How do you find the right investor for your start-up?
If you’re an entrepreneur, you probably have asked yourself this question more than once-in-a-lifetime.
As the over-all tech industry is maturing, capital is more plentiful (but paradoxically competitive), the costs of technologies are constantly dropping, and code is being increasingly commoditized. This leads to more companies being built-up faster and for less. The culmination of all this? A lot less white space, and more serial entrepreneurs competing for seed funding.
With this in mind, what do you, as a founder, need to know to ace your increasingly competitive seed round raise? Here are 6 questions you should ask yourself to prepare:
1. Realistically, are you venture scale?
Even without venture capital, you can build a valuable business. You can bootstrap your way to success. But, if you want to raise money, you better be ready to meet the following criteria:
10x return: To build a venture fundable business, you need to create a value of this scale (or more.)
Velocity: How fast can you grow? There is a tremendous difference between getting to $1M annual revenue in 6 months or 6 years.
This matters for two reasons: 1) Investors will extrapolate your future growth rate from your past performance 2) When you’re raising venture money, you’re building with someone else’s money and there is an often unacknowledged cost to that — namely your ownership and ultimately the funders’ returns.
Product < Business < Asset: VCs are searching for high velocity, high return investments. Startups with clear long-term assets are more valuable, which could be a database of genetic information that’s 20X broader than any competitor, or market share in an industry where there is 15+ year lock-in. At the bare minimum, make sure you are building a business, not a product. (If your go-to-market plan is to leave this to the salespeople you plan to hire at some future point, this ultimately will not work — certainly not for venture scale.)
Bottom line is if you are not venture scale, but you’re raising money — or spending — like you are, you have a problem.
2. How competitive are you?
As a founder, you are laser-focused on solving the challenges directly in front of you. While it’s critical to “stay in your own lane” to some degree, you can’t afford to ignore these three absolutely critical competitive dynamics, if you want to be venture-funded:
Cohort effect: When you start raising money, whether you realize it or not, you automatically become part of a peer group, other companies that have raised as much as you have, or to a lesser extent have comparable metrics (revenue, traction/adoption.) If you are way behind in your peer group, you won’t stand out in a weekly VC partner meeting, all else being equal. You could still come out ahead, but your team, market, and defensibility will have to be that much more impressive.
That’s why I generally advise founders to determine what to call their round based on traction, and use the earliest label which can apply. Be within a cohort where you can compete effectively: it’s the adult version of red-shirting for sports teams.
Winners take all: Assuming that your startup is successful and that you’re tackling a valuable market opportunity, 2–4 direct, formidable competitors will likely arise in your space. Most founders don’t look this far ahead, but by then you’re either at the front of the pack, or not — and in the latter case you will lose out on investor money.
Because of the winner-takes-all effect of technology (where the bulk of value accrues to the market leader), few VCs will rationally put money into the #3 or #4 competitor in a space. And, that’s why we evaluate competitiveness from our first meeting, because who wants to put 4–6 years into a business to run into a brick wall down the road? Neither the founders nor us.
You simply don’t get to be the #1 or #2 in your space without planning and executing on that plan from day Amazon is a fierce competitor, one of the best of our era.
Sector bias: Don’t get discouraged just because you are in a less competitive funding sector. While many funds are generalists, the reality is that they will typically focus on the most profitable sectors, and sectors with structural risks, like health care or education, may be tougher to close investment.
This is also a good reason that sector-focused funds are becoming a lot more common. You should take advantage both of them and of strategic angels in your sector, who can crucially help you navigate hard-to-open sales doors with their industry connections.
3. Are you right-sizing your fundraising based on fund dynamics?
Want to know the truth about VC firms? Simply by looking at the size of the fund, you can tell if your company is the right fit or not. The secret rule of thumb that most VCs have: any single investment needs to be able to return the entire fund. For example, a friend at a $800M fund confesses to me that she won’t take a meeting unless she can see clear sightlines to a $300M business. Given the rule of thumb, she’s actually being permissive.
