You’re about to give up a substantial amount of ownership to an investor or investor group. You’re thrilled to get funding, but how do you know if you’ve selected the right investors?
While it may seem like raising capital is all about winning over investors, it’s really a two-way street. Just because someone has money they are willing to invest does not mean that person and firm can add substantial value to your business or that they are the right fit. You are choosing investors as much as they are choosing you, and you are likely going to have to live with them for many years.
Beyond the obvious reference checking (especially with fellow entrepreneurs), here are five questions that you should and need to ask yourself and potential investors.
1. What value can the investor really add? Let’s be honest: There are investors out there that don’t seem to have a clue. It may sound funny, but I’ve witnessed this first hand -- more than once as both an entrepreneur and an investor. Entrepreneurs need to be very thoughtful about what they want and need in an investor (other than just the money). Do you want someone that understands what it means and what it takes to build a valuable business from scratch? Do you want someone that knows the inner workings of venture fundraising over multiple rounds and can help you do it right? Does the person need to have strong operational experience in a particular area, such as sales, marketing or product development?
Choosing an investor is a lot like getting married. This person will be in your life and sit on your board for many years. There are a lot of great investors out there, but there are also not so great ones. You need to make sure it’s going to work for you and your company.
2. Does the investor know anything about your business? It’s not all about the money. Consider whether it’s important for your investors to understand your business model or have experience in your particular industry. Sometimes it’s crucial, other times not so much. Take a look at the firm’s current portfolio and focus areas. What does this indicate about the investor’s broader knowledge of your business?
Let’s say you are starting a digital-marketing business. Is this the first investment of that type for the investor or the third?Without prior experience, the investor may not have the right networks in place to help you or the right context for advice and decision making. Besides looking at the VC's portfolio, LinkedIn is a great tool to help you understand who potential investors really know.
3. How committed is the investment firm to your type of business? Just as it may be important for the specific investor to understand your business, you need to understand how committed the firm is to your particular area or business category. Do they have other portfolio companies in the same space? Determine if it’s a major focus area for them. Is your company an experiment to test out a new thesis? Are they planning to invest in more companies like yours or are they beginning to get jaded and back away from the category? You want your investor and their firm to be strong advocates and committed to the category.
4. At what stage is the potential investor in his or her career? Most venture capitalists have a 15- to 25-year career in the business. Where they are in both their VC career and overall career can have a significant impact on your success.
For a partner in the first few years of his or her VC career, the lack of experience could be a real issue (especially if they haven’t had a successful established track record in a prior career) Her networks, understanding of the venture business and experience getting a company from startup to success is not as strong as it could be. Also her nfluence in the firm is also likely less than ideal -- you may not get as strong an advocate as you may need in the future.
Try to understand their motivations. When someone is feeling pressure to establish his career or “brand,” his agenda may not be perfectly aligned with yours. This can result in unpredictable behavior at inopportune moments. For example, he may advocate a follow-on investor or board member who “looks good” on his resume but may not be the best fit for your business. Or he may advocate a course of action that is currently “cool” in the VC or startup world, but isn’t a viable, sustainable direction for building value in your business.
On the flipside, if an investor is starting to scale back, his influence in the firm will start to decline. That influence is really important because when it comes time for follow-on financing, your advocate in the firm is a big factor in whether or not the firm participates. Someone late in his career may also not put as much time and energy into helping you become successful as you might expect.
When you give up a substantial amount of ownership in a company, it’s not just for the dollars. It’s for the access, the advice and the help. Make sure you understand where the investor is in his or her career. The individual's investment should be about your company, not the person's needs.
5. How much capital is the firm allocating or reserving for your company? Think ahead to the next round of capital. Find out where the firm is in the life of the current fund and how much capital they are allocating or reserving for your company. Have they fully or tentatively earmarked dollars for follow-on investment? Some firms don’t reserve any funds, and it’s a decision made at the point in time of the next investment -- depending on available funds and other investment opportunities (a.k.a a jump ball). Others have a hard reserve or soft-allocated future funds. Ask how future funding decisions are made and understand the process for when you need to raise more money.