What the VCIC can teach us about Finding Good Investors.

Finding an investor for your startup is hard, and as I partly covered in my last post: What Tier is your Investor (or what to look for in an investor)It involves taking a lot of meetings and dealing with a lot of rejections while at the same time ascertaining how much value-add the investor you are speaking with will provide, above and beyond their investment.

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Last month, I had the pleasure of judging my local VCIC event at the London Business School and it reminded me of the importance of the symbiotic relationship between investors and founders. The Venture Capital Investment Competition (VCIC) is a competition for MBA students aspiring to become VC’s after graduation or trying to better understand the investment process for when they start their own companies. The competition is about how well they analyse a business opportunity and then recommend and close an investment with the founder of that opportunity. It’s a great experience. Probably one of the best experiences to get a business student a feeling for how the entire academic body of knowledge comes together into evaluating and investing in a company. If you are currently doing your MBA, you HAVE to do this if you really want to exercise what you’re learning across all of your classes.

More than 8 years have passed since my personal VCIC experience as a participant, but I still remember it vividly to this day. Since then, I’ve had the pleasure of judging it every year thereafter and seeing many MBA teams go through the process and trying any number of things, ranging from the silly, to the creative in their attempts to out-do their competing ‘VC Firms’ to secure an investment-agreement with one of the presenting founders (which, btw, are always real-live companies). Every time I judge this event, I’m reminded of how important it is for founders to not only find the right investors, but also for investors courting a founder to demonstrate their value (their ‘tier’ so to speak).

During my judging of these events over the years, I’ve noticed there are six key areas that differentiate the best VCIC  teams (read: VC firms) from the worst (both from the point of view of the founder and the judging VCs). These are:

* The best VCIC teams build rapport with the founders & ask the key questions – Sometimes as an investor you have to ask difficult and probing questions. Some are questions that signal your doubt on a current company strategy or perhaps on how the company’s thinking revolves around any operational area. As the VCIC teams ask questions to get these answers and better understand the founding team’s thinking, they need to do so while at the same time respecting the founders and not making them feel like they, just because they have money, know it all, for no one does, no matter what their experience. I consistently saw VCIC teams failing in this area, but a few that really stood out made an effort in asking questions not from a position of patronising the founders, but from trying to understand them and dig into the right issues.

* The best VCIC teams understand the opportunity & dig only into the right issues with their time– Doing your homework is an important part of any mutual discussion. Some VCIC competitors haven’t even looked at the product that the company makes. The VCIC teams that fared better were the ones that, logically, didn’t get hung up on semantic arguments, but rather dug deep into any number of issues that are important. As a founder, you know what are your biggest challenges. If an investor identifies those as well, particularly without you spoonfeeding them on it, that’s a good thing and bodes well for having them on your board. As an investor, don’t show up unprepared and pretend like you can make up for it by picking up a trivial argument. In the competition itself, sometimes you have to dedicate your time to researching a specific company at the risk of showing up unprepared to interview the companies that you are not interested in for investment. This counts against you, so keep that in mind. In real life, as a VC, its as if  you took a coffee meeting with a founder, and then were rude to them.

* The best VCIC teams demonstrate value to the founder – One of the things that VCIC teams have to do when they are asking questions of the startups, is explain who they are. In the context of the VCIC they can fictionalise their ‘fund expertise’ since none of them are running real funds, but part of this exercise is also marketing the right attributes vis-a-vis what the startup team needs. For VCIC teams where a resident expert exists it can be useful, but also consider that you can showcase value by bringing in the right people external to your fund to help the company along.

* The best VCIC teams demonstrate an understanding of the financial requirements of the company – Some VCIC  teams fall short of true analysis and research here, they just take whats given to them. Sometimes they underfund companies and sometimes they over-fund the companies as part of getting their numbers to work. There is probably more to say on this point than can fit into this post, but what I’d recommend is that the VCIC teams explore proxy companies in the market and truly understand the impact of offering too little (or too much) to the company. One point on VCIC valuations: Teams, DCFs don’t work well on companies that don’t have historic data!

