Venture Capital Due Diligence: The Management Team

This is part of GoingVC’s Research Series on Venture Capital Due Diligence

Introduction | The Screening Process | The Market Test | The Scorecard

The Management Test | The Management Team

Product KPIs | Building Product Moats

Accounting 101 | Financial Valuation

Technical Due Diligence

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We last looked at two ways to develop a test to assess the quality of the management team. We now turn to the key attributes of the leadership team to help VCs understand not only what roles need to be filled, but when and what skills are required for success.

To CEO or Not to CEO

Love the product and market but not sold on the team? VCs often struggle with the decision to retain or replace the executive leadership, especially at pivotal turning points in the company life cycle. Of course if the company is looking to raise capital from institutional investors, it is safe to assume the company is likely entering one of these new periods that may require different leadership skills, so these moments often happen in sync.

VCs that bring in seasoned leaders do so to de-risk their investment (and can make it a prerequisite to funding). The downside is the real opportunity costs to undertaking a search, interviewing, and fitting into the culture a new hire, especially at the most senior levels of the company. Past experience and success is not always indicative of future success – especially if the subject company is creating new technologies or markets. There are lots of hidden risks to consider  that quite often outweigh bringing in new management.

Consider if that time would be better spent providing resources to other areas of the company. There are many factors to consider when making this calculus – how quickly is the competition moving? Are there other, larger areas of need?

Two Minds are Better Than One

Startups face a wide range of issues that teams built with a diverse set of skills and backgrounds can likely better tackle than teams who do not. There is little value to overlapping networks, limited breadth of skills, and marginally incremental depth of view points. Complimentary skills and backgrounds are what makes diversity valuable – so find management teams that are diverse yet cohesive. This is where the direct method of assessing management comes in and the ability to observe and report.

Other interesting axes on which to view management diversity is experience in the industry. It may seem obvious that founders and leaders who come from the industry in which their venture operates will have a natural advantage. However, do they suffer from the status quo bias? Would leaders or advisors as part of the management team that come from outside the industry add value from a less biased and outsider view of the problem? Not unlike the value-add of independents on the Board of Directors when it comes to aligning incentives, those who can take a fresh perspective on the space can be valuable contributors.

Assessing the Key Roles and Characteristics

How can VCs develop a process for assessing something that’s inherently hard to quantify? There are key traits and experiences VCs can look for when determining quality. Below we’ll walk through the key roles to develop a framework for this exercise.

CEO

The CEO is the face of the company, yet is often the hardest role for which to identify skills and necessary traits. Past experience again is not always a predictor of future success with CEOs, but it certainly never hurts.

Need to Have Skills

• Leadership: The primary skill of the CEO – being able to lead it’s company through the good times and the bad, fast and slow growth periods, and times of transition.
• Communication: CEOs who can communicate through storytelling, prioritize brevity, and can break down complex concepts into relatable communications are unique and valuable.
• Decision Making: Most important decisions made early on in the life cycle of a company are made singularly by the CEO, so someone who possesses a strong decision making framework will have an advantage.
• Strategic Planning: In the rapid pace of development characteristic of almost all startups, being able to differentiate the forest from the trees and use critical thinking to make strategic decisions is crucial.

Nice to Have Skills

• Money Management and Capital Raising: CEOs who can understand their company’s financial position, the pros and cons of debt versus equity capital, and are able to make sense of financial projections can play a more strategic role in long term planning.
• Market Research: Understanding your competitive positioning can lead to making faster product, people, and pricing decisions.
• Marketing: Being familiar not only with what, but why and how, marketing channels are optimal can help CEOs better understand their target and existing customers, funneling feedback into strategic decisions.

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CTO

The CTO is often the most important role for bringing the concept of an idea to an actual product. Critical to this is not only being versed in the current technology used, but having in-depth knowledge of what emerging technologies may be available to the company in the future.