On the other end of the spectrum, angel investors can have a fantastic outcome with a $50M run rate company, and consequently may be willing to take risks much earlier. Don’t waste your early fundraising cycles if there isn’t a fit, especially not in pursuit of a brand name for your term sheet.
4. Where are you on the seed gradient?
While the metrics at each round change every year, we’ve observed internally that even seed companies fall out in distinct spots along the seed gradient. Know the stages, metrics, and amount of your round, so that you stand the best chance in your cohort — review my 2nd question for you again.
5. Do you have a startup Olympian mindset?
Those who are drawn to founding companies have grit, creativity, and determination. High growth companies require all this — and more. Sometimes liken the process of finding great entrepreneurs to seeking Olympians.
Many people (including me) run an occasional 5K or 10K for fun on the weekend. But envision the difference between the weekend warrior, and the Olympian, who has configured her life to support training, has a team assembled to handle the various aspects of growth, and is ruthless about trying what works and discarding what doesn’t.
If an investor does not move forward, please don’t take it personally, or see it as a fatal blow aimed at the business you’re building. Ask for feedback, learn from it, and look for investors who are excited about your business.
6. Are you willing to optimize for investor fit?
Nothing is more painful than watching startups being ill-served by investors who do not have the best read on their strengths or market dynamics or simply have different values. You may be thinking. Yes, but when you’re spending years of your life on your startup, having the right partners at the table is worth getting right. The worst case scenario is that you build an 8-figure business, only to have one of your investors vetoing a profitable exit that doesn’t align with her/his economic interests.
How do you prevent this? Make sure that you and your investors match up on:
Product principles and prioritization
How involved you want them to be
How they handle it when things don’t go well
Also, speak with other entrepreneurs in their portfolio, which will help you answer the key criteria mentioned. Reference checking is a two-way street! Finally, remember not to ignore your gut. With team members and investors, ask yourself this one question, “Who am I most excited about collaborating with?”
Winning as a startup founder is about building something amazing, but it’s also about building relationships, supporting your team, and having fun on the journey. As you gear up for your seed round, make time to reflect and refocus.
Angel investors put money in early-stage startup companies in exchange for a stake in the company. Investors hopefully to duplicate the high-profile successful investments made in companies like Airbnb, Facebook, Instagram, WhatsApp, Uber, and more. Investors mostly make small bets ($25,000 to $100,000) with the hopes of getting “home run” returns.
Angel investors understand that startups have a high risk of failure. So ultimately and angel investor needs to feel confident that the potential upside/rewards from investing are worth the downside risks.
They put a variety of key issues and undertake due diligence before they invest in a startup.
Many investors consider the team behind a startup more important than the idea or the product. They would want to know that the team has the right set of skills, drive, experience, and temperament to grow the business. Anticipate these questions:
So, the investor will need to make a judgment about whether the founder and team will be enjoyable to work with. Does the investor believe in the team? Is the CEO experienced and willing to listen? Is the CEO trustworthy? Also, witnessing experienced advisors can be very helpful in the early stages to help bridge an early-stage team that is still growing.
Many put are looking for businesses that can scale and become meaningful, so make sure you address up front why your business has the potential to become really big. Don’t present any small ideas. So the first product or service is small, then perhaps you need to position the company as a “platform” business allowing the creation of multiple products or apps. They will want to know the actual addressable market and what percentage of the market you plan to capture over time.
So of the most important things for investors will be signs of any early traction or customers. The company that has obtained early traction will be more likely to obtain investor financing and with better terms. Examples of early traction can include the following:
They will want to know how the early traction be accelerated? Whatever has been the principal’s reason for the traction? How can the company scale this early traction?
Not forget to show early buzz or press you have received, especially from prominent websites or publications. Do the headlines in a slide on your investor pitch deck. Put the number of articles and publications mentioning the company.
More venture capitalists look for passionate and determined founders. They’re individual’s who will be dedicated to growing the business and facing the inevitable challenges? Start-ups are hard, and investors want to know that the founders have the inner drive to get through the highs and lows of the business. Such want to see genuine commitment to the business.
