In order to invest VCs must trust that the entrepreneurs they are backing have the capacity to execute. VCs assess management’s ability in a few ways.

You can demonstrate your ability to think strategically through the quality of your business idea and plan. Your understanding of operations can be illustrated by answering the ‘How’ and sharing your model. Finally, your compatibility is assessed through all of your interactions with the VC. However, knowing that you get along, are capable of executing and really understand your business is not enough. VCs also need to know that you are ethical.

While there are plenty of laws protecting investors from fraudulent activity, unethical entrepreneurs can create lots of problems for VCs. First and foremost, there are always lots of grey ethical zones, where entrepreneurs can choose to create problems for other shareholders without incurring clear legal liability. Second, even if a legal boundary is crossed, the process of taking action is expensive, time consuming and a distraction from other portfolio companies. As a result, it is in the best interest of VCs to avoid making investments in people who are not really team players.

In order to mitigate the chances of investing in unethical management teams, VCs speak to management’s references. References are typically asked about their experience working with the entrepreneurs and through their answers VCs draw conclusions about management’s morale compass.

There are two elements to this test. The first is simply the entrepreneur’s ability to generate a list of people that would be willing to speak on their behalf. If an entrepreneur hasn’t impressed anyone enough with their work ethic and intellect to merit being a reference, then the investor has reason to be concerned.

Second, these references can shed light on the entrepreneur’s ethics. While these references can serve to validate more than management’s moral compass, reaffirmation of the competency of an individual is not typically the primary objective of the call. There is good reason for this.

• First, by the time references are being called VCs have often already decided that the individual is probably talented. This doesn’t mean that references may highlight significant concerns about management’s ability to execute; it’s just that it doesn’t happen often.
• Second, management typically provides the VC with the list of references, ensuring that the VC speaks to people who they believe will say favorable things about their work. However, an old boss that thought the entrepreneur’s work was top-notch may harbor concerns about their ability to be a team player or make ethical decisions. Entrepreneurs are often less likely to be aware of these perceptions because they are typically less integrated in standard feedback mechanism. You can get a promotion or a raise even if your manager wouldn’t trust you to watch their children. This dynamic makes these reference calls more meaningful for testing ethical considerations.

Entrepreneurs and key managers who are progressing through the due diligence process should be prepared to share a list of personal references with investors. Ideally there should be 5-10 names on the list to demonstrate that the individual has made a positive impact on a number of people. The list should include:

• Descriptions of relationships to the entrepreneur
• Phone numbers
• Email addresses
• Time zones (if relevant)