#20- How to choose the right investor for your startup?
Raising funds for your startup: Part 2 - A guide for founders to pick the right investor
vcble is now on Product Hunt!
To know more, please check the post here!
This is Part 2 of the on-going “Raising funds for your startup” series.
You can read Part 1 here, where I have explained the importance of the groundwork before your actual fundraising begins.
And now, onto today’s post!
There seems to be too much focus on entry valuations from founders with very little focus on other factors. The factors that can impact and enhance the profitability of your startup!
The quality of investors and the terms that they bring can have significant bearing on your startup’s road to Nirvana! And hence, it is essential to evaluate the factors other than the pre-money valuation, like chemistry, focus, terms, and the network that the investor brings to the table.
The pre-money valuation offered does not mean anything until and unless you closely look at the terms that the said valuation brings with itself. I have seen quite a few term sheets that say Angels want an exit in 5 years at an IRR of 30% or an IPO at a valuation no less than INR 350 cr (~$47mn), and also the right to drag along (i.e. force the founder to sell his/her shares) if the said exit or IRR has not been provided! And mind you- these are guaranteed returns being asked, not on a best-effort basis!
These are crazy terms!
How can founders honor guaranteed IRRs – especially via founder or company buyback? Dont founders raise outside funds because they’ve run out of cash themselves? In case the growth isn’t as expected, which is almost always a high probability, how can we believe that the founder, or the startup will have the cash to enable a buyback?
And hence, it is vital for a founder to conduct reference checks on the potential investor. And it is absolutely essential to grill the investors on certain questions as well. Like-
Request a sample term sheet, and ask for the kinds of rights the investor wants
Conduct reference checks with other founders funded by the investor
Speak to founders who have had an exit post the investor’s funding
Speak to founders funded by investors, whose businesses are not performing very well
Understand and probe the edge the VC brings that is different from others in the industry
Ask the investors to share an action plan on how they will contribute to growing the business other than capital
As a founder, it is your right to ask these questions. Any investor who refuses to, or only sporadically responds after these requests, or does not provide a comprehensive list for you to go through - is a big red flag. Avoid with a forty-foot pole!
There are some more ways to save yourself from ‘marrying a bad VC’:
If there are multiple investors coming in a round, or as a group - make sure to only interact with the lead or a nominee. You do not want to waste your time managing multiple relationships and investors. A good investor will respect this choice. And very often, too many cooks do spoil the broth!
Prefer VC funds that are run, set up, and comprised of ex-founders. These funders will have been in your shoes, dealt with similar experiences, and understand the challenges of building and running a business - far more than an Ivy league MBA who only knows number-crunching! And mind you, experienced founders who turn investors are far more humble and empathic than your run off the mill MBA turned VC!
In the end, remember VCs are investing to make returns. It is business. There will be hard negotiation.
But if an investor only wants to make cold hard cash rather than share a vision to build a better business - you are better off without them. Such an investor will not add value to your business, might even run it to the ground.
Entrepreneurship is a difficult journey - make sure you share it with someone who can bring their heart as well!
If you like what you read, please subscribe below!