There is a mystique about “warm introductions.” The phrase describes the referral of an emerging company to a venture capital source through a contact who is familiar with both parties. Examples of such mutual contacts include entrepreneurs and professional advisors who are trusted by both the founders of the company seeking money and a principal in the venture fund.
The key is “trusted.” Both parties must trust the referring source that:
- She understands the business of the company and the investment criteria of the fund in order to make a good match.
- She knows well both the company’s management team and the partners of the VC fund, because the referral assumes compatibility, confidence and integrity on both sides.
It’s kind of like matchmaking in the romantic sense. The better the information, the better the match.
A critical assumption of romantic introductions is that, without the matchmaker, the two parties would never meet and an opportunity for a great relationship would be lost. In the financing world, however, warm introductions are helpful, but not critical. They are merely an easier way to put a company looking for money in front of a possible funding source. In other words, it is simply a means of improving the quality and quantity of deal flow. In exchange, the referral source expects some reciprocity: professional employment, recommendations for a board seat, or perhaps simply the maintenance of a good friendship.
Matchmaking between companies and VCs is very hard. Unlike a dating couple, the relationship between funds seeker and funds provider is not one of equals: the VC holds most of the cards. The VC has far more choices to establish an investment relationship (i.e. deal flow) than your typical start-up or high growth company, Facebook, Instagram and a few other “hot” companies excepted. Warm introductions are intended to break through the noise of the thousands of deals flowing across the desk of typical venture capitalists.
Let’s face it. Warm introductions are a normally a free alternative to matches put together by business brokers or investment bankers. However, as they say, you get what you pay for. In the case of warm introductions, the person making the introduction receives nebulous benefits and generally is only willing to spend a small amount of time ascertaining the fit between company and VC. In comparison, a good investment banker or broker earns his rich fee by doing research on both sides of the transaction and following up on each introduction. Curiously, VCs are typically hostile to deals presented by professional intermediaries. They don’t want their investment capital to pay brokerage fees.
Is there a lesson here for the entrepreneur? There surely is. If an entrepreneur wants the warm introduction to be valuable, he or she should be the one doing the research on the potential venture capitalist targets, as well as his matchmaker. He needs to make sure that:
- The VC fund that he wants to approach focuses on the particular business segment that his company is pursuing.
- He identifies the specific partner in the VC fund who is the expert in his industry.
- He verifies that the VC fund has no competing investment already in place.
- He puts together a compelling executive summary which even an ADD-afflicted venture capitalist will read.
- Most importantly, he ensures that the purported matchmaker has genuinely good contacts with the individual having the subject matter expertise at the VC fund and can break through the noise to get a good hearing.
These are not easy tasks. However, only through accomplishing all of them could the entrepreneur be sure to properly utilize a warm introduction.