What to think about when you’re bringing on investors
This edition of Inside the Boardroom is Part 2 from last week, where we turned the tables on our Startup Board Course Director, Ashleigh Camm to hear about her background and why she loves facilitating the Startup Board Course. In this Part 2, our Head of Startups, Josh Sharma, asks Ashleigh a final question: what’s important for founders to think about when bringing on investors?
It's tough out there to raise at the moment, and not all of us have the luxury of choice when we're fundraising, but whether you’re taking on first-time investment or wanting to be strategic in later stages, here Ashleigh shares her tips to help set yourself up for success from the outset.
Josh Sharma runs our Startups team which supports pre-Series A startups across legal and accounting - get in touch with Josh if you need support here.
PLUS places are filling fast for our next Startup Board Course cohort kicking off on 14 August 2024 - apply here.
In exploring this, I’ll focus on Venture Capital (VC) funding for simplicity, but to highlight that, at the early-stage, there are other potential funding options, including:
Friends and family;
Angel investors;
Grants;
Revenue-based financing (if you have consistent revenue);
Accelerators and Incubators; and,
Crowdfunding.
All of these options have varying requirements and approaches, and different strategic outcomes for a startup, but in this article, we’ll focus on VC investors and seeking VC investment.
Before we contemplate fundraising from VCs, it helps to know that if you’re going for this type of funding, this is not a transactional relationship where you’re just getting money in the door and that’s it. Bringing on a VC investor, to use the relationship cliche, is more like entering into a long-term marriage where divorce is not really an option.
Depending on how you like to enter into relationships, the startup journey doesn’t often afford us a lot of time to get to know a potential investor, so you’re making a big, life-changing decision, essentially very quickly.
Helping yourself before you get here: understanding the VC business model
Before we get to assessing potential compatibility, it is helpful to understand the foundations of the VC business model, so you know where VCs are coming from. The typical business model of a VC is based on a 10-year fund life where they invest in multiple early-stage companies so that over the 10-year fund life, a few may outperform and deliver out-sized returns, which might enable the whole fund to achieve target returns in the order of around, say, 3x money (3x the money investors initially put into the fund), or whatever the fund’s target return is. We’ve all seen the failure rates of startups, and by their very nature the risk is high, so for a VC the risk needs to be spread via a portfolio approach so that the chances of being invested in the breakthroughs can potentially outweigh what they will lose, or not gain, on the ones that fail or plateau (relatively). This is known as the Power Law.
So, in this manner, a VC is a long-term, strategic relationship that you can expect to last for c. 10 years, if your startup does, and the VC is incentivised to support you to exponentially scale, so your startup has a chance of being one of the ‘breakthroughs’ (or a unicorn), consistent with the needs of their fund.
This may or may not be your idea of success, but if you’re going for VC money, it needs to be, otherwise you’ll be aiming in different directions, and that doesn’t usually work out. Additionally, it’s a long-term relationship that needs to perform, even in the challenging times, so you’ve got to work out what aspects you will need in this relationship to endure, or at least the aspects that you might need to avoid based on your personal preferences.
Identifying what’s important to you in relation to your startup and a long-term investor
Not that all of us have the luxury of choosing our investors, but when starting out, it can be helpful to think about who would be best for you and your startup - things like:
what you as the founder would want in a long-term investor partner;
who would make the most strategic sense for your startup; and,
The strategic growth options that you and your startup will likely need along the way, and making sure you’re not choosing types of investors that might prohibit options for you in the long-term (more on this another time).
An initial framework for assessing compatibility, even before you meet
If we translate this into how founders can assess their likely fit with potential investors, aside from the fundamental commercial aspects that investors need and will assess which we speak to in our article on Investability here, setting yourself up for success as a founder looking for VC investment starts with understanding and getting clear on these three key elements:
Founder needs (investor expertise)
Investor needs (investor drivers)
Compatibility
If you find potential investors in the sweet spot across all three, they might just be a great match.
Let’s explore these key elements:
1. Founder needs (investor expertise)
This is all about identifying your needs as a founder - what would be the characteristics that you would want in a potential investor? Considerations like, but not limited to:
Are they focused on industries and sectors that you operate in?