Need to Have Skills

• Technical Know-How: The most critical skill for the CTO is to be well versed in the technologies used within the company’s products. Also critical is an ability to potentially divorce any biases when it comes to assessing incumbent versus emerging technologies. For example, the Blackberry technology team refused for too long to move away from Java and focus on software over hardware, ultimately watching Apple and Google use better, emerging technologies and open-source their software, spelling the end for the Blackberry phones as they knew it.
• Engineering and Product Management: Skill in managing what and how products get developed is critical – ensuring products come to market (cost) efficiently and are built exceptionally well are hallmarks of a strong CTO.

Nice to Have Skills

• User Experience and User Interface Testing: CTOs who can partake in UX and UI testing and distill customer feedback into actionable takeaways make business analysts and designers lives easier.
• Decision Making: While most major decisions will come from the CEO, technology decisions are often made by the CTO – so in the same sense, having an ability to make strategic decisions are an added benefit for any CTO.

CFO

Spreadsheets. The lifeblood of any early-stage CFO – and critical to validating the business model and eventual capital raises. While companies can often get away with not having a CFO on day one, when it comes time for growth and institutional capital inflows, CFOs play a critical role.

Need to Have Skills

• Financial Modeling and Tools: The CFO should be responsible for implementing the necessary accounting and financial management tools as well as being able to develop proforma financial projections and model capital expenditure projects (for cost/benefit analysis), among others.
• Capital Raising: Determining how, what type, when, and how much capital to raise.
• Master of Financial Concepts: A solid understanding of GAAP principles, cash flow analysis, budgeting, break-even analysis, financial statements, and present value analysis are required skills of any CFO.

Nice to Have Skills

• Inventory Controls: Beyond accounting basics related to inventory such as LIFO versus FIFO and the tax implications, a deeper understanding of the inventory logistics can aid CFOs in projecting budgets related to inventory.
• Marketing Concepts: The CMO should be responsible for maintaining the data relevant to marketing campaigns, but a CFO who can understand the terms such as CTR, CPA, etc. will be better able to make sense of the marketing efficiency and roll up into budget items for the marketing department.
• Market Research: CFOs who can understand how their company is competitively positioned can make better decisions with the management team when it comes to long term strategic decisions.

The Complete Guide to Venture Capital Due Diligence

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CMO

Often an under-the-radar quantitative role, the CMO should have skills that straddle both the qualitative aspects of generating unique marketing campaigns while also possessing the quantitative skills to digest diagnostic data and build processes to synthesize the takeaways into feedback and action plans.

Need to Have Skills:

• Market Research: CMOs and team need to design and analyze market research studies, including user experience testing, A/B campaigns, and advertising strategies.
• Strategic Planning: The CMO is primarily responsible for long term strategic planning when it comes to brand development – from segmenting the target audience to signing off on and budgeting  large marketing expenditures.
• Sales Management: While not directly relating to the marketing management, understanding the company’s sales process and incorporating the key metrics, goals, and progress of the sales department has a direct impact (and vice versa) on the marketing team – and these two teams need to work in tandem for either to succeed.
• Channel Distribution Management: Once the initial marketing strategies are developed and inaugural marketing channels are developed, curating the data and optimizing the distribution to channels ensures the marketing budget and efforts are efficient – and this responsibility ultimately falls to the CMO.

Nice to Have Skills:

• Technological Proficiency: Marketing teams benefit these days from a slew of tools to help automate their efforts, making an ability to understand and implement best-in-class technologies important. CMOs who can wade through the seemingly infinite number of options to find the best technology for their department will have an advantage, and this often requires some basic technical know-how.
• Basic Financial Concepts: Marketing is inherently a numbers-driven process, so being able to relate marketing data to financial data is an advantage when it comes to making strategic marketing decisions.

Ready to go out and identify world-class teams? We hope this primer helps, but it is certainly far from complete. A major trend, as you likely noticed, is the ability in any leadership role to take in lots of inputs, make sense of it, and create clear deliverables.

This skillset, more than any specific one, is likely the best signal for success as a manager. Those who possess this ability likely benefit from being strong communicators, delegators, and leaders – so look for problem solvers above all else.

Companies that meet the market and management test are then move through to the next round of more in-depth due diligence, which cover the entirety of the business and financials.