Many first-time founders don’t realize this, but it’s crucial to understand that an investment round is not only the investor choosing the startup to invest in but also the other way around. Choosing the wrong investor can ultimately bring significant consequences which might take months or even years to correct. Recently we discussed what entrepreneurs should look for in their investors, what type of interview questions and track records they need to understand before they can bring a term sheet to the table. Today I’d like to start looking at the consequences of choosing the wrong investor for your startup.
Recognize first and foremost that you are choosing a partner, not money. People have opinions, biases, and egos, money does not. You need to go in with this mindset and imagine yourself spending significant time with this person. Do you feel a level of mutual connection and mutual respect? On the flip side, always ask yourself the proverbial airport test: if you were stuck overnight in a dirty, smoke-stained motel room on the outskirts of O’Hare Airport with this person, would live through the night, would you feel neutral, or be glad for the unexpected quality time?
What Makes An Investor Wrong?
You may not have the best fit with your investor – be it personality, background, even lack of sector expertise, but these can often be overcome. But if the motivation is wrong – if they’re just looking to offload funds before the end of the tax year, for instance – you’ll find it hard to get the conviction of an investment partner who genuinely believes in you and your business.
Other signs can be when you hit that inevitable startup valley of death: will they offer the right commitment, support, and input? It’s easy to be supportive in the optimistic glow of a raise but you need to make an assessment of how they might react when things get sticky. How did they deal with any tricky issues during your negotiation?
If investors bring little value other than cash, you may want to reconsider them as ideal partners going forward? Can they also bring advice, mentoring, industry expertise, an incumbent network? Think about the long-term too. Can they provide follow-on funding or will you have to go through all this again?
Watch for the Signs
One of the key signals is delay, delay, delay. Beware of investors who lack clarity about what they want from you and/or suddenly start rushing you into last minute, and unfavorable terms. Compare your investor’s terms with others and conduct your own due diligence on their previous investments. Ask them for contact details of investee companies and get in touch with them to find out their experience. Again, any points of resistance from your prospective investor and you need to raise the question, why?
Also, ask the question; what happens if you run out of money? What’s the follow on or strategy for further assistance? Who do they usually co-invest with? What are their feelings on syndicates?
Avoid The Temptation To Take The First Offer
Investors are bombarded with the good, bad and very ugly of business plans. They have to sift through bags of noise, before pinning their investments on the few ideas that stack up and have a fighting chance of survival.
When it comes to approaching investors, be 100% clear about what you’re looking for. Where will $Xmm take your business? What’s comes next, a bridge, mezzanine, series X? What’s your one year/five year/ten-year plan? Investors who know will be seeking this vision from you. And they will understand if their offers don’t match up to this.
Research Your Investors
Most (if not all) investors will do due diligence on you — some more than others – and I’d be wary of anyone who does not perform due diligence. If they’re not bothered to learn about you but are willing to offer an investment there will be strings attached that you might not see. Run away, now!
Similarly, you should do your own research on investors. Personally, I learned the hard way by NOT doing due diligence on my follow on investors which left me playing catch up to learn who I was speaking to and how my company needed to be presented to them. I was initially super stoked about some investors who became after-thought prospects once I talked to other entrepreneurs. And there were other investors who seemed, meh, initially that I became excited about after some digging.
How can you go about doing due diligence? One way is by reaching out to the investors (or Angel groups) investee companies and having a heart-to-heart. If you’re dealing with an Angel group, go to one of their meetings, this is a great opportunity to network, but also meet other founders who can provide valuable insights. Ask them about their experiences working with the investor or group, how they’ve been helpful, what their core value-add has been. Don’t forget to ask about the tough times too: “What happened when shit hit the fan”, “What is something that could have been done better?” Trust me, every investor has their flaws, so ask a lot of questions and remember to balance it all using your own judgment.
Another way to do due diligence is to reach out to anyone in your network – entrepreneurs and anyone else connected – who know this investor and ask them for their candid thoughts. These should all be relatively quick emails that lead to an easy 5 – 10-minute phone calls. Do these steps, and anything else you can think of, it will pay off in the end.
You are choosing your investors just as much as they are choosing you. Find out who they are – their strengths, weaknesses, and ways they add value to their investments – before you take the investment.
Remember, you can always say no.
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