Bring Investors Along
Understand an individual investor's motivations to triangulate the storytelling around your business.
Greetings! We hope the past two weeks have been splendid and you’re gearing up for the last week before the unofficial start of summer, Memorial Day!
💭 Thought Bubble: People Before Pitch
The theme of relationship building and understanding the other person’s perspective surfaced in several very different discussions this week. In many cases, general assumptions were being made about what the customer needs or what the investor likes to invest in without taking the time to understand the nuances of that person and/or organization.
It got me to thinking about a common mistake I see early-stage founders make when approaching investors—jumping straight to the pitch. They skip over asking the investor about the firm, if the fund has a focus area, or any other details. I get it. The pressure of trying to bring a fundraising round together can make the getting-to-know-you dance feel like a waste of time.
For investors at the earliest stages, though, so much of the investment decision comes down to the team, specifically the CEO—are they capable of building a $1B business? Can they recruit an A+ team? Will investors at the later stages want to work with them? Unless the investor knows you and you have a good track record, these are largely unknowns. When investors evaluate founders, they’re constantly looking for signals of potential. This can be hard to demonstrate on a 30-minute Zoom, which is why time spent developing a relationship with an investor can be helpful in getting an investor to a “yes”. Every investor will tell you this: they invest in lines not dots & letting an investor see how you perform over time, especially at the earliest stages, derisks one of the most important parts of the business, the founder(s).
Relationship building with investors should not be one-sided. It is critical and mutually beneficial for founders, too. It’s cliché, but taking on a new investor is like getting married. The question isn’t if, but when you’ll go through hard times, and you want to make sure your investors are the right people to get you through these. While you can never predict how someone will be in a situation, the more time you log with an investor, the more you’ll start to understand their strengths and their not-so-great qualities, enabling you to make a better decision on working (or not) with them.
During fundraising, it’s easy to get sucked into a transactional mindset, but it’s important to remember that your work with an investor only begins when they get to a “yes”. So, how do you run an efficient fundraising process while still giving you the space to vet investors & help them get to know you? A couple of pointers:
Research investors: Spend some time on a firm’s website and read articles or social media posts that investors put out to get a sense of how they think (see episode 71 on knowing your audience).
Talk to other founders: Of course, most of what you find online is likely going to be some type of marketing designed to make the investor/firm look good, so it’s important to get offline and talk to other founders who have worked with the firm. Ask them questions about not only how they are to work with but what the firm’s preference is for meeting founders. Do they like to meet early before a round is in progress? How buttoned up do they want founders to be on that first meeting? If the firm seems like a good fit to connect with, ask that founder to intro you (see this week’s episode 102 for how beneficial this can be in getting that first meeting).
Ask questions: When you do finally meet with an investor, don’t jump straight into the pitch. Ask them questions to understand how they think about the market your company is in, how they like to work with founders, or even why they got into venture in the first place.
Spending a little time getting to know an investor will help you decide whether you want to work with them, and if you do, triangulate your story in a way that resonates with them (see episode 105), making it easier to bring them along for the journey.
😱 Investor Nightmare
There is a time in early diligence when investors are floating on a cloud. They’re hitting it off with a founder, see the big vision for the company, and believe it has the potential to be a massive business. They’re pumped!
Then, they start their diligence, open the data room, and take a look at the cap table only to find that it looks something like one of these:
Oof… Talk about a punch in the gut.
Yair Reem, a partner at Extantia Capital, shared the above chart on LinkedIn about common issues with cap tables that almost always result in a pass from his firm. While Yair focuses on frontier tech addressing climate change, software companies aren’t immune to messy cap tables. The two issues we most frequently see are founders owning <80% at the Seed round and a “zoo of investors”.
Why are these issues? For founders that own <80% at the Seed stage the upside that comes from a potential future big payout when a company exits is tied directly to how much equity the founders have in the company. Makes sense, right? If founders give up too much equity too early, eventually over time and subsequent funding rounds, the founders’ equity gets diluted to the point that it doesn’t act like much of an incentive. This why (good) investors don’t want to own a large chunk of the company right off the bat. They know doing so will not motivate the founder in the long term and will act as deterrent to future investors.
Have you ever herded cats? I hope not, but you know where I’m going. Corralling folks to get s@!t done is exhausting and time consuming, doubly so for folks who have a lot going on and the benefit for them in taking an action, say signing a form, is marginal or nonexistent. Logistically, a “zoo of investors” is difficult to manage, but the bigger issue is that there aren’t a lot of options for potential new investors to correct this. Sure, they can buy out previous investors, but this isn’t ideal for Seed-stage funds. Investors don’t want their money to go to buying someone out because that takes money away from business operations. Another tactic is to “cram down” previous investors to a point where they lack meaningful ownership. This isn’t ideal, either, because no investor wants to completely disregard the previous folks who got the company to its current point. The optics around this for the new investor are not good and investors would rather pass than potentially take a reputation hit.
In the early days, it can be tempting to take any investment to get things moving, but the short-term gain may create a longer-term impediment to receiving future investment. Be mindful of how new investment impacts the company’s cap table and feel empowered to explore different options to ensure your cap table doesn’t wind up scaring off future investors. It’s the best thing for you and your business.
🤔 VOTE: To date or not to date the pitch deck
We had a brief internal debate on whether founders should include the date in the file name of their pitch deck; e.g., “Company Name May 2023”. On one side, folks thought it was helpful for investors tracking the company to be able to compare a company’s pitch decks from different points in time. On the other side, folks were concerned that if months pass from the date in the file name it can call into question why that round is taking so long to come together. What do you think?
😴 Decompression Zone
Last week’s episodes (97-101) featuring Alex Raymond, founder of the Conscious Entrepreneur Summit, covered some common founder mental traps and the toxic myth of entrepreneurship. It’s a good reminder to take some time to reflect both on the business you’re building AND your motivations and desires as a person.
Have a great week!