June 20, 2022

VC Explained: Diligence Process

VC Explained: Diligence Process

It’s been a while since I last wrote in this series, meaning to democratize how venture capital works. See my stories here on how we find companies and the best way to tell a VC-oriented story. I’m finally getting around to another topic - how do we decide to make the investment?

Now - to be clear here, every firm is different. I’ll give some insight into how HPVP does this work, which definitely starts with the first conversation (go back and read the storytelling entry for more information here). There are some funds (and definitely a lot of angel investors) who will cut a check after the first conversation. They like you, they like the idea, here’s some money. That is fantastic - but tends to be smaller checks that won’t necessarily enable you to raise the amount you want to or should. They’re also probably cutting a lot of checks - and so if you’re looking for a deep relationship and guidance from your investors, they might not be the ideal partner.

There are also a lot of thesis-driven funds - funds that focus on a particular functional area (say, fintech or healthcare) and then within that specialty have highly developed points of view about what an interesting idea or investment looks like. They’ve spent a lot of time researching a corner of the industry, have a sense for all of the major players, the holes in the market, etc - and may be talking to you because what they saw just from publicly available information (or heard through the grapevine) was close to their hypothesis. In that case, much of the research about the market opportunity is done ahead of time, and they want to learn about you as a founder, the deep details about your product, and see how you’ve executed so far - so will spend more time digging in there. 

Hyde Park Venture Partners is neither of these things. We do relatively deep diligence on companies prior to investment, and it can take anywhere from a couple of weeks to a few months to make an investment decision once we’ve decided to start digging in. We are also a generalist fund - we all know a little about very wide range of topics, but are true experts in very few areas.The latter means that when we see something new that sounds interesting, we need to get up to speed on it quickly and form a perspective, even without all the information

In the diligence process, there are four core things I’m looking to build a firm perspective on. Three of them we’ve definitely talked about in the first call - the team, the problem/solution, and the evidence of success. The fourth is the market opportunity, which we may or may not get to in the first conversation. For each of these areas, I’ll dig in via a process that sometimes involves you as the founder, and sometimes does not. And while the exact things I’ll ask for vary from company to company, there’s a general outline of what I look for each time. 

One other note - even with some interest, we might not dig in after the first call - we might decide to check back in a few months to see how things have progressed, and then if we like what we hear, start the diligence process. We’ve invested in companies before that we first met years before actually cutting the check. 


This one is the easiest to diligence, because it mostly happens as I continue to have conversations with the founder. Via 1:1 and group conversations, I want to believe that you have the skills, experience, temperament, and leadership abilities to grow a successful company. Sure, it’s partly based on your previous track record, but (especially for less experienced founders) it’s often much more than that. Can you dig in extremely deep into the problem with me? What’s your handle on the questions I’m asking? Would I encourage my friends or coworkers to work for you? Have you thought deeply about the roadblocks you might face? Is the team balanced, and able to resolve conflict? All of this doesn’t come from any external sources - it’s entirely my impression of you via our direct interactions. While some firms do this differently, after we issue the term sheet, I’ll do some post-term sheet reference calls on the founding team - both for people you tell me about and some back-door references - to confirm that yes, the people you’re about to place a big bet on are exactly the people you believe them to be. One thing to realize - if I decide not to invest because of any of this, I almost definitely won’t tell you about it outright! Sorry, but that’s the truth. 

Problem / Solution

Obviously, getting an understanding of the problem you’re working on and the solution you’re building for it is important! Diligence wise, if you have software, I’m definitely asking for a demo of the product during my process. The next parts of my diligence process here will likely happen without your direct involvement. I’ll do some desk research - see what the internet says about what you’re doing. At Hyde Park, we also prioritize finding people to talk to who we know but you don’t who are experts in the space to get their perspective on the problem and potential solution. Questions, pitfalls - and do they agree that this is a big problem. In an ideal world, these are potential customers of yours - and if it’s a positive call, we’ll ask if they’re open to an introduction to learn more. Most VCs ask if they can be helpful (it’s almost a meme at this point) - but honestly, we try to during the diligence process because selfishly it helps us too! If we can sit in while you pitch your product to a customer, we’ll learn way more about the value prop than we could otherwise. If we have a number of calls with experts in the space and get negative - or even neutral - feedback, then that’s almost guaranteeing we’ll pass, and we’ll tell you so. 

Evidence of Success

Ah, the famed “Data Room”. While everyone looks for different things in it, I’ll tell you what I’m not super concerned about at this stage in the game - your cap table, your 5-year projected financials, your legal operating documents, or your last 2 years of financial statements. It’s not that I won’t look at it - I will, eventually, but they don’t tell me anything about how your business is actually doing. Here’s what does - your revenue, and specifically, how it’s grown over the period you’ve been in operation. How many customers you have, when you added them, the size of your contracts, and whether any of them have churned. If you’re B2C, I care a lot about your retention rates. If you’re doing enterprise sales, I want to know about your sales cycles, and your ability to land and expand. Any data you have to support any of these questions, I’ll take a look at. If you’re growing quickly (2-3x YOY+) and your customers are sticky, then I’ll keep digging. I won’t ask to talk to any of those customers until after the term sheet - the last thing I want to do is interrupt your sales cycles or create any issues for you with them - but will want some customer references very late in the process. 

Unrelated to customer evidence of success, I’ll also take a look at the org chart - a big piece of the evidence is your ability to recruit talent, and so if you’re able to demonstrate that, perfect.


This is the other area where I’ll dig in mostly without your participation. The same experts and potential customers I’m talking to about the problem and solution will likely have a perspective on competition, whether the market is ready and excited about a solution like yours, and how much they’d be willing to pay (which is important for market size), and so I’ll ask them. I’ll also look into how big the market is (top down, and bottoms up - and no, I won’t trust the numbers you give me). If you’re in a smaller market (still needs to be sizeable!), I’ll do a lot to validate this can get to a pretty big slice of that market. If you’re in a giant nominal market, then it’s about positioning and timing - how are you differentiating, and are there market forces (consolidation, regulation changes, new entrants, etc) that will make your success easier or harder. If you’re in a greenfield space, I’ll try to figure out the states of the world where your version of the future will be the champion. 

For all of this - I’ll ask you detailed questions about it! I want to figure out how our perspectives are the same or different after I learn more. Feel free to challenge me about my conclusions about what I’ve learned! Strong perspectives are good, and none of this happens in a vacuum. 

I hope this helps with your next raise - there’s no reason for any of it to be a secret!