The venture capital (VC) product has long been defined in terms of capital and value-add. This leaves aside important nuances that need to be acknowledged. What exactly are the differences between investors and what traits do founders value most? Which factors contribute to and ultimately determine founder-investor fit?
Now more than ever, the founders that are being perceived as high-potential are faced with oversubscribed funding rounds and have to select which investors receive an allocation and which do not. In making this decision, different founders take into account and then prioritize different factors. As an emerging investor, you need to think about your value proposition to founders – the features, benefits and overall experience associated with your investment – in as much detail as possible and then be prepared to articulate it succinctly. The goal is not to claim to offer everything to every founder profile but rather to identify your strengths, decide what you won’t do and clarify your position in the market. As a starting point, here are some key questions you need to have an answer to.
What process do founders have to go through to get to an investment decision?
How straightforward is it for founders to find out if you are committing to investing in their company? While fundraising is very much part of a founder’s role, it is far from being their only focus and I’m yet to meet a founder whose main motivation for building a company is the thrill of fundraising.
As an emerging investor, it’s definitely worth spending time refining your decision-making and investment process, particularly with regard to what the different stages are and what the founder should expect. Provide founders with an overview of your typical process, the key decision-making factors and the overall timeline. Communicate effectively along the way so that they know where in the fundraising process they are and what to expect next. This can help you stand out in an industry where there’s still a lack of clarity and transparency.
A shared vocabulary and semantics are also essential. Make sure that the way you phrase a yes, a maybe, or a no is clear enough. Time is valuable so timely responses – including a quick no when you know early on that there’s no fit – are appreciated by founders.
How much capital are you looking to contribute to a funding round?
Founders often think about the investors’ ticket size in relation to the total size of the round they are raising. In doing so, they are aiming to find a balance between having a manageable number of investors – not too many – and offering an allocation to a relevant and varied enough selection of them – not too few.
As an investor, if your strategy is to invest small amounts of capital per company, relative to their capital requirements at the time, do put the ticket size in context and show founders why it would be worth engaging with you. A good place to start is by articulating what you can bring to the round beyond the capital. You should also be mindful of bespoke due diligence requests and how much time and effort you’re demanding from the founders. When founders optimize for raising the total amount needed and closing the round, small ticket size investors with disproportionate demands run the risk of being left behind. Due diligence efforts aside, small amounts can, in theory, easily be accommodated and help generate momentum early on. In practice, however, investors who can commit larger amounts tend to have more negotiation power and might ask founders to give them an ownership stake in the company that doesn’t leave enough room for the other, smaller-ticket size investors who have expressed interest in the round.
For emerging investors, a degree of flexibility when it comes to ticket size – especially being able to slightly reduce it – and a collaborative spirit can go a long way in building long-term relationships within the ecosystem.
What are the terms and expectations associated with the capital you provide?
Founders are keen to engage with a number of different investors. Some of whom negotiate terms and (co)lead rounds, others who follow. You need to decide if and under what circumstances you are comfortable being in each of the two categories.
Emerging investors should educate themselves with regards to the terms that are considered standard in their market and should be careful not to introduce less founder-friendly ones if they want to stay competitive. The key concepts to keep in mind, as detailed in Brad Feld’s and Jason Mendelson’s book, Venture Deals, are economics and control. Economics refers to the returns that you will get in a liquidity event and the terms that directly impact that return. For example, price/valuation, dilution, warrants, liquidation preferences, pay-to-play, vesting, employee pool, and anti-dilution. Control refers to the mechanisms that would allow you to exercise control over the company. Terms to look out for refer to the board of directors, protective provisions, drag-along rights and conversion.
Beyond the agreed terms, founders’ and investors’ expectations can differ significantly. If you’re new to startup investing, take some time to familiarize yourself with the space, understand the risk profile and the uncertainty that surrounds startup journeys, so that you don’t impose unrealistic expectations on the founders you invest in. It’s important to understand that there’s no guarantee of success, despite the founders’ best intentions and efforts.
It’s worth thinking about what would constitute a good outcome for you as an investor and the time horizon associated with it. This will be linked to the size of your fund or the total amount of capital you want to deploy and to the way you’re thinking about portfolio construction. Share your expectations with the founders so that you are on the same page and prevent core misalignment.
