Cup of Zhou

Recently I’ve been hearing a lot of power law this, power law that. And you guessed right, that’s VC and LP talk. Definitely not founder vocabulary. Simply, that 20% of inputs lead to 80% of outputs. For instance, 20% of investments yield 80% of the returns.

Along a similar vein… what about questions? What 20% of questions lead to 80% of answers you need to make a decision? Or help you get 80% of the way to conviction in a deal?

‘Cause really, every question after those delivers only marginal and diminishing returns. And too much so, then you end up just wasting the founder’s or GP’s time. As the late Don Valentine once said, “[VC] is all about figuring out which questions are the right questions to ask, and since we don’t have a clue what the right answer is, we’re very interested in the process by which the entrepreneur get to the conclusion that he offers.”

While I can’t speak for everyone, here are the questions that help me get to 80% conviction. For emerging GPs.

I’m going to exclude “What is your fund strategy?” Because you should have either asked this at the beginning or found out before the meeting. This question informs if you should even take the meeting in the first place. Is it a fit for what you’re looking for or not? There, as one would expect, you’d be looking into fund size, vertical, portfolio size, and stage largely. Simple, but necessary. At least to not waste anyone’s time from the get go.

Where are you at as a GP by Fund III? What does Fund I and II look like by Fund III?

Discipline. In the first 4 years of a fund, you’re evaluated on nothing else except for the discipline and the prepared mind that you have going in. All the small and early DPI and TVPI mean close to nothing. And it’s far too early for a GP to fall into their respective quartile. In other words, Fund I is selling that promise. The prepared mind. Fund II is selling Fund I’s strategy and discipline. Fund III, you’re selling the returns on Fund I.

Vision. Is this GP thinking about institutionalizing a firm versus just a fund? How are they thinking about creating processes and repeatability into their model? How do they think about succession and talent? And sometimes I go a few steps further. What does Fund V look like? And what does the steady state of your fund strategy look like?

What value do you bring to your portfolio companies?

This is going to help with reference calls and for you to fact check if an investor actually brings that kind of value to their portfolio companies. So, in effect, the question to portfolio companies would be: How has X investor helped you in your journey?

On the flip side, even during those reference calls, I like asking: Would you take their check if they doubled their ownership? And for me to figure out how high can they take their ownership in a company before the check is no longer worth it. There are some investors who are phenomenal $250K pre-seed/seed checks for 2.5-5% ownership (other times less), but not worth their value for $2-3M checks for the same stages. To me, that’s indicative of where the market thinks GP-market fit is at.

I also love the line of questioning that Eric Bahn once taught me. “How would you rate this GP on a scale of 1 to 10?” Oftentimes, founders will give them a rating of 6, 7, 8, or if you’re lucky 9. And the follow up question then becomes, “What would get this investor to a 10?” And that’s where meaty parts are.

Of course, it’s important to do this exercise a few times, especially with the top performers in their portfolio to truly have a decent benchmark. And the ones that didn’t do so well. After all, our brand is made by our winners. And our reputation is made by those that didn’t.

In the trifecta of sourcing, picking, and winning, this is how GPs win deals.

How do you resolve conflict or disagreement in the partnership?

This is really prescient in a partnership. Same as a co-foundership. If someone says, we never disagree, I’m running fast in the other direction. Everyone disagrees and has conflicts. Even twins and best friends do. If you don’t, you either have been sweeping things under the rug or one (or both or all) of you doesn’t care enough to give a shit. Because if you give a damn, you’re gonna have opinions. And not all humans have the same opinions. If everyone does, realistically, we only need one of you.

Hell, Jaclyn Freeman Hester even goes a step further and asks, How would you fire your partner?

Personally I think that last question yields interesting results and thought exercises, but lower on my totem pole (or higher if you want to be culturally accurate) of questions I need answers to in the initial meetings.

How are you finding companies? How are you building your pipeline?

This is always a question I get to, but especially valuable, when I ask it to spinouts. Building a repeatable and scalable sourcing pipeline is one of the cruxes of being a great fund manager. But in the age when a lot of LPs are shifting their focus to spinouts from top-tier funds, it’s an important reminder that (a) not all spinouts are created equal, and (b) most often, I find spinouts who rely largely on their existing “brand” and “network” without being able to quantify the pillars of it and how it’s repeatable.

For (a), a GP spinning out is evaluated differently than a partner or a junior investment member. A GP is one who manages the LP relationships, and knows intimately the value of what goes in an LPA, on top of her/his investing prowess. And the further you go down the food chain, the less visibility one gets of the end to end process. In many ways, the associates and analysts spinning out need the most help, but are also most willing to hustle.

Which brings me to (b). Most spinouts rely on the infrastructure and brand of their previous firm, and once they’ve left, they lose that brand within a year’s time. Meaning if they don’t find a way or have an existing way to continue to build deal flow, oftentimes, they’ll be left with the leftovers on the venture table. This question, for me, gives me a sense of whether an investor is a lean-in investor or a lean-back investor. The devil’s in the details.

What are the top 3 reasons I shouldn’t invest?

This is a test to see how much self-awareness a founder/GP has. The most dangerous answer is saying “There are no reasons not to invest.” There are always reasons not to. The question is, are you aware of them? And can you prioritize which risks to de-risk first?

In many ways, I think pitching a Fund I as illustrating the minimum viable assumption you need to get to the minimum viable product. And Fund II is getting to the minimum lovable strategy (by founders and other investors in the ecosystem). And with anything that is minimally viable, there are a bunch of holes in it.

Another way to say the above is also, “If halfway through the fund we realize the fund isn’t working, what is the most likely reason why?”

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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.