If not, how important is this to you, or can you see ways that they could bring other benefits (pending the Thesis question below)?
Where do they invest geographically?
How do they support international expansion?
Could they help your company to expand to your target regions?
What experience have they had in your relevant sector/geography?
Are they operators-turned-investors, or little to long-time investors?
Do they have experience that could help you and your startup?
How do others in their industry speak about them, if identifiable?
What other startups are they invested in now or in the past?
Who is in their current portfolio? Past portfolio?
What exits have they had?
Plus any other questions that you may want to ask in relation to what you need as a founder.
2. Investor needs (investor drivers)
If a potential investor has progressed through the above, this is all about identifying their needs, so you know what they are looking for in a founder and startup, and whether that might be you.
In addition to the commercial aspects we outline in our Investability article here, characteristics like, but not limited to:
Similar to the industry and geography question above, but more generally, what is their investing thesis?
Does this align with your startup and the problem you’re solving? If not, this is likely a *deal breaker*.
What stage do they invest in? ie. Seed, Series A, Series B, etc
Does this align with the stage you’re at, or a future stage, and in which case, could you start to get to know them now?
How much do they invest? Do they like to keep capacity for follow-on investments? Could this be helpful? (But knowing these are never guaranteed.)
Is this on par with what you might need? Will they need to co-invest? If they usually do that, who do they usually team up with? Look at past deals to see what you can learn.
Where are they in their fund cycle? Are they raising a new fund, in their investing period, fully invested, or in an exit / divestment cycle?
Will they be able to invest in you in the timeframe you need?
Or is this a potential future investor?
How do they make decisions, and in what timeframes?
Are these clear to you?
Do you know what they will need from you?
Who are their Limited Partners (LPs - a VC Fund’s investors)?
This will help you to understand the drivers of your VC even more, for example: are they a big fund with institutional LPs that will have relatively more stringent reporting requirements (that you may/will have to meet too), or primarily Family Offices, for example, which may need less in terms of reporting?
Plus any other standout attributes that will help you understand the drivers of a potential investor.
3. Compatibility
If you’ve progressed to this stage you’ve ticked feasibility, as in, an investment in your startup could be feasible (setting aside the commercial aspects of the investment decision we mention earlier). ‘Compatibility’ is as it sounds: all about identifying your potential compatibility and whether you think you can work with a potential investor over the long-term.
You may want to think about getting clear on elements like:
Are they aligned with you and your startup’s vision and values? For an early-stage startup, this is also a big part of the investment decision for investors as well. More qualitative considerations here could be:
Your early-stage investors should be your biggest supporters - it’s a c. 8 - 10-year commitment.
Experience aside, have you been impressed by the questions and Due Diligence they’ve done on you? Are they making an effort?
Are they contrarian in any way, and if so, on what, and is it material/how do you view this? Can you ‘forecast’ what may happen in future when this plays out and do you want that?
Do you see them as a collaborator on your startup’s vision?
Can you see yourselves getting along professionally over the long-term?
Do you get along? Can you be yourself around them? Do they like, or at least appreciate, your approach and style? What is your intuition saying?
Can you or are you likely to be able to have hard conversations with them?
Do you see them as a mentor? Do they want to be a mentor to you?
How do they support founders and port coys through the cycle, particularly when times are tough? What can you learn from that?
And explicitly re the above, how have they treated you in the interactions that you’ve had together?
What does this tell you?
Even if you ‘get along’, are there any red flags, like being demanding or dismissive? Will they be manageable?
Plus any other standout attributes that will help you understand whether you think you can build a great relationship with your potential future investor, or even just a professionally respectful one, and what your deal breakers might be along the way.
Going through an exercise like this also helps you to have a ‘prepared mind’ when it comes to thinking about what your needs will be - from a founder and your startup’s perspective - and the kind of investors you’re looking for, which is always helpful and will be appreciated by the right investors too.
From here, you can then rank your potential investors based on feasibility and compatibility preferences, and go from there.
Stay tuned for more on this topic in the future 🚀
Whether you’re a founder or in the management team of a startup, if you want to know more about the ongoing management team <> board <> investor relationships and how they can efficiently and supportively work together over the lifecycle of your startup, we talk about all of this and more in our Startup Board Course - find out more here.