* The best VCIC teams don’t overcomplicate their termsheets – First of all, if you are a VCIC competitor, you should familiarize yourself with actual termsheets, and word of advice: keep it simple. Check out the Series Seed docs for the USA and the Seedsummit Docs for the EU as a starting point. Secondly, as a VCIC participant (and real investor) keep in mind that term sheets can actually signal quite a bit to the founder of what you think of them and that this does have an emotional impact on the founders. Do they have too many control provisions, for example, or are the economics of the deal indicating some concern? While supervision isn’t necessarily bad, as a founder, the smart thing to do is ask what the investor’s expectation is engaging with founders post investment. Are they meddlesome, for example? Are those control provisions there to protect you or are they draconian in how they operate? Ask to speak to the CEOs of other portfolio companies of theirs. Regarding the economics of a deal, perhaps the economics imply that they think you are overpriced. Ask them to walk you through how they came to that value and why. As a VCIC team, be mindful that overly complicated termsheets can come back and haunt you by providing perhaps too many mixed messages to the founders. As a founder, push back on items that don’t make sense.

If you are a team about to participate in the upcoming finals, I wish you the best of luck. If you are a founder, keep the above points in mind when you are doing a review of your investors-to-be. As for me, I look forward to continuing to be part of the VCIC experience in the future, I always learn a ton and am continuously impressed what teams achieve in such a short amount of time. I find that every time that I judge it, I’m reminded of the delicate interplay between investors and founders and how trust needs to be built over time.

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

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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 Best Ways to Reach Out to an Investor

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Getting in touch with an investor is probably one of the hardest and most frustrating things to do. It is usually, step 1 in a fundraising process. As such, it isn’t to be taken lightly… The worst thing you can do, frankly, is the non-descript email to the info@investorsdomain dot com email that goes to no one.

Just don’t do it.

1) Research the Investor and his or her firm. The worst thing you can do is reach out to someone that invests in the wrong sector or stage of your business. Review their website. Read about what they are interested in, professionally and personally. This will make your interaction with the investor far more relevant.

2) Rely on a 3rd party for an introduction. If you can find someone that knows them, that introduction will serve you far better than reaching them directly. One tool I use is LinkedIn to find out who of my network knows them. This makes the introduction process far more relevant.

3) Keep your initial email short and to the point. Don’t over do it content wise and length wise, otherwise you are likely to have the investor gloss over the sheer mass of your email and relegate the email to the ‘to read’ bucket.

4) Think of your initial email as merely a ‘preview’ or elevator pitch and with a call to action, such as for more information if they are interested in the idea.

5) Don’t forget to thank the person who introduced you. If you want to, feel free to keep them updated on the conversation as well, but remove them from the cc of the initial intro email. You don’t want to overburden their inbox either!

6) Twitter is increasingly becoming an efficient tool for contacting people for quick things… if used sparingly and in a very specific and non-generic way, you can @ reply someone you are interested in to engage in a conversation or comment on what they said as a starter, but use this tool sparingly, don’t tweet-stalk someone.

7) Get out of the Office! Go to networking events. When there, find people to introduce you to them or network your way into the conversation, avoid interrupting ongoing conversations, but don’t be afraid to be friendly and try and work your way into the conversation if they are open to it, if they seem engaged, back away and come back later. Remember, you might be a ‘relief’ to the conversation they are having, but you don’t want to be the ‘distraction’ either.. feel it out, but don’t be afraid to take the risk…. and get to the point quickly. You have about 30 seconds to make your conversation with someone, anyone, relevant to them. BTW, If an investor gives you feedback during this conversation, the worst thing you can do, also, is to come across as defensive.. that will make you stand out for all the wrong reasons.

I hope that helps…

Remember, Investors are just as eager to meet you as you are them.. they are just very time-starved and don’t want to waste time on opportunities that are likely not for them.

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Setting Appropriate Milestones in an Early-Stage Startup

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Updated Post on Nov 11, 2013 – See bottom of post for updated notes.

