VCs like to give out homework. They won’t call it
that, though. But rather they use words like “diligence” and
“information requests.” Just like in school, the homework can actually
be productive, as in this case it can lead to a new customer or advisor.
But just like bad teachers did in grade school, VCs sometimes assign
completely useless busywork.
Receiving a homework assignment or two after initial meetings with a venture capitalist is generally a good sign
– it signals that the potential opportunity is interesting and exciting
enough to engage further. They’re often positioned as simple diligence
requests that (actually often genuinely) help an investor get a better
sense of the startup and its prospects. Yet as those initial assignments
turn into an endless string of assignments, the signals can turn south.
At the best it’s an indication of indecisiveness, and at the worst repeated homework can be indicative of bad intentions to show minimal engagement to “hang around the hoop.”
There are a number of reasons why venture capitalists give out homework to entrepreneurs who have pitched them… usually the rationale isn’t one of the following, but rather a combination:
- Answer specific questions.
Whether it’s about the market, competition, etc., VCs typically want to
“get smarter” about a domain, especially if they’re less familiar.
- Validate thinking.
VCs walk out of a pitch with a thesis – it might be about the team or
the market opportunity or whatever – but they like to hear from others
that that thesis is indeed sound. In other words, they seek supporting
points to verify their reasoning.
- Overcome their partner’s objections.
If a new non-linear homework assignment comes up mid-evaluation
process, it’s typically a direct reaction to a VC’s partner objecting to
the investment on specific grounds. The homework assignment can be a
way to provide ammunition to overcome those objections politically
(especially within larger firms).
- Build trust.
Sometimes the content of the assignment is irrelevant, but rather the VC
is utilizing the process as a way to build a rapport and see how an
entrepreneur interacts beyond an hour pitch-meeting. The process can
reflect if an entrepreneur listens well and is open to feedback, meets
expectations about output, and generally does what he says he’s going to
- Delay. Going through a process of repeated
diligence requests can sometimes be intentional stalling tactics to a
deal process, allowing VCs to gather more data and preserve optionality
for as long as possible.
- Play chess. Assignments can be a part of a larger power-play game with respect to negotiation of an eventual deal.
Given the above motivations, a number of kinds of homework tasks can emerge:
- Produce more internal reports.
Often VCs are looking beyond the headline numbers in a pitch deck to
validate that the “traction” is truly real or just spun for a
presentation, but other times the requests are just to verify what an
entrepreneur said is true is.
- Produce financial models.
Sometimes these spreadsheets are helpful to run different scenarios
about what the drivers are of the business are and/or outputs under
different sized capital raise. But more importantly, it’s a way to
demonstrate deliberate thoughtfulness about the business. However, there
is a risk (and I’ve seen it happen) of VCs sending an entrepreneur on
endless modeling exercises which are completely useless – you can’t
dictate the impossible into reality, but you sure can model it.
- Assemble (third-party) reports.
Additional information about the market sizing, competitive dynamics,
potential acquirers, etc. can help educate an investor about a space
where s/he is less familiar.
- Allow for customer / partner / advisor / employee conversations.
It’s sometimes a sensitive topic to allow potential investors access to
key constituents within an emerging organization, especially customers,
but they are often the most revealing about the opportunity and can be
the final convincing data to push an investor towards conviction.
- Talk with a own domain expert.
VCs have their go-to people in their network, sometimes formally
affiliated with the firm or sometimes just friendly informal
relationships, who they introduce to entrepreneurs to hear their
perspective on the opportunity (see #2 and #3 above).
- Talk with new potential customers or partners introduced by the VC.
Often if a VC has made other investments in a (related) space, he is
able to introduce potential new customers or partners to a company even
before making an investment. These kinds of intros (if they’re actually
apropos) can be beneficial to the startups, but they also give an
investor the ability to first-hand see how a potential new customer
reacts. Trouble, however, can arise if that customer isn’t as good a fit
or has another idiosyncrasy which generates erroneous feedback back to
In all of the above, I haven’t shared a value-judgment
to either the motivations for these assignments or the types of them.
But it’s clear that some can be quite constructive for a startup, while
others can be neutral to even unconstructive. My partner Rob Go wrote a
post a couple years ago about interpreting diligence requests to figure out whether indeed they’re “bad” or “good.” Because
just as a VC uses the diligence process itself to evaluate an
entrepreneur as the leader for an investment opportunity, entrepreneurs
can similarly use these interactions to decipher if a particular VC is
going to be a good partner to the company going forward once an
investment has been made.
David Beisel is a Co-Founder & Partner at NextView Ventures. You can find this post, as well as additional content on his blog called GenuineVC. You can also follow David (@davidbeisel) on Twitter by clicking here.