Perception becomes Reality

I was recently invited to an entrepreneur event to speak about how we (or a typical early-stage VC firm) go about deciding to invest in a startup.

One of the processes that I chose to discuss (or should the verb here be ‘reveal’?) in greater detail was that of reference checks.

So what is a reference check and how do we do it ?

In plainspeak, it is a background check on the Founders through candid opinions shared by people that have known and observed them closely in their professional, academic and personal lives. These opinions are not only collected from connections facilitated by the Founders, but also, much more potently, through feedback collected discreetly without the Founders’ knowledge (also known as backdoor or backchannel references). 

The rationale for this process is fairly simple : 

• Even with the most comprehensive of due-diligence efforts, our understanding of the Founders will never match the observations made by a supervisor or peer in a candid setting over an extended period of time.
• The argument that people who have managed to cultivate good reputations thus far will also continue to do so when it comes to building a solid bond with investors, employees and business partners, is, at least in theory, a hypothesis that is easy to buy in to.

If you, dear reader, are an entrepreneur that have already known of such discreet reference checks, you already enjoy an advantage : Power and glory to you !

But, if you are like most entrepreneurs in the audience that day, your reaction to knowing this is probably a mix of surprise, and the feeling that this process might be discriminatory and biased, throwing the outcome of the investment decision even further away from your comfort zone.

Before I address these issues however, I see the opening for an anecdote that relates to this post in the typically arbitrary way that anecdotes often do.

For the best part of the last 5 years, whenever someone asks me who I idolize, my answer has always been the same : Arnold Schwarzenegger.

One of the most common (and immediate) responses that I get for this is, 

“Oh, you mean the guy who cheated on his wife ? Why would you like someone like that ?”

Many of you reading this might have had exactly the same thought come up in your head. For you, the rest of this post is merely an articulation of the process that led you into making this judgement about Arnold Schwarzenegger.

If, however, like me, you believe that this is a highly unfair verdict on the former Governor of California, the leading movie star of his time, and the most famous bodybuilding champion of all time, then the rest of this post will attempt to drive home an undeniable, and perhaps unfortunate, truth.

Perception becomes Reality.

Image source : Dilbert.com

So how much of a difference can reference checks make ?

In the last 12 months alone, we have said no to at least 6 deals primarily because of poor feedback on the founders over reference calls. It is important to note here that while we might have ended up turning some or all of them down eventually (you can always rely upon a VC to never run out of reasons to say no), the negative feedback precipitated our decision making.

On the flip side, in the same 12 month period, we ended up investing in at least 3 companies where, in each of those cases, we held doubts over the business and its relevance for the market. In each of these cases, we could not overlook the sheer force of overwhelmingly positive feedback that made us submit to the realization that we were backing entrepreneurs that were truly (in our opinion) one-in-a-million. 

Over a more long-term view, we have tended to see similar numbers play out, both in terms of the number of companies we end up rejecting due to poor feedback, or giving the benefit of the doubt to because of outstanding feedback.

So, yeah, the evidence is hard to argue with. 

Reference checks can indeed make the decisive difference between a Yes and a No in an investment decision. 

There is a darker side to this process though, especially from an investor’s asymmetric perspective.

Because negative feedback over a reference call is only typically shared under the condition of complete confidence (Because, you guessed it, people generally don’t want to be known as backbiters or slanderers), it becomes impossible to reveal the true reason or rationale for the justification. 

Therefore, unless there is an extraordinary amount of trust that merits revealing more, the entrepreneur(s) may never come to know that certain individuals in their professional circles don’t think highly of them.

Which brings me back to the aforementioned speaking session and my audience.

Many of them had very pointed and highly relevant questions that sought to either challenge or reconcile the legitimacy of reference checks to the investment process:

• What if the general feedback on me is good but one person has a vested interest in making me look bad ?
• I wanted to be an entrepreneur but did not enjoy working at my previous organization, and my boss knows this ? Will this hurt the feedback he gives me ?
• Do I need to socialize more and become “popular” to get good feedback ?
• Isn’t it unethical to source feedback about the entrepreneurs without their knowledge ?
• Is there any way I can have more control over the reference check process ?

Fortunately, the answers to these questions come as relatively straightforward recommendations : 

- Don’t be difficult

It may sound overly simplistic and old-school but handling yourself with class and grace might still be the simplest way to create a solid reputation. Way too many first-time entrepreneurs adopt behaviors and mannerisms that reek of a shallow attempt to present themselves as a “maverick” or “trailblazer”. It might surprise you just how much people will continue to like you if you are always nice to them (without being a pushover).

Of particular importance here is how founders conduct themselves with investors during the evaluation process, and even more critically, when investors say no. A rejection from an investor is not an open license to give up on decorum. In fact, if handled well, an investor can help you convert the no into a yes.

- Seek feedback (and then act on it)

Chasing continuous improvement through feedback should be on every professional’s to-do list. But the act has some incredibly positive effects for a future reference check.

• A very small proportion of professionals actually take the initiative to seek out feedback from their peers and superiors. That alone will set you apart from the crowd and mark you as an individual with the humility to accept his/her failings and the drive to better yourself.
• Regular feedback helps you keep a tab on shortcomings and areas of improvement (that might otherwise have been revealed over a reference check) and work on them to become a high-performer at work (Which, in turn, makes you highly desirable from a VC’s perspective)

- Don’t make claims you can’t back up

…especially if those claims are refuted by the first person I reach out to for a reference check on you. Need I say more ?

- Use positive references for referrals

Here is a hack that can help you wrest back some control in the (distinctly one-sided) reference check process. 

Do you know people who could introduce you to other VCs and present you in a positive light ? In using them to refer you to other investors, you will benefit from their credibility in choosing to vouch for you.

It is an open secret that VCs love referrals from fellow VCs. We have invested in several deals that were referred to us by friends in the industry. Quite a few entrepreneurs that we referred to other investors also ended up receiving their first investment through that channel.

- Be honest (proactively!)

If all else fails and you are already aware that some of your reference checks are likely to be negative, you might still be able to salvage the situation (to a certain extent, depending on how damaging the feedback is) by having the courage to acknowledge what went wrong and how you plan to improve and address the resulting ramifications. Honesty and self-awareness might yet save the day for you.

Oh, and did I mention you (as an entrepreneur) should also do reference checks on the VC firm you are talking to, and more specifically, on the individual from the firm who is championing your deal ?

If nothing else, it makes the exchange a little bit more fair. 

After all, should we go the distance, I will most certainly not be cutting you any slack on the reference checks.

• Have you read my debut book “VCs are from Venus, Entrepreneurs are from Mars” yet ?
• For more of such posts, head to Shubhankar.co