No, VCs Don't "Skip" Diligence
Every time there’s a slowdown in VC funding or a well-funded startup fails, a torrent of people rush to proclaim that investors hadn’t done their homework. It’s like clockwork. As markets have pulled back over the past few weeks, the usual suspects have come out of the woodwork with their “gotchas” and “I told you so’s.”
On Monday, the founder of Eco added some major fuel to the fire when he claimed that a recently-funded competitor had copy-pasted their entire business.
To be clear, if the claims made by Eco turn out to be true, it’s beyond unethical. It’s sketch AF. But that’s not the point of this post.
The purpose of this post is to obliterate the myth that VCs skip diligence in hot markets.
Santa can take a flame thrower to VC myths. Because Santa is 100% real.
Let’s Rewind for a Minute…
Before I get too ahead of myself, I want to be clear about what I’m referring to. When the fundraising market is hot, deals happen faster. In a strong market, more capital flows into the ecosystem, which results in increased competition to invest in the best startups. It’s also important to highlight that founders have become significantly better at fundraising in recent years. The best founders understand how to orchestrate a competitive process that maximizes their leverage and optionality.
Put these two things together and investors, on average, have less time start-to-finish to make a decision.
So What?
There’s a dangerous myth stemming from the above dynamic that permeates many founder and investor circles: in a hot market or a competitive deal, big-name investors “skip steps.”
The implication of this myth is that the only way a deal can be done in a competitive, fast-moving scenario is by cutting corners.
Here’s the thing: I don’t know a single legitimate VC that doesn’t do their homework. Not one.
Actually, I’ll put it even more bluntly: the idea that any VC worth their salt is going to write a multi-million dollar cheque without doing diligence is stupid. Saying so might get you a lot of likes on Twitter, but it’s flat out wrong.
VC Logan Bartlett poking fun at the situation
But Really…So What?
At this point, you’re probably wondering why I’m making such a big deal about this. I promise it’s not because I desperately need a gold star.
Look at meeeeeee! I did my diligence 😄
The fact is, buying into and propagating this myth is dangerous for both founders and investors.
Why It’s Dangerous for Founders
When founders buy into the myth of investors skipping diligence, it provides an excuse to not look in the mirror.
“Company X raised $5M and our product is way better than theirs, so…”
Far too many founders rely on this myth to justify continuing down a path akin to banging their head against a wall. They continue to fundraise with a misguided belief that they can somehow “trick” investors into not noticing their gaps. If they just tell the story differently or meet an investor that “gets it,” the problems in their business won’t matter.
That’s just not the way it works. (Want to see a concrete example? Check out my own Seed deck from 2013).
To succeed at fundraising — especially in a market like the one we’re in — it’s essential that founders be self-aware and recognize when fundamental issues are causing investors to lean away. Although it frequently takes 100 “no’s” to get a “yes” when fundraising, often the solution is to pause and address the underlying issues that investors see as risks.
Why It’s Dangerous for Investors
Investors….well, frankly, investors should know better.
It blows my mind how frequently I hear Canadian investors talk about Silicon Valley VCs getting caught up in FOMO or cutting corners to win deals.
Please.
Do you really believe that partners at the most successful, most sophisticated firms in the world are skipping steps to win deals while noble, disciplined Canadian VCs are the only ones doing things the right way?
If you believe that, I’ve got something to sell you…
It’s an arrogant perspective, but why is it dangerous?
For the exact same reason it’s dangerous for founders: it provides an excuse to not look in the mirror.
Believing that competitors skip steps is a great excuse for investors to not improve. “They’re lazy, so why do I need to get better?”
You might now be wondering why I would call this out. While I certainly might benefit in the short term from this type of behaviour, it’s not long-term good for me, because it’s not long-term good for the Canadian ecosystem. For Canada to thrive, we need everyone across the ecosystem to continue to get better — founders and investors alike. That means not resting on our laurels and not giving into convenient myths.
If VCs Aren’t Skipping Steps, What’s Happening?
The same thing that happens in every startup when there’s a deadline: all hands on deck.
In a startup, when there’s a big product release or a customer emergency, the whole company rallies to get it done. The same thing happens in top-performing VC firms. Partners, associates and analysts rally around hot deals so that they can complete the necessary diligence in time.
This doesn’t mean that the firm will research every possible aspect of a startup. It also doesn’t mean that investors aren’t prone to FOMO (they certainly are). What it does mean is that they will prioritize the diligence they feel is necessary to gain conviction around the deal. The best VC firms can do this very, very fast.
For non-deep tech companies, technical diligence has become less important to many pre-seed and seed investors
This ability to prioritize diligence and rally behind hot deals is a skill that Canadian VCs, for the most part, haven’t had to develop because we haven’t historically had the same level of competition as in the US.
We’re starting to see meaningful evolution in Toronto, but the majority of investors I’ve encountered still parrot the myth of cutting corners.
NGMI
What About Eco?
As of this post being published, that story is still in development. There are a lot of knee-jerk reactions that the VCs who invested in their competitor didn’t do their homework, should have known about Eco, etc.
But here’s the thing: the competitor hadn’t yet launched a public website (fairly common for Pre-seed and even Seed companies). Which meant unless the investors had personally seen (and remembered) Eco’s pitch deck, there would be no way to discover the supposed copy-and-paste.
