Fundraising Out Loud #6: asking Level 3 diligence questions

October 14, 2022

I’m surprised by how many lazy questions investors ask.

I also get asked some very good ones. And I appreciate that there are many ways to conduct due diligence, and that asking questions may not be the most important skill for an investor. But experiencing the range of questions is making me realize how really good questions can filter out the me-too from the authentic and differentiated.

There are several ways for a potential investor to ask about a topic. Let’s take impact as an example:

  • Level 1: what impact metrics do you report on?
  • Level 2: what is your impact evaluation and measurement process?
  • Level 3: walk me through an example from your Fund I portfolio that demonstrates your approach to impact? (follow up question: what’s an example of passing on an investment because of your impact process?)

The difference between the amount of detail required to answer a Level 1 question and a Level 3 question well is massive. Level 3 questions demand world class answers with details, stories, and data. Level 1 questions get Level 1 answers.

Sitting in the hot seat of raising, I love getting asked Level 3 questions. They create opportunities to tell stories that highlight specific examples of what we’ve achieved, how we work and think, and who we are. Similarly, having stumbled in answering a Level 3 question, I’ve also realized how important they are in doing diligence.

In contrast, when I get a Level 1 question, it feels like the potential investor is at best checking off a box on their list, or at worst genuinely not sure what good looks like.

In the spirit of reflecting on what it’s like being on the raising side of the table so that we can be better investors, here’s what I’m learning about how and why to ask Level 3 questions.

Level 3 questions focus on leading not lagging indicators

Naturally, we often get asked about the performance of our first fund. A Level 1 question sounds like, “what’s the mark-up on Fund I?” We can of course answer this question, and often providing the number is sufficient and the conversation moves on.

But it feels like so much valuable territory is left on the table unexplored.

It’s analogous to a VC asking a startup about revenue, and then moving on after hearing the number. It’s important, but for early-stage investing (like recent vintage funds), it’s a lagging indicator and by no means tells the whole story.  

A Level 3 question instead focuses on leading indicators. For example, “tell me about the leaders in the fund I portfolio, why you think they’ll be successful, and how their performance aligns to your initial investment thesis?”  

Level 3 questions tease out (multiple) examples

One thing we emphasize that’s different about Tenacious is how we’re thesis-driven. We not only evaluate and respond to everything that comes in the top of our funnel, but we also proactively do research on areas of potential interest and publish our learnings.

Based on how investors respond when I say we’re thesis-driven, I suspect they’re skeptical. They’ve asked other VCs who didn’t have examples. When we get asked, we handle it by sharing things like this and this and this. The key is that we have multiple, strong examples.

A Level 3 question asks for a specific example, and then another. The second best example- both what is said as well as what isn’t- often reveals a lot more.

Level 3 questions get people to think, not just talk

The other day a potential investor asked me about the most challenging lesson I’ve learned during the Fund I journey so far, and what we would be doing differently as a result for Fund II.

I had never been asked this, and I really had to stop and think about my answer.

Level 3 questions, like this one, go beyond rehearsed answers and create opportunities to evaluate how people think, not just what they say.

Level 3 questions are an opportunity

One of the reasons I made the commitment to fundraise out loud is because it provides a forcing function to make time each week to reflect on what I’m learning, and in doing so, become a better investor.

Asking a lazy question doesn't make an investor a bad investor. It's just a missed opportunity to gather the best information. To distinguish between clever, persuasive talkers who don't have the goods, and the teams that do have the goods, no matter how smooth or polished they present.

Experiencing all different levels of questions has made me realize how important Level 3 questions are for due diligence. Level 3 questions create opportunities to identify differentiated strategies, filter out me-too strategies, and build relationships.

What’s your favorite Level 3 question?

This is the fifth post in our “fundraising out loud” series. To learn more about investing in Fund II and our vision for a digitally-native and climate resilient food system, get in touch here. Early-stage agri-food tech startups looking for funding, reach out here.

Disclaimer: The information in this post is not investment advice or a recommendation to invest. It is general information only and does not take into account your investment objectives, financial situation or needs. Before making an investment decision you should read the information memorandum and seek financial advice from a professional financial adviser. Whilst we believe Information is correct, no warranty of accuracy, reliability or completeness is given, except for liability under statute which cannot be excluded.

Key takeaways

  • Asking lazy questions is a missed opportunity to gather the best information
  • Level 3 questions focus on leading not lagging indicators, and get people to think, not just talk