When looking to plan for your company’s growth strategy or to go fundraising, it’ll serve you and your company well to break down what you need to do in terms of projected milestones. Technically speaking, I believe a milestone is a future ‘marker’ within your company’s stated growth trajectory.

Therefore, milestones, in the context of startups, are effectively points in time along the company’s timeline prior to a future event or goal. These points in time are usually defining points in a company’s history…  such as a key hire, a product launch, a certain number of users, a retention rate, first revenues, first profit, etc.

Rather than the goal itself (an example goal could be to create a successful, cash-self-sufficient company, that provides tangible value to its customers and is floated on the public market), milestones are a subset of ‘the goal’. As such, milestones of any size can be created throughout the lifetime of your company as it progresses to your company’s ultimate goal.

Milestones are important from a fundraising point of view because they can define whether a company is caught with little to show to potential investors at the point of fundraising or with a strong showing of what the company’s been able to accomplish to date.

Lets, for example, look at the following points in a company’s history (I’m making the timing up for example only, don’t assume these are ideal timings):

  • Month 3: Minimum Viable Product
  • Month 5: Private Beta Launch
  • Month 8: Key Hire
  • Month 11: Public Beta Launch
  • Month 12: x% daily growth rate in subscribers

If a company knows how much money they need at all points in the timeline (see the article on how much money should I raise), then the question is which is the best milestone to fundraise on?

From an investor’s psychology point of view, risk is what is being managed. Minimization of risk while not losing an opportunity to invest in a hot company is the balance game that all investors play. Investors are constantly trying to find the least risky point to invest in a company relative to what they afford to invest (valuation) and the ability for them to invest (there is space in the investment round for new investors).

As such, the best time for a company to fund raise is either right before the completion of a key milestone or right after the completion of key milestone but before too much time lapses right after its completion such that there isn’t a sustainability of the reached milestone.

Let me explain. First, let’s look at the psychology of investing right before a key milestone is completed:

If an investor feels confident that the company is on track to hit its milestone, the investor knows that once the company succeeds, the company will inherently be more valuable to the outside market because it has been meaningfully de-risked by some amount. As such, the investor wants to ‘get in’ on the deal right before ‘launch’ for example, so that they can get a specific valuation while the company is still a little bit riskier, but not overly so.

This makes sense and is therefore quite simple to understand, but only companies that can instil confidence in potential investors of managing growth post milestone completion, generally get investors rushing to get this done. However, it’s a great for a start-up to be in, because generally, for things like a product-launch milestone, it is easier to control than say, a specific user growth rate.

Now let’s look at the psychology of investing post a key milestone being completed:

If an investor feels like he wants to ‘stall’ to see if the company is completed, or the number of users hit, etc.… then he is trying to effectively fully de-risk the investment before committing cash. However, he knows that being playing the cards this way, other players will also be on the table quite quickly because the company is not only attractive to him, but also to many others that were standing by the sidelines waiting to see what the company would do (relative to their risk profiles as in, this doesn’t mean that late stage investors, for example, will change their mind to invest in your company). Therefore, the investor in question wants to get in before the company is too valuable for them to invest in.

Therefore, the art of picking milestones is trying to determine which ones are the key ones to focus on.

As a rule of thumb, these are the biggest ones:

Human Resources  – Hiring key people that will make a huge impact on your organization (not just employees for workload purposes, but like a shit-hot marketing person, for example).

“In terms of team growth, I believe there are other significant milestones, where organization changes happen roughly every doubling in size:  founding team (usually 3 -5) expands to 7 -12, expands to 25-30, expands to 50-70, then above 100 and beyond. More often I see companies do quick jumps rather than continuous growth, and the jumps are always followed by significant growth management challenges.”*

Product – Product launches vs. version releases

Market – Market validation. As in, first customers, or first paying customers, etc.

Funding – Maybe some money being committed to a round that the investor in question can lead or participate in.

You can break these down into smaller and smaller ones if you’d like, but that’s where you start having to make judgement calls as to what is meaningful and what is not.