What is the prospect of future capital like?
Founders like to understand if the investors they engage with are setting aside reserves for follow-on and what their approach is to deciding which of their portfolio companies will receive their continued capital support. Typically, founders welcome the prospect of future capital from their existing investors. If investing in subsequent rounds that portfolio companies might be raising is not part of your strategy, make it clear to founders early on. It’s rarely a deal-breaker. Also, if later-stage investors are aware of your strategy, there should be no negative signals with respect to the quality and performance of the company when they next go out to raise without further investment from you. Alternatively, if following-on is part of your strategy, be prepared to discuss the circumstances under which you will provide a portfolio company with further capital.
Beyond clarifying your follow-on strategy and potentially providing more capital directly, you can also consider supporting founders in raising capital from other relevant investors.
How are you planning on using your experience and expertise in their support?
There are many ways to think about the support you could offer founders. You can start by breaking it down into skill-specific (e.g. marketing, business development, hiring, fundraising, culture building, technical/ strategic guidance), stage-specific (a pre-seed founder has different focus areas than a post-Series A one) and sector-specific support. This support can be provided by you as an investor or be available in-house through experts who work with you, perhaps as part of a dedicated post-investment platform team.
Be careful not to overpromise and then underdeliver. Founders are tired of investors that claim to add value and then fail to so in the way they conveyed pre-investment or worse – end up being a nuisance. Be realistic about your availability, the time you’ll be able to dedicate to the founders and the nature of your support. Are you going to be joining the board or supporting founders more informally? Are you planning to offer bespoke one-on-one support or access to standardized best practices and templates? This decision will be influenced by many factors, including your investment strategy and portfolio size, the human resources you have available and whether investing and supporting founders is a full-time job rather than something you do alongside other commitments e.g an operator who is doing angel investing on the side.
How can you structure and leverage your network?
Beyond supporting companies directly, investors can provide value by increasing access to relevant people and companies. These can be potential customers, talent, or other investors but they can also be experts who can provide skill-specific, stage-specific or sector-specific support. Investors who want to include their network as part of their offering to founders should think about how to organize and identify the most relevant matches. While a certain level of serendipity could prove to be useful, highly targeted and relevant introductions should be the norm as they make the most out of founders’ precious time.
What does it mean for a company to be associated with you and your brand?
Early in a company’s journey – when reliable data points are not readily available – associations with well-known and well-respected investors can act as validation, sending a positive signal to the rest of the market. This can further impact fundraising, talent and customer acquisition.
As an emerging investor without an existing platform and brand, the process of making a name for yourself in the industry – and potentially acting as a stamp of approval for your startups – can be daunting. The idea of deliberately trying to develop a brand may seem artificial to you and, given the long feedback loops in the venture industry, you won’t really be able to let your portfolio speak for itself for quite a while. One way to start is by thinking of two layers. The first relates to the information about you that’s publicly available: from your background and the initiatives you’re part of to the views you’re expressing and the credibility and relevance conferred by those. The second relates to how people you engage with directly perceive you and word-of-mouth: the reputation you’re building one interaction at a time. Decide how much time and effort you want to spend on the former but don’t neglect the latter.
Keep pushing the flywheel, be authentic and lift others in the industry up. With time, this will positively impact your reputation and the brand you can lend to startups.
What kind of relationship do you look to establish with founders?
For a founder, picking an investor is both a functional and an emotional decision. The rapport you establish with the startup early on can be indicative of the future relationship. Strive to have a healthy relationship with founders. Building and scaling companies is hard enough without dysfunctional partnerships led by overbearing investors. Trust, respect and shared core values should be the norm. As should open and honest communication, especially during challenging times. Beyond that, think about the type of relationships you would like to have with the founders you invest in. Do you want to be the first person they call when they face a challenge or would you prefer to have more structured and pre-scheduled engagement? Does your approach to investing include a mentorship or coaching component, or is it more about backing the founders with capital and then getting out of the way, perhaps trusting that others will fulfill that role?
Be prepared to share with founders how you typically prefer to engage with your portfolio, your expectations and the roles you can play in the context of their wider investor base. Keep in mind that it’s a long-term evolving partnership and that your role will likely change with time.
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