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Start Ups Need to Do Due Diligence on VCs

JPMorgan prepares for the arrival of Facebook management.
CNBC
JPMorgan prepares for the arrival of Facebook management.

The fallout from Facebook’s disastrous IPO has been swift, no doubt about it. Lawsuits, increased regulatory scrutiny and public relations damage control are all things the Mark Zuckerberg-led social networking giant now has to contend with. But for tech companies waiting in the wings for their moment in the IPO sun, the effects of Facebook’s mismanaged offering are starting to be felt.

Already, there’s talk of other tech companies delaying their stock market debuts. Online travel company Kayak is reportedly postponing its public offering. One of the most anticipated, Twitter, got tongues wagging this week with the leaking of internal revenue projections. Commentators speculated whether they were laying the groundwork for a stock market offering soon. But that’s unlikely, for a variety of reasons, not least being letting the markets’ ire calm down before another tech IPO debuts.

The fallout from Facebook’s botched IPO is also rippling through Silicon Valley. Prominent start up guru, Paul Graham, co-founder of influential incubator Y Combinator, warned earlier in the week, it will now be harder for entrepreneurs to raise money. In an email to start ups, he said they should lower their expectations for fundraising and that some may face lower valuations in subsequent rounds of financing because of less exuberant investors.

Graham’s warning comes at a time when the macroeconomic situation in Europe creates another potential black cloud over the funding market for tech startups. Together, the two forces are potentially potent in driving down valuations for tech companies. The fact is, we are in a bipolar funding environment. As Naval Ravikant, founder and CEO of Angel List, tweeted, “You are unfundable until you are oversubscribed.” If it is a bubble, it only feels like that for a fortunate few.

Another change is how important choosing the right VC has become. Venture capital was originally conceived as a bridge to the public markets. What in the past may have been a short-term marriage of convenience can now feel like a lifetime. The right venture capital partner complements the entrepreneur and his management team with cash, appropriate expertise and know-how and a network of useful contacts. The bad ones can destroy your start up.

How often does an entrepreneur think about whether the venture capitalist he’s pitching to is the right fit in terms of investing philosophy, hands-on management advice and yes, even personality traits? More likely, the entrepreneur is thinking, how much money will the VC invest and at what valuation. The seduction is hard to resist. Yes, there’s talk about partnership and working together, but oftentimes, judgement can be clouded by the need for a cash infusion. Or a brand name.

Just as venture capitalists perform due diligence on start ups they want to invest in, these companies should also do careful research on who their potential backers are. A few meetings aren’t good enough. Checking on references and performing full due diligence is de rigeur. Raising capital from the right venture capitalist can become a significant competitive advantage.

At Business.me, we’ve put together a multimedia interactive directory of the top VC firms in the country investing in Internet start ups. Along with selected videos from these firms (because we think video is a great way to transmit and consume business information), start ups can access links to the social network presence of the key players in each firm. Access to how they think and what they’re thinking about is just as important as how they make their investing decisions.

We started to build the report to have a list of VCs for our own use and we got a bit carried away. We hope it will be useful for other entrepreneurs doing their homework for the next financing round.

Oscar Moreno, repentant investment banker turned tech entrepreneur, is CEO of Business.me, a business video-sharing website that provides tailored recommendations based on users’ professional interests.

Email us at SmallBiz@cnbc.com and follow us on Twitter @SmallBizCNBC.

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