Other examples of milestones include*:

  •  Proof that you can work together as a team, usually historical evidence
  •  Proof that you can build something, i.e. working prototype
  •  Proof that it’s useful to someone – first users and clients
  •  Proof that you can talk to investors – every financing round, even small ones
  •  Proof that you can talk to audiences – 100k users or 1M users or 10M users…
  •  Proof that the initial team is able to attract talent – key hires are C- ad VP- level professionals, which will drive your growth further. Every startup will eventually need a functioning management team consisting of CEO, CTO, COO, VP Sales, VP Marketing, and possibly some others depending on what you’re building.
  •  Proof that ecosystem agrees with your ideas – bringing respected industry advisors or partnerships on board
  •  Proof that there is market – $1M annually
  •  Proof that you can manage your finances – cash-flow positive operation
  •  Proof that you can scale – $10M annually
  •  Proof that the market is big! – $25M annually and beyond

Just keep in mind, milestones are all about moving from one stage of risk to the next. As you start planning your fundraising strategy, you want to make sure you time it so that you have ample time to fundraise so that you are in control of which milestone your company hits when. You just want to make sure your fundraising strategy uses these milestones to your benefit and not get caught between them and stranded for cash.

* Additional Comments from Bostjan Spetic of Zemanta.com

Update Note from Nov. 11, 2013

You should raise as much money as you can, but at least enough money for you to accomplish your next most meaningful ‘validated’ milestone + some buffer funds to help you spend time fundraising afterwards. This means you should look at a variety of points across your company’s timeline to see which can be made into meaningful milestones.

Whichever country you are in, you will have different fundraising challenges depending on the mix of individual and institutional investors. In a country where the funding comes mostly from individuals, you will likely not be able to raise substantially large rounds, in countries where you have access to organised groups of individuals, you’ll have access to larger rounds, and in countries where you have access to many institutional investors, you will likely be able to raise the largest rounds.

If you want to go for really really big, you should go to the geography where you can get that meaningful amount. Otherwise you will be underfunded, regardless. Keep in mind that in those markets, costs of running startups are going to be higher, so you need to include that in your plan…hiring star coders, for example, in the USA is very very hard these days.

In markets where you are not going to be able to raise the appropriate amount you need up front, try and articulate your requested amount this way: “This is what I need [big number], but this is what I can accomplish [milestones] with this [smaller number]”

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Managing the Legal Process in an Early Stage Startup

 

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One of the most time consuming things founders have to do other than raise money is deal with all the legal paperwork pre and post termsheet that fundraising typically generates. Not only can the legal process be time consuming, but also it can be emotionally difficult depending on how many items are being discussed before finalizing.

While there is no standard process (largely due to the variability in deal types and jurisdictional issues) that can be outlined for how to deal with your unique legal situation, I’d like to propose a few tips that might help you navigate your process along the way. As such, read this post not so much as a how-to, but more-so as a list of things to consider while going through your investment documents.

0) Always be mindful that the most important thing you have at your disposal is your word. If you make promises, keep them. Create trust between everyone you deal with. Say what you mean and mean what you say, and ask questions if you’re not sure. This will help build you a good reputation that will greatly help you along your way.

1) If you aren’t incorporated yet, or if you’ve just started working on an idea with friends, have a pre-founder and advisor arrangements (relating to splits and vesting) agreed before lawyers start drafting stuff later. Lawyers often need to change docs several times to accommodate founders changing their minds or negotiations taking a different turn before the legal docs. We’ve put up a document on our Seedhack site called the Founder’s Collaboration Agreement, which you can use if you don’t have something like this. I assume that for most of you this is not a relevant point, but perhaps for some of the newer teams that haven’t incorporated yet.

2) Always check what your legal responsibilities with existing shareholders are before taking any decisions with or without them. When you have existing shareholders, involve them (including the distribution of information about the new round) as per whatever rights they may have agreed with you as part of their investment documentation. If this means you need to inform them, then inform them, if this means you need to ask them something, then ask them, but don’t leave it to the last minute. Generally speaking, they’ll try and be helpful, but depending on how busy they are, they can take a while, so don’t leave it for the last minute.

