As entrepreneurs set out to raise money, they should evaluate all fundraising options, such as small business loans, grants, angel investors, venture capital or “bootstrapping.” After assessing these options, entrepreneurs who decide to pursue funding from angel investors or a venture capital fund will need to identify the investor that is the best fit for the business.
Early-stage investors can, and should, provide companies with more than just dollars. Remember: the search is a two-way street, and a business should evaluate potential investors just as investors assess the business. In particular, entrepreneurs should consider the following factors when evaluating investor options.
Ideally, the potential investor will have applicable industry expertise through relevant work or investment experience, as well as a large network. Entrepreneurs should take the time to fully understand an investor’s background, connection to the community and prior investments in the industry. An investor with the appropriate expertise may introduce a business to potential customers and partners or even, down the road, to a potential acquiror.
Understanding a potential investor’s desired level of involvement in the company is critical to maintaining a healthy and fruitful relationship. Entrepreneurs should understand investors’ expectations about what degree of input they like to have in their portfolio companies. Will they expect to meet with members of the team regularly and outside of Board of Directors meetings? Will they quickly respond to phone calls and participate in meetings with potential members of management or potential customers, if requested? How many other boards do they serve on (an indicator of how much time they may have to devote to the company’s needs)? A misunderstanding in this area can cause discontent for both parties and result in too much or too little information exchange.
Entrepreneurs should understand the company size and growth stage that a potential investor typically targets, and then focus their searches accordingly. An investor that does not usually make investments comparable to what an entrepreneur is seeking is unlikely to ultimately contribute funding. In addition, entrepreneurs should understand an investor’s history of providing follow-on investments. For example, if the investor is a venture capital fund in a Series A financing, does the investor typically invest in Series B and Series C financings? Otherwise, the business will need to spend time pursuing new investors for the next round. Entrepreneurs should also determine if the investor has a history of supporting companies with bridge financings if the next financing round takes longer than expected or the company otherwise requires short-term financing.
Entrepreneurs who plan to raise capital from multiple investors in the current or in a future round, should understand how potential investors work with co-investors. Some investors may prefer to always be the lead investor and seek to influence future investors. Others may expect only to lead the first round but will help the business find a lead investor for future rounds. Understanding an investor’s willingness and experience working with other backers can help prevent disputes down the road.
Entrepreneurs should research the portfolio companies of the firm that is the potential investor, not just those of the person leading the investment discussions. While businesses often benefit from working with a firm that has made other investments in the industry, entrepreneurs should ensure that no portfolio companies are considered direct competitors (or are likely to become direct competitors). Firms with an existing investment are unlikely to invest in a potentially competing company if conflicts of interest are likely to arise. Entrepreneurs generally should understand any competitive investments prior to meeting a potential investor to avoid exchanging confidential information with a firm that is already invested in a competitor.
Entrepreneurs should speak with current and former portfolio company founders to get their perspective on an investor’s (and his or her firm’s) style and influence. Speaking not only with founders who have had successful exits but also with those whose company either shut down or otherwise had a disappointing exit will be instructive. Entrepreneurs should learn how the investor will work with them in both good times and bad. Potential investors should be able to facilitate these types of conversations. If an investor is unwilling to do so, that, in and of itself, likely reveals something about the investor’s relationship with founders.
Entrepreneurs should seek potential investors whom they get along with and respect, given investors and entrepreneurs will likely be spending a lot of time together in high-stress circumstances. In addition, entrepreneurs should take the time to get to know an investor before jumping into a formal relationship. Any early legwork building a relationship will pay off down the road when situations get tense.
Entrepreneurs should be aware of any potential investor’s expectations for the investment. Is the investor expecting the company to grow into a billion-dollar public company over several years or are they seeking a smaller, but earlier exit? Setting clear expectations about the end goal of the investment is imperative. Ideally, the investor and the founder will have the same understanding of what success means and can work together to reach that goal.
Despite the common temptation to jump into a deal, entrepreneurs should carefully consider a variety of factors before selecting investors. Angel investors and venture capital firms will become essential partners as the company expands. In fact, securing the right investors can determine whether or not the business ultimately succeeds.