VCs I did not do the work with because, the VCs have such a great brand, I just didn't do it right and that was to my regret, to be honest.

The truth is every VC is going to give you references. For example, companies that have succeeded because the truth is if the founder succeeds, every VC likes hanging out with them. Every VC is whining, dining, checking in at the board meetings, and helping a lot. If the portfolio company's successful, that founder's going to be very happy about the VC because VC is all on top of it, but we all know that character is revealed not when times are good, but when times are bad. The truth is, times are bad, 39 times out of 40 times we just talked about. So there are so many popular companies that honestly are not successful, zombie, dying, closed, or acquired. That is the normal case. That is 39 out of 40 cases. It is 19 out of 20 cases. It is 18 out of 20 cases. You have to take that self-awareness pulse.

I have to be like, okay, I'm going to be in for a really tough two years where I have, a 1 in 20 chance, 2 in 20 chance, I'm really optimistic by myself. 3 in 20 chance of crushing it, but the other majority of the time is going to be really, really tough. So, have that conversation with other founders who have gone through that 17 out of 20 chances of tough times, failure rates, and so, so forth. Have conversations about how the VC works with me to de-risk the company, to experiment, to think through the future, to connect to other folks, because if the VC doesn't do any of that, then just buy capital. Just get into debt. Different customers. If all you want is capital, there's capital out there, but if you're trying to get a VC, you want to get, you're trying to buy better odds.So that's really the crux of it. You got to do those three things, which is first building a great business, a product-market fit that's proportionate to the capital stage that you're doing. Secondly, therefore, on the back of that good business, experimentation, run a process that lets you evaluate multiple VCs. That lets you have the ability to choose a professional, relatable, and someone who actually understands your business type of VC. Thirdly, run a solid and professional reference checks process from both successful and unsuccessful founders in their portfolio.


Adriel Yong: (15:29)

Thanks so much, Jeremy, for running through that thought process around what's a good VC to pick. How do you even pick one? And especially that point about reference checks. It's, it's almost like doing reverse due diligence, as a founder when you're always getting the one due diligence.

But it's such an important part of the fundraising process, especially when you're picking a partner for the next 10 years. I think the next part to that question is really around, what are the red flags as you sort of go through this due diligence process as a founder yourself. What are the things that you should look for, whether it's in the initial conversations with the VC, the due diligence stage, or even at the point of signing a term sheet, the discussions around the terms?


Jeremy Au: (16:17)

Yeah, I mean, I think there are lots of different things here. At the top of it is that it is true that VCs seem to pick founders. I think that's how the market sees it. That's how the media sees it. That's how, when I, as a founder, saw it. The truth of the matter is that on the other hand, the best founders get to pick VCs, which is, that's a tricky part. It's like there's a mindset shift which is that, are you a customer? Are you a buyer? So sometimes, it's like the VCs are selling you, you get the buys and so forth, but customers get to choose, right? So I think that's something that you have to think of quite a bit. The red flags that we have, there are three of them that I've thought of. Obviously, there are so many red flags and so many horror stories that I experienced myself, that I've heard from my friends, or that I've actually seen counterparts or peers do right in the space.

So I think the first one, I think that's the most obvious is the exploding term sheet. So, it’s a very fast kind of process. So this is an easy one, but I say this just because sometimes it's not obvious for first-time founders. It's actually okay by the way, for a VC to issue a term sheet straight away. They like you straight away, and then they tell you what the terms are straight away, discussing the parameter range and then maybe they issue with the term sheet straightaway. Maybe they issue a term sheet the next day. I think that's good because it means that this VC's excited and that's kind of the position that you want to have a founder to be so that you have VCs who are passionate about what you're doing. I think what's tricky is I think exploding term sheets, and what I mean by that is like a term sheet where it doesn't give you sufficient time to make a decision. I would say that anything below three days is really out of the market norm. I would say a week is pretty fair. Maybe get two weeks, right? I'm just saying this as an example, but at least a week is a good time to let someone make a considered decision.

The reason why I'm trying to say this is because obviously, from a technical basis, a term sheet can be complicated. It can have economic terms. It could have your control rights, it could have your board members, and it could have dilution clauses. There's a whole bunch of stuff that takes time. For a first-time founder, it takes time to learn. You're learning how to fundraise and so, so forth. So, you want to take this time to talk to a lawyer. Maybe you don't even have a lawyer. So you want to arrange with a lawyer, talk to a lawyer, get you to know, the coffee first, the consultation first, and then get legal advice very quickly to get a point of view.

You want to speak with your co-founders to say like, this is the decision I made, or these are options I have. An easier opportunity maybe to tell a bunch of other VCs, I'm just saying right, to say, hey, I have an offer and I would like you to come in now and make a decision and then go there. It gives you time to negotiate and say maybe we can move some of these parameters. Maybe you care much about economics, but I care about control rights, or I care about control rights, I can give a bit more on economic sites, but there's a conversation I can have. Now, of course, gives it an easier time to think through the strategy because the VC normally has an implied strategy for seeing you. You see your future and you need to be like, whoa, hold up. They see a vision of me as a financial company, or the other VC thinks of me as a full-stack company.

