I want to share with investors a tried and tested way to get a complete picture of the entrepreneurs who they’re backing. Reference checks are a very important part of the research process before making an investment because they help investors who haven’t worked with an entrepreneur before understand how the entrepreneur dealt with business and life challenges in the past. And unlike the stock market, I’ve discovered that the past behavior of people is often a pretty good indicator of their future behavior. Since a founder’s future behavior will determine the fate of their startup, investors benefit from knowing what to expect.
The problem with reference checks is that the references are traditionally provided by entrepreneurs. Since entrepreneurs have a clear incentive to portray themselves favorably, they guide investors to those references who they know will vouch for them. A potential solution to the resulting positivity bias which references show is to explicitly ask the reference to describe an area in which the entrepreneur can improve. This usually takes the form of a personal attribute which is supported by an example of when the entrepreneur displayed the attribute. However, this rarely solves the problem of the positivity bias. Since the reference remains favorably disposed to the entrepreneur, they describe an attribute which may have a negative connotation but support it with an example of the behavior which had positive consequences.
A classic example is that the entrepreneur is a perfectionist. Perfectionism can lead to a willingness to do everything very well and hence an inability to prioritize what’s truly important. This can have disastrous consequences in the hectic environment of a startup. However, the example provided by the reference is rarely along these lines. Instead, it tends to showcase how the entrepreneur stayed up until 6 AM one morning to deliver a product to a customer’s front porch, and how that customer later became the company’s biggest revenue source. In other words, the perfectionism almost always has a positive consequence.
A better solution to the positivity bias inherent in the traditional model of reference checking is to speak to those people who have a neutral or even negative view of the entrepreneur. There are two ways to do this. You can either find these people yourself, for example by searching for prior colleagues on the web or requesting the names of other people who the entrepreneur worked with from the original references. Since this approach sidesteps the entrepreneur, it can result in a breach of trust if the entrepreneur discovers that you’ve contacted their prior colleagues without their permission. And it’s usually not a question of if, but when.
My preferred approach is to be transparent and directly ask the entrepreneur to provide references who will portray them in a neutral or negative light. Everyone has people with whom they didn’t click, or situations where they wish they had behaved differently. As a result, if an entrepreneur refuses to provide neutral or negative references, or does provide them but the references are also invariably positive, investors get a pretty good signal that the entrepreneur is hiding something. On the other hand, if the entrepreneur does provide the references and they do indeed help paint a more balanced picture, investors get a pretty good signal that the entrepreneur is comfortable with their past and open to criticism. As an investor, these are the entrepreneurs who you want to consider backing.