3) Don’t be annoying:

a) Lawyers cost money for both sides of the table. Do as much research as possible on your own and try and aggregate your questions as much as possible so that you use your lawyers and their lawyer’s time efficiently.
b) Make sure you have a position on items that are being discussed so that you don’t go back and forth on stuff on the phone or after decisions have been made. Nothing is more annoying than backtracking in legal processes.
c) Don’t let your lawyer get annoying or overly aggressive with your investor. The investor can always walk away if you and your lawyer are coming across as overly difficult and asking for stuff that might actually be destructive for the company in their view. Be assertive for sure, but don’t be divisive. Seek to understand the issues and always think creatively on how to solve them rather than letting the lawyers get into a stalemate or in an argument with your potential investor. Always feel free to say “let’s park this point for now and return to it after we’ve had to consider it”.
d) Don’t let paranoia of what others could do to screw you get the better of you. It is OK to be slightly paranoid (I know I am), but don’t let it be so bad that you make the legal process feel painful as you come up with bogus reasons by which to reject perfectly common clauses in an investors proposed documentation.

4) Legal documents have two parts, the commercial stuff (like valuations, percentages, etc) and legal stuff (like which jurisdiction, which filing/reporting procedures, etc). Get all or as much of the commercial points agreed between you and the investor before involving the lawyers (this is effectively what the termsheet is, but sometimes some stuff slips into the subsequent docs to keep the termsheet ‘light’) so that the lawyers are just left with representing these on your documents. If you need to have a discussion on a commercial point, do it with the investor alone and offline (even if you had to ask your lawyer or another shareholder for advice) you shouldn’t spend time on the phone with lawyers negotiating commercial points. Lawyers will help you through the technical points.

5) Always ‘red line’ any changes you make to documents. Keep track of all changes. Use track changing on Word. Google Docs may have this, but lawyers don’t use Google Docs generally.

6) Generally speaking.. and this is just a general rule… conversations are Founder <> Investors and Lawyer <> Lawyer.. meaning, you rarely speak to the counsel of the Investor directly or the Investor with your counsel directly without you guys being on the phone with them.

7) Keep CALM AT ALL TIMES. If you lose it, you will lose it.

8) Always seek solutions. There are multiple ways to skin a cat. Any issue can usually be solved via some creativity. The lawyers aren’t there to come up with stuff for you, you have to sometimes be the one (along with the investor) that can come up with solutions and then the lawyer’s articulate it legally. Although.. Don’t get too creative too, cause that can burn you.

9) Most of you are using lawyers that have been recommended and are experienced, but maybe you are struggling with your current counsel and are looking to switch. It is important that you get good counsel (read my post on this here). Don’t be cheap on this one. You’ll regret it later.

10) Do propose using standard documentation that other lawyers have frequently seen, in the USA consider using the Series Seed docs, or here in Europe, the Seedsummit docs which are based on the US Series Seed docs, or the BVCA ones, etc. there are probably a few more out there, just familiarize yourself with a few to ask them if the ones they send you are based on ‘standards’ as that will reduce everyone’s workload.

11) Managing the closing process. This is a difficult one and in the UK, with deed execution requirements can be difficult, but when there are multiple angels involved lawyers often spend a lot of time getting signatures and it increases the costs that founders don’t want to pay (I just heard of a deal that had 9 angels and the lawyer spent 20 hours managing that process for the entrepreneur, thus ended up overall 3x over budget).  Sometimes, you as founder, can handle this but best case is if one of the leading angels takes charge of this process, we have seen this and it has been really good but you can’t count on having that organized person being on board, so be prepared to be ‘that guy’.

12) Do your due diligence homework. Get your IP agreements, employment agreements, etc organized to help the process go by faster and smoother for your new investor as they will likely have to review these documents.

Hope that helps, and feel free to add your suggestions in the comment section below!

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