Reverse screening: How do encryption project founders select suitable VCs?

Author: Alana Levin, Variant Investment Partner

Compiled by: Luffy, Foresight News

Just as VCs conduct due diligence on investment projects, founders should also conduct due diligence on potential investors.

The primary task of a VC is to increase the probability of a company's success. VCs can achieve this goal in various ways, and determining how each investor can effectively support their startups should be at the core of the founders' due diligence. From the founders' perspective, I would filter VCs based on the following criteria.

First of all, can VC really increase the chances of project success?

Can investors provide other value beyond just pure capital?

I think it's possible. Through communication with the founders, here are some of the most commonly mentioned ways in which VCs can really help.

Brand: Gaining support from "first-tier" venture capital institutions typically (at least in the short term) enhances the company's brand. This provides direct assistance in recruiting talent. The brand halo effect is slightly less impactful during the initial hiring of the first 10 employees, but it becomes crucial for attracting talent once the company reaches the Series A financing stage or beyond. Given that early hires have a significant influence on the company's development trajectory and culture, the ideal approach for founders is to attract these talents from their personal networks.

A strong brand means that the organization or partner is well-known, highly respected, and seen as a key factor in the success of the project. Success is the best brand.

Knowledge and Insights: Do investors have experiences that entrepreneurs can learn from, providing useful advice? Are they particularly skilled at identifying factors that influence the market or business?

There are actually two points here: first, VCs may have relevant experience accumulated from successful companies in their portfolio (or similar experiences as founders themselves); second, they are able to provide a clear understanding of broader market dynamics and how these dynamics may impact the company in the next 6 to 12 months.

Networking: Sometimes VCs can help founders (or other heads of departments) connect with the right people. The "right people" may include other executives with relevant experience or potential customers. Founders still need to fight for business on their own, and few customers are acquired solely due to the influence of VCs. However, investors can certainly help entrepreneurs at least open some doors they want to enter.

Promotion channels: Some VCs have their own audience, so becoming a "KOL" is part of the value they provide. This is very obvious nowadays: many VCs are trying to establish their own promotion channels through podcasts, newsletters, X accounts, etc. Sometimes, these channels can indeed become effective means of raising awareness and driving traffic for new startups.

You have received an investment invitation, what should you do next?

First of all, congratulations! You have the opportunity to choose from a range of competitive investment offers, which is both an achievement and a privilege. Take some time to enjoy the process.

You may have some intuitive judgments about the partner you want to collaborate with. The due diligence process often reveals certain situations, such as the types of questions people ask, the insights they share throughout the process, their response speed in follow-ups, and whether there is a sense of cultural fit, among other things.

It's time to validate this intuition. Here are the steps I will follow, in no particular order:

Conduct background checks on investors: These checks should cover successful companies in the VC portfolio as well as those that are on the verge of or have already gone bankrupt. It is important to understand what kind of partners investors are in both successful and stressful situations. Ideally, these references are companies that have also collaborated with the investors you are considering partnering with.

Check for conflict risks: Does the agency have a history of investing in competing companies? More importantly, have they invested in any companies that could theoretically compete with yours?

Consider the tenure of partners at the institution: typically, the one you choose is both an institution and an individual partner. I encourage more founders to inquire about the aspirations and future plans of potential partners. A relevant thought experiment is to ask yourself: if this partner were to leave tomorrow, would you still be interested in this institution?

Determine whether the institution matches the stage of your company: whether a fund continues to invest in companies at the same stage as your company will affect the usefulness of its resources, the extent to which your company is prioritized in resource allocation, and the relevance of the advice the investor can provide. A $1 billion fund providing a $5 million seed round investment accounts for only 0.5% of its total allocation. Frankly speaking, if a fund invests $50 million to $100 million in later-stage companies, it becomes more difficult for earlier companies to gain attention and assistance from the institution internally.

Understand the institution's view on exits: This may sound a bit strange. However, in an era where IPOs are becoming increasingly rare, understanding investors' perspectives on acquisitions or the sale of secondary equity can prevent a lot of trouble down the line. Similarly, in the cryptocurrency space, understanding investors' views on selling tokens is a useful reference factor for token design and launch strategies.

Choosing a partner is often a "one-way street." Selecting the right VC can never "make" a company, but it can increase the chances of success for the company and at least make the founders' days a little easier. Spending a few extra days conducting due diligence on potential investors may pay off in the long run.