In the dynamic world of startups, venture capitalists (VCs) are vital. They provide the necessary funding, mentorship, and network connections that help startups thrive. However, not everyone who claims to be a VC genuinely fits the bill. Some individuals adopt the title for the cachet, to enhance their resumes, or to access deal flow, without the true capacity and at times intent to support startups. These “pretend VCs” can create significant issues for founders, leading to financial distress and wasted time.
The Impact of Pretend VCs
Pretend VCs may agree to funding terms without having the necessary committed capital to back their commitments. This can leave startups in precarious positions. When expected funds fail to materialize, founders may face a cash crunch, forcing them to take drastic measures such as reducing headcount, taking out predatory loans, or delaying payments to suppliers. Such financial instability can derail a startup’s growth trajectory and add immense stress to the founders.
Beyond financial strain, the time and effort spent in negotiations and due diligence with pretend VCs is a significant lost opportunity. This time could have been better spent securing funding from genuine investors who have the resources and commitment to support the startup.
How to Identify Pretend VCs
To avoid the pitfalls associated with pretend VCs, founders must perform diligent background checks. Here are some critical questions that can help differentiate a true VC from a pretender:
- What capital do you have committed where there is a mandatory capital call?
- True VCs manage funds with committed capital, ensuring that money is available when needed. Pretend VCs often lack such committed funds, relying on unsecured or ad-hoc commitments.
- Do you have full decision-making authority on the investment, or do you need to go back to your investors?
- Genuine VCs typically have the autonomy to make investment decisions within their fund’s mandate. If someone needs to seek approval from others, it may indicate they lack real decision-making power
- Who are your investors – are they institutional or individuals?
- Institutional investors bring credibility and stability. They perform rigorous due diligence before committing to a fund. Investors who are primarily individuals or less-known entities might signal less certainty. Particularly be careful of individuals whose limited partners (LPs) are simply mom and dad.
- What is your process for closing and funding this investment?
- Understanding the investment process provides insight into how well-structured and professional the VC’s operations are. A well-defined process indicates experience and reliability
- May you please introduce us to other founders in your portfolio company?
- Speaking with other founders who have received funding from the VC can provide real-world insights into their behavior, reliability, and the value they add beyond capital.
Transparency and Trust in the Startup Ecosystem
It’s essential to acknowledge that all investors and supporters of the startup ecosystem are welcome. Diverse forms of support, from financial investment to mentorship and networking, are crucial for a vibrant entrepreneurial landscape. However, transparency about one’s limitations is paramount. Potential investors must be upfront about their capacity and constraints, allowing founders to make informed decisions.
In conclusion, while the presence of pretend VCs is a concerning reality, founders can protect themselves by asking the right questions and conducting thorough due diligence. Ensuring engagement with true VCs who possess the commitment, resources, and decision-making authority is crucial for the success and stability of startups. Transparency and honesty from all parties involved can foster a healthier, more trustworthy startup ecosystem.
If you have questions about identifying the right investors for your company please send me a line at frankie@riseattorneys.com.
