You’d Better Shop Around: Doing Due Diligence on Your VC

8/2/11

For a first-time entrepreneur, dealing with a venture capitalist can involve an equal mix of excitement and apprehension. If the VC has any sort of reputation or prominence, entrepreneurs are often grateful simply to be pitching their idea in the first place. Should discussions get far enough along that a term sheet is offered, a new entrepreneur is usually thrilled beyond words.

Those certainly were my emotions back in my entrepreneurial youth, the first time I dealt with venture capitalists. It was one of the most exciting times of my life. But I also remember a few other, much more troubling, emotions, and I know that these, too, are part of being a first-time entrepreneur. These involve the vaguely-formed stories that many entrepreneurs hear about the dark side of the venture world; stories of VCs who weren’t trusted partners interested in growing a business, but who simply took advantage of inexperienced or unlucky entrepreneurs for a quick, unsavory gain.

I fortunately never had to deal with that caliber of VC, and I don’t think you will, either. Telling one kind of VC from the other is much easier than you think, even if you are a first-timer. The task requires entrepreneurs to use a little common sense, and to do some of the same sort of the due diligence with their VCs that their potential VCs are doing with them.

First, the common sense. If you’re lucky enough to be dealing with a top-tier venture capital firm, you have much better things to be doing than fretting that your venture firm is plotting to steal your company away from you. The technology world seems sprawling from the outside, but once you are actually inside, it’s a rather small and tight-knit community. No venture fund can get to the top of this world via a career of double-dealing.

But what if a potential VC partner doesn’t have an obvious bit of Silicon Valley pedigree? This is where due diligence becomes important. Every VC lists their investments on their web site; give some of those investments a call and ask your counterparts what their experiences have been like. Good VCs won’t mind being “checked up on” in this way; to the contrary, they will view it as an indication of your seriousness and thoroughness.

If you end up doing business with a VC, the interaction will be based on the term sheet that spells out the particulars of the venture firm’s investment in you. Term sheets can be extremely complicated documents, and you’ll need the guidance of an experienced lawyer to help you with your side of it.

I am not that lawyer. But there is one element of a term sheet I’d like to mention, in part because it seems to confuse many entrepreneurs, and in part, I regret to say, because I have occasionally seen unscrupulous venture capitalists use it to their advantage.

A “no-shop” clause is often, but not always, a standard part of a term sheet. During the period covered by the clause, the entrepreneur agrees to … Next Page »

Nat Goldhaber is a co-founder and managing director of Claremont Creek Ventures in Oakland, CA. Follow @

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