They looked for founder’s who truly understand the financials and key metrics of their business. Should needed to showcase that you have a handle on all of those and that you are able to articulate them coherently.
Down are some key metrics that angel investors will care about:
Whether the investor already knows and likes the entrepreneur, that is a big advantage. So the entrepreneur doesn’t know the investor, the best way to capture their attention is to get a warm introduction from a trusted colleague: The entrepreneur, a lawyer, an investments banker’s, other angel investor, or a venture capitalist. Investors get inundated with unsolicited executive summaries and pitch decks. Much if the times, the solicitations are ignored unless they are referred from a trustworthy source.
So first thing the investor will expect is to see a 15-20-page investor pitch deck before taking a meeting. Till he pitch-deck, the investor hopes to see an interesting business model with committed entrepreneurs and big opportunity. Such make sure you have prepared and vetted a great pitch deck. So other pitch decks and executive summaries can help you improve your own.
They want to understand what risks there might be to the business. They’ve want to understand your thought process and the mitigating precautions you are taking to reduce those risks. Therefore, inevitably are risks in any business plan, however, so be prepared to answer these questions thoughtfully:
Start-ups that can show they have reduced or eliminated product, technology, sales, or market risks will have an advantage in fundraising.
Therefore, Entrepreneurship must clearly articulate what the company’s product or service consists of and why it is unique, do entrepreneurs should expect to get the following questions:
Investor’s will absolutely want to know how their capital will be invested and your proposed burn rate (so that they can understand when you may need the next round of financing). It’s willing too allowed the investors to test whether your fundraising plans are reasonable given the capital requirements you will have. So it will allow the investors to see whether your estimate of costs (e.g., for engineering talent, for marketing costs, or office space) is reasonableness given their experiences with other companies. Investors want to make sure at minimums that you have capital to meet your next milestone so you can raise more financing.
Doesn’t the company have differentiated technology?
As much angel investors invest in softwares, internet, mobile, or other technology companies, an analysis of the start-up’s technology or proposed technology is critical. The questions the investors will pursue include:
Akin to that, the angel investors will do due diligence on the key intellectual property owned or being developed by the company, such as copyright, patents, trademarks, domain names, etc. Is the intellectually property properly owned by the company, and have all employees and consultants assigned the intellectual property over to the company?
If you’re start-ups presented investors with projections showing the company will achieve $1 million in revenue in five years, the investors will have little interest. Investors want to invest in a company that can grow significantly and become an exciting business. So, if you show projections in which the company predicts to be at $500 million in three years, the investors will just think you are unrealistic, especially if you are at zero in revenues today.
Avoid presumably in your projections that will be difficult to justify, such as how you will get to a 400% growth in revenue with only a 20% growth in operating and marketing costs.
So ordering to believer yourself financial projections, Investors willing wanted you to articulate the key assumptions you have and convince them those assumptions are reasonable. your can do that’s, then the investors won’t feel that you have a real handle on the business. Expecting that investors will push back on the assumptions and they will want you to have a reasonable, thoughtful response.
Investor’s knowledge that buildings a great product or service is not enough. The companies just haven’t the beginnings of a well thought out marketing plan. The marketing questions will include:
Investors maybe ask them followings questions about the financing round:
Validation will be an important issue for the investors. If you’re tell an investor you want a $100 million valuation even though you started the business three weeks ago, or don’t have much traction yet, the conversational will likely end very quickly. Often, it’s best not to discuss validation in a first call/meeting other than to say you expect to be reasonable on valuation. Busy the investors too does want to waste a lot of time on a deal if the valuations expectations are unreasonable or not attractive.
Validation at an early stage of a company is more of an art than a science. To help bridges the valuation gap for early-stage startups, you often see investors looking for a convertible instrument with customary conversion discounts and valuation caps. These instruments, such as convertibles notes and “SAFEs,” have become quite common.
Final Tips for Entrepreneurship Seeking Angel Investors
Here’s see somewhat concluding tips for entrepreneurs seeking to obtain angel financing for their startup: