What Tier is your Investor (or what to look for in an investor)?


One question that I often get from founders is what ‘tier’ a prospective investor is. As in, what differentiates their prospective investor over another as ‘better’ or ‘worse’, relatively speaking, and on what basis.

Just to clarify, although there is no formal ‘ranking system’ for the tiers of investors, generally speaking, every investor sort of knows where they ‘rank’ relative to others or at least relative to the top investors. The best funds, generally known as ‘Tier 1 investors’ are the most in demand, and then, the tiering is largely subjective from that point onwards as to whether a fund is Tier 2, or Tier x, so there isn’t a huge benefit to spending too much time trying to actively find the ‘objective’ rank of an investor.

That said, what IS worth exploring is what differentiates the better ‘tier’ investors from the rest. Below are the seven attributes that I believe differentiate ‘the best from the rest’.

As you seek out potential investors, keep an eye out for these variables, the more of these your prospective investor has, the likely better off you will be as a founder.

1) Has a great network – the biggest value-add, in my opinion, that an investor can bring to the table, is their network. The larger their network, the more doors they can open for you. Nothing beats a direct intro to someone you need to meet.

2) Has a great brand-name – this helps with the network, but having an investor with a great brand name, either as an individual or fund, can help not only open doors indirectly (as in not requiring an introduction), but also to provide your startup with instant validation to potential customers, partners, and new investors.

3) Has sufficient levels of capital to support you – Although different investors have different strategies around this (eg. an Angel rarely can follow-on as much as an institutional fund), it is generally a good thing to have an investor who can invest in your company throughout the lifecycle of your company.

4) Has sector expertise – One way that investors can differentiate themselves as a top tier investor from the usual suspects is by having focused experience in your sector. For example, an investor could be a generalist Tier 2 fund (remember that this is subjective), but as an ecommerce investor they may be a Tier 1, great if you are a ecommerce company, but just ok if you’re a fintech company. This is because they will likely have a large network (see point 1 above) in their sector of expertise.

 5) Has deal experience – You will go through a lot of unique and stressful situations during a fund raise. It really helps to have someone who has gone through the process before and can help smoothen things out between all parties involved if needed.

6) Isn’t burdensome – An excellent investor does not burden the founder during the investment process with unnecessary or unusual diligence requirements for the stage your company is in. For example, a company that is very early stage will likely not have much to be ‘diligenced’, if an investor is requiring you to have an accurate version of what will happen in your company 5 years from now and you started your company three months ago, question whether they truly think the information you will give them has any likelihood of being true (and whether you think they’d make a good investor for you).

7) (Lastly, and most importantly) Has a big vision – Good investors on your board will help you by working with you on best practices for company building, but great investors will help you by helping you set the right vision for your company. The better investors help you think big because they think big themselves. This means not only having an attitude of can-do vs can-not, but also having the experience on how to coach you through this type of thinking.

Now, keep several things in mind, however, after reviewing this list:

1) There are many new investment funds and or individual angels that come to the ecosystem and therefore may not have an established brand name, but have great networks and experience. Don’t dismiss them prematurely, however, do ask others that they’ve worked with what it’s like to work with them.

2) Although founders that have done well and gone on to join a fund can be awesome people to have on your board, however, investors don’t have to have been founders themselves to be great investors. Experience as investor, having done many deals and knowing how the best companies operate, can count for a lot, so look for  a blend of all attributes in your investor and not just look for a founder-turned-investor that can empathetically relate to what you’re going through, but provides little beyond aged anecdotes about how they did things.

3) If you’re ever stuck between two potential investors, really really consider that the person that will be working with you on the board will help you define many things about your company over the coming years. Choose wisely and ask yourself who you would rather work with long term, you wouldn’t want too chose someone on a brand name alone, but causes you hair loss, heart burn, and emotional stress on a regular basis.

I hope this helps you in your quest to find your potential investor.

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The Importance of Good Mentors

Mentoring a Demography trainee

The importance of having great mentors in your career or company cannot be emphasized enough. Mentors can generally provide you with a structure and feedback that school or books alone cannot provide. If you don’t have access to great mentors where you work, look for them in structured mentoring programs such as Seedcamp’s if you are a startup, or in your school’s Alumni if you are a student, or your industry’s groups if you are an employee. Look for mentors that can help you on functional areas as well as ‘bigger picture’ areas. Build your own ‘advisory board’, per se, of people who can help ‘polish’ you, your skills, and your thinking process over time.

From a personal perspective, I’ve been lucky in having had some great mentors throughout my career, and lucky enough to have had them as my co-workers as well. In my first post-university job as a network consultant with what was then called GTEi Professional Services and led by one of the most supportive bosses I’ve ever had, Adam Lipson, I had the pleasure of working with two great mentors: Allen Gray and Walter Urbaniak. Allen Grey is one of those guys that if you ever had a weird technical problem, he was the guy to call. He was the Navy Seal Team Six, all by himself, for any problem a client had. He was a hacker in the truest sense of the word. One of the most impressive things at the time for me, was when I visited Allen’s house and witnessed what had to be the closest thing to having a “HAL” from the movie 2001, controlling every aspect of his home environment both locally, and even more impressively, remotely.

Walter Urbaniak, shared many traits with Allen, in that he too, was a one man army, but if Allen was the Navy Seal, Walter, ‘Doc’, as we called him, was the General who laid out the plans and arranged troop movements. Being one of the contributing creators of ‘Layer 2 routing’ and someone who regularly collaborated with the inventors of the internet’s backbone (you can read more about some of the early works here: Where Wizards Stay Up Late: The Origins of the Internet), Doc always ‘knew’. In its simplest form: Doc excelled and the “Why”, and Allen at the ‘How’.

Working with Allen and Doc together taught me the value of not just smart mentors, but about the process of smart mentoring. Allen would inspire me to come up with cool ideas and hacks, but would never ‘finish’ the job for me.. always leaving me halfway for me to figure out the rest. I can vividly remember us playing around with a Gnome hack for Red Hat Linux on my live ‘work’ machine and him leaving me mid-way through the hack and with a full work day ahead of us and my basically having to blunder my way through to ‘a’ solution.

Doc’s teaching style was 180 degrees from Allen’s. I remember one day when I was stuck with some subtlety of TCP/IP and Doc took me to his blackboard and asked me to walk him through every step a packet takes from the moment it leaves your computer until it arrives where it needs to go, with him heaping me fill-in the blanks along the way where I couldn’t. This ‘overview’ of the bigger picture helped me understand where things could go wrong, rather than just focusing on the specific micro-problem that I had, and getting bogged down with just those details.

Fast forwarding to a closer time period after my days as an engineer, I had the pleasure of working with Ivan Farneti & Nigel Grierson while I was at Doughty Hanson Technology Ventures. Ivan was personally responsible for some of DH’s greater exits, including the sale of Gomez to Compuware back in 2009 for $300m and had seen many a deal in all their varieties leading to his deep understanding of just about any situation and question I could throw at him. What made Ivan great as a mentor was his ability to help you analyse & dissect businesses for their business and not get distracted by other attributes. He regularly admits not understanding the ‘technology’ of a company (or at least that’s what he likes to say), but curiously, he is always dead-on in understanding the business challenges that a company can and will have. Nigel, similar to ‘Doc’ from my days at GTEi, was excellent at providing the greater context of an industry and explaining how things came to be. Nigel is also passionate about teaching and more importantly, learning about teaching, a key attribute of good mentors.

Of course I can’t say that these mentors were ‘it’ for me, quite the contrary, I have a number of friends and colleagues spread out throughout the industry who have provided me with invaluable direction over the years in every aspect of a company’s development and my own personal development as an investor. I know I still have so much more to learn, but am glad that I work within an industry and environment where I can continuously learn from others.

Over the past several years, I too have become a mentor to others. The feeling is always a bit strange when it starts happening to you, but many people underestimate their ability to help others. As a mentor, other than developing your own style of mentoring, I believe your three main duties are 1) to have a passion and desire to continue learning about the subject your are mentoring on, 2) to know what you know and what you don’t know and be clear about it during mentoring, and 3) to continuously seek to improve your mentoring skills so that you can structure the advice you are giving for best effect. This does require a discipline of self-analysis to catch yourself when you are falling short on any of the above, but that is a good price to pay when you see the progress you’ve helped others achieve.

And with that, I encourage you to seek out the best mentors that you can for what you are trying to achieve, but also, perhaps so you can also be a great mentor to someone. Don’t discard the idea until you try it!

Summary of “The Importance of Good Mentors” (via tldr.io)

  • Mentors are very important for your career and your company. They provide a structure and feedback that scool or books cannot give.
  • Build your own “advisory board”. You need to have mentors that help you on functional areas and mentors for “bigger picture” areas.
  • Over time, you will also mentor others. You need to have the desire to continue learning about the subject you’re mentoring on.
  • You must be aware of what you know and what you don’t, and be clear about it during mentoring.
  • Finally, you need to continuously seek to improve your mentoring skills to achieve the best effect.

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How do you issue the right number of shares/options to an employee or an advisor?

HM Revenue & Customs at Mevagissey Harbour
HM Revenue & Customs at Mevagissey Harbour (Photo credit: Cross Duck)

Most founders have desire to share their equity with people that helped them along the way, both as a thank you, but also as a motivation tool. However, how to share is always a big question mark for every Founder. The two most frequently asked question is, “How much equity should I assign an advisor?”, which is shortly followed by “How do I know when to issue shares to new employees and how much do I give them?”.

So, let’s take step back and look at why we are doing this in the first place.

Motivating employees and or advisors is a key part of having a productive workforce. One key element to unlock this productivity is by creating a culture of fairness. In his book titled ‘Drive’, Daniel H. Pink talks about how an employee’s productivity can be binary provided that the right results-oriented work environment is created AND they are treated fairly from a compensation point of view. Effectively, if you don’t create a feeling of fairness in terms of compensation, relative to the market, employees will simply not be ‘open’ to be fully motivated as they will feel slighted. It’s a simple concept on paper, harder to implement in practice.

Therefore, the word ‘fairness’ is what’s important here.. how do you define the fairness culture in your startup?

Let’s start with advisors:

Advisors need to commit some time to your company to ‘earn’ their equity. The first thing to do is to define what kind of role this advisor is going to take. Is he going to provide board-level feedback and help or just operational help (marketing, for example). Is she going to meet with you once a week or once a month?

Then, define a time period for this relationship before you review it for extension. As in, Joe, your marketing advisor, will work with you once a week for 9 months, at which point you can review your working relationship to see if he is needed any further or if it is working out.

It’s really quite simple, find someone that can help you, narrowly define expectations you have of each other and for how long, and then find an equity amount that is in line with the market and that makes them happy.

For the USA, the Founder Institute has come up with some guidelines on numbers, and you can read about those here:

They also include an agreement you can sign with your advisor to narrowly define the engagement. For the UK, I’ll be linking to one soon… stay tuned.

Onto Employees (which is a bit trickier and I’ll include the topic of valuations as a bonus):

Back to the topic of Fairness… Fairness is defined by having the total compensation of your employee meet his or her expectations as defined by the market. As such, you need to think of your employee’s total compensation (cash + equity) as something that is within the boundaries of the market norm for his or her role. Deviate too much and not only is hiring hard(er), but you will have inherently unmotivated employees. Total compensations at startups usually have low or no salary, so that fairness is established by assigning equity.

So in order to quantify the value of the equity portion of the total compensation of an employee, one important thing to consider is that the total value of the option package issued, is a function of both the total number given, but also the strike price they have. The two go hand in hand.

But before we go any further, a quick definition check on Strike Price:

An option’s strike price is the fixed price assigned to an option for the purchasing of the underlying share (typically ordinary shares) in the company. In effect, you have to pay the [strike price x  the options] you’ve been granted, to exercise your right to buy the underlying shares. Once you’ve ‘exercised’, you own the shares.

Pricing strike prices is a bit of a pain. In the USA, you have to do 409A valuations. More on that from Fred Wilson here:

Pricing in the UK is both simpler and more difficult. More difficult because it isn’t as clear as the USA, but simpler, because there is more flexibility.

Here is the exact language from HMRC (http://www.hmrc.gov.uk/shareschemes/emi-new-guidance.htm#10):

If EMI options in an unquoted company are granted the company can, if it wishes, agree the market value of the shares with HMRC Shares and Assets Valuation (SAV). To agree a market value with them the company will need to propose a value for the shares and provide background information to support the proposal. It will need to complete form Val 231 for EMI options.
The form outlines the information needed to support the proposed valuation. When it is complete, it should be sent it to HMRC Shares and Assets Valuation (SAV).
If the form is not used or the company does not supply all the information requested, it may be asked to supply the missing information before a valuation can begin. This could delay the agreement of the valuation. When HMRC Shares and Assets Valuation (SAV) receive your completed form, they will tell you within ten working days if they need any further information.
Asking HMRC to agree a valuation is not the same as:

  •    notifying HMRC of the grant of EMI options
  •    or making the annual tax return required for EMIs

This language does give you some flexibility on how you want to value and define your company’s value at the time you are setting the strike price. Book an appointment with someone like
http://www.completeaccountingsolutions.co.uk/ to discuss how you might go about setting this, or with your lawyers. Getting this right is important because if you don’t get it right, it will have serious tax implications for your employees or any other option recipients.

So back to strike pricing and its effect on the value you give to your employees:

If you have a very high strike price, you affect the employee’s total return on an exit. In a simplified equation (that isn’t designed to give you the present value of your options (Black–Scholes), but rather just the mechanics of cashing out), the value of the options will be:

(Share Price at Exit * Options you have) – (Strike Price you have * Options you have) = value to employee in cash at exit

You can see where to match employee 100, who comes in when the company is worth a lot more, with employee 10, who came in early, you’d have to issue employee 100 many more shares to ‘equal’ the same given to Employee 10. Try explaining all that to your hundredth employee and also to your first few, who might feel slighted that someone has more ‘shares’ than they do for the same job function.

Also, here is an interesting point to consider: different exercise prices for fully vested employees will cause them to behave differently. An employee who has 100 shares to buy, but only at $1 each will act differently (buy the shares and be a passive shareholder) vs an employee that has 100 shares at $100 (more likely to make a calculated decision as to whether to exercise (or not) the options upon a departure). Remember, if you set an exercise period after someone leaves the company, the question is, do you want them to keep the shares as a bet (low price) or only keep them if they really believe in the company (high price)? Again, no right answer as you balance between equity you give out.

So how much equity to give them?

After the above exercise, you see the challenge between articulating fairness mathematically, but also in terms of how employees chat between themselves and can sometimes get the wrong impressions based on not having all the facts.

Transparency is very useful in the early stages of a business, but as you grow, you may choose to just share the basic information of your company’s equity buckets, or strata. It’s really up to you and how you want to stratify the different kinds of employee equity issuances, for example: director level, supervisory level, and admin level.

The trick here, is really in how to ‘define’ who is what. I’d say that the important strata are:

  •    Those that set strategic direction overall (typically the founders or CEO)
  •    Those that set functional strategic direction (typically someone like a CFO, or CMO)
  •    Those that set budgets to hit strategic goals (Directors, VPs)
  •    Those that manage people according to budgets (Supervisors, Line Managers)
  •    Those that execute (Developers, Sales people, etc)

Then, you define what’s a fair total comp bucket value for each of these, and then use the math equations to give you the relative values of equity for each strata.

As with most things of this nature, however, there are more than one way to slice the onion.

Fred Wilson’s post below on what to issue each strata is useful as a guide for both an equation to calculate absolute numbers, but also to help understand the different tiers of employees.

And here is Guy Kawasaki’s suggested split (via @brandid):

Lastly, here is another version of how to divide things ‘fairly’ between everyone (via @gosimpletax): http://www.brightjourney.com/q/forming-new-software-startup-allocate-ownership-fairly

Once you’ve chosen your preferred method, one mistake to avoid is to promise early employees ‘percentages’. Meaning, don’t say, I’ll give you 2%, but rather say, I’m giving you 2,000 shares which represent 2% of our current cap table. The reason is that if you leave it verbally at 2%, you may inadvertently make them believe that at the next round the will continue to have 2%. Don’t assume all employees understand the mechanics of financing rounds and/or dilution.

Another mistake to avoid is not including a vesting period. Without a vesting period, your employees have full access to what you’ve promised them, whether they’ve spent time to ‘earn it’, it is dangerous for the company to not have one. Read here an explanation of why that’s important:  http://www.seedcamp.com/2012/11/seedhack-founders-collaboration-agreement-version-2-0.html

In the end, this is more of an art, and you will get it wrong at least once, and don’t be afraid to experiment, but as long as you have a process, I believe you will have less issues going forward, particularly when the company grows larger, than if you leave things entirely open-ended.

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New Books to my ‘Recommended’ list.

I haven’t had as much time to read as I would have liked this year, but three books stood out so I’ve added them to my bookroll:

I can wholeheartedly recommend them all.

The Positioning book stood out in recent reads beyond this year mostly because it goes counter to what many consider convention.
Likewise, Drive shares many of the similar attributes due Positioning in that it rocks your world with some changes to general conventions around motivation.

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