This's a different vision of the future. When you sign a contract, you're not just signing the terms of the capital, you're signing the terms of the working relationship, and you're signing the terms of the strategy and the promise that you are making over the next two years. So, having that time to take a considered decision is in the interest of both the VC and the founder. For the founder is because he lets you be in a position. If you, at the end of that process be like, I'm glad I met a VC who was fast and decisive and really liked me to issue a term sheet. After doing my homework and really doing intensive homework over the past week, I feel comfortable. I made a decision, I win the sign and built that relationship with the VC. For the VC, it's better too because you want someone who goes in, and thought about it, did a view rush, and then is considered, and is willing to work with you. You don't want a shotgun marriage, and then people are going to get frustrated. People are going to get angry. People want to announce the marriage, then everybody has a trip, an awful time. So, let that be a process, to have that process, and that time to breathe. So that's one.

The second one, in terms of reputation, is when you do reference checks, et cetera. If the person has a board seat but the person doesn't turn up or the person turns up late, or the person doesn't read the board materials beforehand or doesn't understand the business, and you hear that under reference call you, sometimes I think people can be like, oh, that's okay. That's okay because the guy wasn't there. Good for me, I can run the board myself. I still bought control. I still have two seats out of three or one out of two. It's better than a person absent, but then, I think, and that's what I was thinking for a while. The question for you is you had to be there, then why am I giving you this control if you're not there? While we, in this term sheet, why do you have to be a board member? Maybe you can be a board observer if you don't turn up, or maybe you don't even have to be on a board. All I'm trying to say is if you want, I think there are a lot of promises that VCs can make about how they're going to improve your odds, et cetera. But if you hear on reference checks that this person's not checked in, I mean, come on. If the board member's not checked in, how could this person help you build a good strategy? And when times are tough, how can they help you make a good decision? Let alone make the right decision, let alone do a decision that's in the best interest of the company.

So why are you giving away board control rights to someone who's not there? So I think there are a lot of complaints I've heard. This is like, I heard my board members are not checked in and then it's just, I'm just like, yeah, then. And this I think is less about often the firm. Often, I think this might be more tagged to individual partners in terms of their style or preferences, and I think there are good economic reasons for VCs because, for them, they're busy. They have to talk to new founders, they have to raise money from LPs. There are lots of good reasons for a partner to be busy, but from a founder's perspective, that's very cold comfort, right?

This is your company. That's for them to figure out how they distributed responsibilities within the fund and all that stuff, right? So I think really be very clear about who's going to be on your board and what's the value they're going to provide and making sure that they are going to be there for the good times, but also be decisive in the right way, in a top full and considered way during the bad times.

And the last thing is, this is a bit softer, but the last red flag is, are they trying to pull a fast one on you? Are they trying to "blitz" you? This is actually quite tricky because I think all of us as founders are always trying to sell. So we respect the hustle when someone's trying to sell you. So they're selling me, I'm selling them, and we're both selling each other. So that's okay. We all trying to blitz each other. And yeah, I think there's a transactionality obviously to it, right? But the truth of the matter is that transactionality is not the right seed crystal of the relationship because you're all going to be working together on a board or as investors for the next 10 years. And there's often a phrase that he used, right, which is, you can get married and divorce from your spouse tomorrow, but you can't remove someone from a cap table for 10 years. I think that, and they can, there's lots of harm they can do in terms of like vetoing or joining this thing or all kinds of random stuff.

But there's also a little good they can do, and so you wanted that right seed crystal. And truth, again, as it says, 39 out of 40 chance, there's going to be tough times. And even in a 1 out of 40 chance, there's going to be a bunch of near-death experiences on the way to get there, right? So there's going to be so many hard decisions.

And you don't want someone who's going to be pulling a fast one on you, right? Because then how do you trust that person? What's the seed crystal or trust that you're going to have there? And so you want to take that time to be like, okay, is this person telling me the truth? The full truth, not half-truth, not lie, whatever it is, is this person giving me space to learn and get educated. I remember I had this experience with a great VC and he was like, hey, Jeremy, this is what you want. This is what I want. The truth of the matter is that we are both going to gain if we hit this certain level of outcome and if we don't get there, we're both not going to get an outcome. This is what the parameters are. I'm willing to move to this parameter for you and this parameter is very important to me. Then let's have that conversation. The reason why this parameter is important to you is because of A, B, and C, and this parameter is important to me because of D, E, and F. In this scenario, all is aligned. And in these two scenarios, these things are not aligned, right? So how do we want to build our relationship together? I was just mind-blown because I was just like, oh, this guy's explained to me the clauses where we may choose this control. For example, it's not good for me in some scenarios, but it's good for both of us in other scenarios, and build trust because I'm going to have to fundraise from the next investor, the series A investor, the series B investor, series C investor, and I have to trust this guide explaining the financial terms because it's a long relationship. And so I think, being thoughtful about that from point A to point B to point C.

At the end of the day, the three major red flags are one, exploding term sheets or not giving you sufficient time to consider certain negotiation or key clauses is one because it's less about the contract and more about the starting step of the strategy and your partnership. The second one is really about reference checks. If the person is not present or, of course, bad or underperforming as a board member, but not checked in as a big one. The last one is they are trying to pull a fast one, they're trying to blitz you. They're trying to hot sell you and not trying to help you understand. I think those are three major red flags when you're picking a VC as a founder.


Adriel Yong: (26:58)

All right. Thanks so much, Jeremy for walking us through how you think about picking a good VC, doing diligence on them, and what the red flags to look up for through the entire process. That was really insightful and a good sort of learning for me, as a VC and as someone who intends to build a company in the future as well.