Three Questions Founders Should Ask Scouts Before Taking An Investment

[Stefon voice] “The hottest club in Silicon Valley is ‘Scouts.'” Yup, after Sequoia and a few others funds debuted a ‘Scouts’ program several years back, many firms have lined up their version. The format differs but let’s generally describe Scouts as, individuals using money fully or partially fronted by another VC fund to make investments in early stage companies with hopes of giving the sponsoring fund an advantage in leading a larger round for the startup later on. As Tomio Geron wrote in this week’s WSJ,

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At Homebrew, we don’t currently use Scouts, but generally welcome any investors into syndicates who can provide value to the founders. That said, I’ve got three questions that I recommend founders ask any angels participating in their rounds.

1. Are you a Scout?

You’d think this one is unnecessary but I’ve heard different stories from founders with regards to when individual investors disclose they’re investing someone else’s money. Sometimes not until the wire transfer is in process. Sometimes post-investment. From my perspective, a Scout should disclose upfront, either when requesting a first conversation about an investment or during that first meeting. Every fund says they tell their Scouts to disclose the relationship but I’m not sure it always happens in the same way.

If I were a founder, I’d ask pre-first meeting because I want to know going into a discussion what the motivations and objectives of an investor would be. When a venture fund approaches you, it’s safe to make the assumption they’re investing other people’s money. When an individual approaches you – especially a non-full time investor (Scouts are usually founders or industry operators) – it’s nature to assume the opposite, that they’re investing their own money. Best for everyone to understand this upfront.

2. Are you a Scout for multiple funds? Do I have the option of taking money from just you, or will you only invest from the Scout pool?

Yes, some people are repping multiple funds. The ties in Silicon Valley are complex! Understanding which pools of money a potential investor will be drawing from gives mutual clarity on expectations and goals. It’s also fair to inquire if an angel routinely draws from their own money or are they only investing from the Scout fund. With this information you as a founder can establish the guardrails with a potential investor. You can tell her, “look, I’d love to have you involved but only if you’re using your own capital. Is that possible?”

3. What information about this investment do you share with the sponsoring VC?

This is the most important question of the three. Information is power. If the Scout is passing along your email updates and investor updates to their sponsoring fund, you should know it. This can happen quietly without your knowledge, or because the sponsoring fund is a GP or LP in the Scout fund. Scouts are investing before their sponsoring fund would. For example, pre-seed ahead of a seed, or seed ahead of an A Round. There are other objectives for the sponsoring fund (building relationships with Scouts who could be advisors to their funded startups or future GPs at their fund), but the primary reason is dealflow, access, a first look.

We support mutual transparency during a fundraising process. When you’re out for that next round it really helps build trust if you can give an investor access to raw data, a narrative about what’s working and what’s not, and a sense of momentum. But you want to do this on your terms and timeline. If there’s a Scout on your cap table and you don’t know it, or don’t know what information they’re sharing – written, verbal or otherwise – it handicaps you as a founder. If you take money from a Scout, I think it’s perfectly reasonable to expect that Scout to signal to their sponsoring VC about how things are going. And as a founder, this is the risk/cost/benefit (depending on how you see it). I do not think it’s fair to have the Scout transfer founder updates or company information verbatim. Especially since it’s possible the sponsoring VC has an investment which might be competitive. As a founder you might think in general about not giving information rights or detailed updates to individual investors/Scouts if you’re not 100% confident in their transparency (although to be honest, I’d strongly advocate not taking money from any investor you don’t trust to begin with!).

So, overall the presence of Scouts is a GoodThing, in that it enables more people – especially those early in their career, women, PoC, etc – to become value-add investors in startups. As a founder just realize what you’re signing up for and make sure you understand what working with a Scout means.

Update 7/20: Sequoia’s Roelof Botha, one of their managing partners and the originator of their Scout program (and, disclosure, a grad school classmate of mine), notes that their firm doesn’t ask for information rights from their Scouts.