The challenges associated with founder due diligence in VC funding, highlighting the importance of developing quantifiable benchmarks and standardized evaluation methods to better assess founder potential
Investors are constantly searching for the next startup unicorn, and a significant factor in their investment decision-making process is the due diligence they perform on company founders. In this blog post, we will explore the issues associated with assessing founder potential in VC funding, focusing on the following aspects:
One of the key challenges in assessing founder potential is the lack of quantifiable benchmarks to evaluate founders. Many investment decisions are based on qualitative assessments of the founder's abilities, which are inherently subjective. This can lead to biased decisions and missed opportunities, as well as potentially over-optimistic forecasts.
As American economist Burton G. Malkiel notes, "The problem with venture capital is that we simply do not know how to quantify entrepreneurial talent and judge the chances of success" (Malkiel, 2007). Developing standardized benchmarks for founder evaluation could help mitigate this issue and provide a more objective basis for investment decisions.
Another challenge in assessing founder potential is the absence of normalized evaluation criteria across the VC space. Different firms and investors often use different criteria and assessment methods, making it difficult to compare investment opportunities objectively. This inconsistency may lead to investment decisions being influenced by factors unrelated to the founder's potential success, such as personal relationships or biases.
To address this issue, the industry could benefit from the development and adoption of standardized evaluation methods, such as a common set of criteria or a rating system that assesses founders' strengths and weaknesses.
Personality assessments are commonly used in founder due diligence, despite their subjective nature and the potential for bias. While these assessments can provide some insights into an individual's character, they may not necessarily predict their ability to lead a successful company.
According to entrepreneur and investor Peter Thiel, "Investors should be looking for the business plan, the technology, and the market, not for a founder's so-called 'winning personality'" (Thiel, 2014). This highlights the need to consider a wider range of factors and avoid overreliance on subjective evaluations when making investment decisions.
Off-the-shelf assessments, while easily accessible and cost-effective, may not always be the best tool for understanding a founder's potential to build a successful company. These assessments may lack the specificity and context needed to evaluate a founder's unique skills and experiences relevant to the startup world.
Investing in tailored assessment tools designed for the VC industry and considering a more holistic approach to founder evaluation could help improve investment decision-making.
The value of a founder in a startup cannot be overstated. A founder's vision, determination, and adaptability can significantly impact the success or failure of a company. As Paul Graham, co-founder of Y Combinator, states, "The most important quality in a startup founder is not intelligence or skill, but sheer determination" (Graham, 2009). Furthermore, research by Noam Wasserman (2008) has shown that founders are essential in building the company culture and attracting the right talent, thus shaping the organization's trajectory.
Despite the immense value founders bring to their startups, the process of evaluating and investing in them often lacks quantifiable benchmarks. Developing and utilizing such benchmarks can help investors mitigate risks and make more informed investment decisions.
Quantifiable Benchmarks for Founder Evaluation
Creating quantifiable benchmarks for founder evaluation should take into account various factors that may indicate a founder's potential to lead a successful company. Some potential benchmarks include:
To better mitigate risks and make informed investment decisions, VC firms and investors should consider incorporating these quantifiable benchmarks into their founder evaluation process:
By focusing on quantifiable benchmarks and data-driven insights, investors can make more informed decisions, better understanding the potential of founders and the startups they lead. This approach not only reduces risks but also enables VC firms and investors to support promising entrepreneurs who can drive innovation and create lasting value.