In the startup world, expenses can pile up quickly and can be tough to manage when you’re focused on scaling a business. Early on, it’s easy for new companies to cover cash flow needs with small injections from a founder or close friends and family. At some point however, a startup needs to consider more serious sources of capital to help cover a longer runway and take the business to its next level of growth.
When it’s time to raise money from serious investors, it is natural for an entrepreneur to be more focused on identifying as many investors as possible, rather than operating strategically and identifying the right investors willing to participate. During this process it important to emphasize quality over quantity as investor-company fit is the most important aspect of the investor selection process.
The process of selecting an investor and successfully raising capital is also an extremely time-consuming process, and only becomes more stressful when trying to run and scale a business at the same time. This is a key reason why many businesses take the first investment they are given, often overlooking the importance of who they are choosing to partner with.
As a way to help our following of high-growth entrepreneurs, Exbo Group has assembled a list of 6 items to consider when selecting outside investors:
What is the Investor’s Track Record?
No matter the level or size of the round, an investor should be willing to contribute more than just capital to a business. Premier investors can also often provide meaningful strategic advice and guidance related to how they intend to help the business succeed, and the more aligned the entrepreneur and management team are with investors, the better. It is therefore important to ask probing questions to understand how much the investor expects you to compromise your vision, mission, and goals if they were to get involved with your business.
There is also no better indicator of future performance than past performance, especially if investors tend to stick with the same types of companies (i.e., industry, business model, size, location, etc.). Does the investor have experience scaling businesses in your industry? Do they possess partnerships, customer, or advisor relationships in the space that can help to increase your rate of growth?
We always recommend exploring resources like Crunchbase, AngelList, and the portfolio section of the investor’s website in order to unlock additional information about their firm’s track record and strategy. Pay close attention to how often the firm reinvests in the same companies in later rounds, as this will provide some assurance that these investors consider themselves strategic partners that are in it for the long haul.
How Much Support Is Offered?
Without their guidance and resources, an investor becomes nothing more than a source of capital with leverage. This is why it is critical to judge the amount of time and support a potential investor can offer before deciding to work together.
In many situations, the individual who will be joining your board or prioritizing your company at the firm is the most important consideration when working through the specifics of an investment. Major firms such as Sequoia and Andreessen Horowitz may have a big name, but that doesn’t always guarantee that they will be willing to allocate a partner that will truly be involved in providing hands-on assistance to help elevate your business.
Once you have an opportunity to meet the person you’ll be interacting with the most, find out how many other boards this person sits on and how easy it will be for them to prioritize your company when it comes to things like major launches, strategy meetings, and key negotiations. The right investor should be accessible and attentive when they are most needed.
What is the Expectation for Communication?
While having an investor involved in supporting a business can be great, it is important to set and manage expectations from the onset. An investor’s first priority is to protect the money they’ve put into your business, and as a result usually require at least regular updates on the health of the organization.
Some may prefer monthly P&L reports, whereas others will want to have bi-weekly conference calls to discuss a range of topics. Before you sign the investment agreement, be sure you have clarity around an investor’s expectations to ensure it will work for you and your team.
Understand their Fundraising Process and the Window for Investment
Investment firms vary greatly on their strategy when it comes to raising their own funds and saving room in those funds for follow-on investments. Some firms like to focus on large early-stage investments while others like to make small, but significant investments in companies as they grow. Entrepreneurs rarely ask for more information about their investors’ fundraising and portfolio strategy, but the more you understand about each fund’s lifecycle and your investors’ goals, the better you as an entrepreneur can plan for future stages of growth.
Check with Current and Former Portfolio Companies
Similar to an employment reference call, it is often the case that a potential investor will provide contacts to other entrepreneurs who had a positive relationship with the firm. While this is good to get an understanding of how you can use a firm’s strength to your company’s advantage, the right firm should also be open and willing to discuss investments that didn’t work out as planned.
Don’t be afraid to ask an investor to connect you with entrepreneurs who were part of a less than desirable outcome. This will give you a better idea of the investor’s true character. It is also useful to talk with entrepreneurs who built companies in a similar industry or with access to similar partners and resources. They will have the best understanding of the investor’s level of industry knowledge and how they can add value to the business.
Typically, investment terms are set by the investors leading the round. Pay close attention to the warrants and mandates to ensure investors are acting in the company’s best interest while understandably working to protect themselves. This is certainly not the time to hold back on asking advice from any legal and advisor counsel resources. Seek out folks with experience who have been through this process in the past and know what to look for. Make sure to understand the liquidity preference terms and how much dilution the founders can expect over time.
Raising capital from the institutional investment community is a challenging and time-consuming process. Please wade into this process carefully and do not hesitate to ask the advice of others to provide insight and help along the way. We hope that this guide has served as a useful overview of this process, and will help you make better-informed decisions when thinking about which investors to work with during the fundraising process.