Capital Raising: How VCs and Professional Investors Add Value to Your Company — Part One
Funding your company is only part of the equation from good VCs and investors. The other half of the equation is the way they add value to your company.
These days, a lot of VCs, angels, PE executives and professional investors are themselves successful entrepreneurs. This way, they get to distinguish themselves to you from all the other investors you may be speaking to who have not been at the coal face themselves. That’s right — investors need to distinguish themselves as well. This is because they compete for the best deals — and simply providing money is not a way to stand out from the crowd.
Some investors may have domain experience in your sub-sector and many of them can provide introductions to potential clients, marketing experts, designers, lawyers, accountants and new recruits. They are also a handy source of possible mergers or acquisitions. The bottom line, having put money into your company, they now want to do everything they can to promote and help their investment.
Why They Want the Information
The day the money goes in is the day that they start work in moving your company forward. A major part of the value-add is the way in which the investors monitor your progress against the business plan you presented them with in the first place. This gives them an insider’s view of the position of the company and helps them alert you (and them) to possible problems that are looming.
This constant flow of information does two things:
- It helps your investor (and therefore you) to identify issues before they become really big issues
- It helps your investor to identify your misdeeds, misjudgements and misallocations.
What this means is that if you have a good relationship with your investors and you are a straight-up entrepreneur, you should get along fine. The issues start when you realise (or reveal) that you only wanted them for the money and that their required level of disclosure makes it unlikely that you can spend their money on “pot plants and Ferraris.” In the latter case, the continuous, detailed disclosure will provide the ammunition for your investors to engineer significant changes in your company.
One of the main advantages of keeping your investors informed is that when you do hit a bump in the road, you can pick up the phone and get some advice quickly. If they don’t have up-to-date information, you won’t be able to get this advice until they are up-to-speed. The investors’ course of action might range from doing nothing and leaving it to you or your management, or offering advice, or (in urgent cases), stepping in and directing a course of action through their board representation. When the problem is serious, and your relationship with your investors has become strained, you may be thinking that you can work your way out of the problem by selling more product, cutting costs or some other management-type remedy. Whilst you are thinking that, the investors, who have often seen it all before, are quietly planning a quick merger or trade sale for the company.
Post-investment monitoring is an art all of its own. It requires that the investor’s representative have a high degree of rapport with the management team. Sometimes this doesn’t sit well with the transaction-driven members of a venture capital or PE team. Transactions are seen by some to be more glamorous than monitoring the investments. Arguably, however, monitoring is equally important — there is no point having brilliant acquisitions if the investee companies subsequently tank.
How Monitoring Looks In Practice
Monitoring starts with board representation and regular board meetings. “Regular” usually means between eight and twelve times and year. Board meetings will consider management and financial reports and operational matters. They are often held in person, but can be held by Skype or phone or other electronic means if the shareholders’ agreement permits this. There will also be special board meetings in special circumstances, such as proposed acquisitions, mergers or business exits. The shareholders’ agreement will set out all the situations where a board meeting is required.
Monitoring by investors also takes place by them simply walking around your premises. Investors will visit you, talk to the people and look at information in real time. You may or may not find this intrusive, but there is serious literature pointing to the fact that this leads to more innovation in your company — and also to better business exits.
Monitoring also involves staying abreast of developments in your sub-sector and your sector as well as keeping abreast of macro themes that affect your business. Investors will usually monitor your competitors, your market and the economy both here and abroad.
What the Monitoring Looks For
Monitoring is basically looking for problems. Perhaps 80% of monitoring is directed to looking for problems and 20% is directed at looking for future opportunities. The problems investors are looking for include:
- Financial problems: are you on trend for the numbers you put forward in your business plan, or are there problems in your sales, margins, inventory levels, accounts receivable, or cash flow? In a sales oriented company, collecting debts is often neglected to the point that management is asking for more investment when it could simply collect its debts and be in a similar position as if it had raised money.
- Marketing problems: failure to achieve sales volume could be referable to marketing issues — losing product/market fit, pricing issues, increased competition or simply a failure to close deals through lack of sales training.
- Delayed responses from management: This is a real red flag. Delays of days or even weeks by management in supplying information means that something is wrong. At the very least, their is a systems issue in that the information is not ready quickly. Usually, however, it means (in the investors’ opinion, at least) that management is either making it up on the fly or cooking it up to fit some earlier projection or claim.
- Staff resignations: This is often a warning sign that there is something wrong on the shop floor.
- Disagreements within the founding team: This is a warning sign simply because disagreements usually only happen when something is wrong. At this point, the investors will have to step in to mediate before the team splits irrevocably and the investment is in danger.
- Management incompetence: You would think professional investors would have made this call long before they put the money in, but time and time again people only reveal themselves as incompetent when the rubber hits the road in one or more of the key skills needed to build a business. It might be a simple inability to close deals, or a propensity to chase every shiny new object that comes along, or an inability to distinguish reality from the entrepreneur’s “reality distortion field”. 
Rational decisions can’t made and good advice can’t be given without solid data. The flow of information to the investor that starts in due diligence keeps going throughout the term of the investment. It makes sure that you have a fully informed source of advice — and also that you don’t have your hands in the cookie jar.