Why We Invest in Startups
There are only four reasons people invest in startups. Do you know what they are?
In the hundreds of investment pitches I’ve heard over the years, I can’t remember a single founder asking what would motivate me to invest.
Yet, if you stop and think about it, that’s the only thing that really matters.
For one, if you don’t know what is important to your prospective investor, how can you possibly close them? Perhaps this lack of awareness or interest on the founder’s part is why they close less than 10% of their investment leads on average. I know this because I watched founders fumble thousands of leads on Crowdfunder. I also know that the best founders close about 50% of investors who express interest.
The other reason you should understand your investors’ motivations is that you are going to be stuck with them for the life of your company. So rather than think of their investment as the close of a transaction, you are much better treating it as the beginning of a marriage. All too often founders find out shortly after accepting investment that the investor is not in it for reasons that align with the company’s goals or values. Such misalignment can sink the company quicker than just about any other threat. No startup can afford an investor lawsuit, and the mere fact of legal action must be disclosed to any new investors, which is the kiss of death for fundraising.
Thus, because understanding investor motivations is so important, I’m going to let you in on the secret. There are only four reasons people invest in startups.
1. You Are a Cash Cow
This is the most important reason we invest: there is a clear and present path for high return on investment, in a short period of time. If you are cashflow positive this is outstanding and you will close lots of folks on this fact alone. Short of that, growing monthly revenues over a 12 month period is solid.
If your investors are expecting you to return capital in a two year timeframe but you have no revenues, then you should not accept their investment.
2. We Love Your Product/Service
Especially if you are pre-revenue, we have to resonate with what you are doing on a visceral level. Either you are solving a problem that I happen to have, or I’m so wowed by what you are building that I want to be the first customer and participate in the company’s upside. In other words, your avid customers are you best investor leads.
3. We Already Have a Strong Personal Relationship With You
VCs always talk about how they invest in the founding team (rather than the idea or product). This is because they know the original idea/plan will most likely change, and the founders must navigate lots of choppy waters to survive and ultimately thrive. There is no way to gain this trust/faith without having established a meaningful relationship over a long period of time. Investors want to see you how you handle both success and failure before they invest.
Many founders make the mistake of not going to their friends and family, but rather hit up total strangers instead. Not only will total strangers not likely invest, they will certainly not do so if the people who know you best haven’t invested first.
4. FOMO (Fear of Missing Out)
This is the least powerful motivation, and it only motivates us if one or more of the other three are in play. For example, let’s say you have growing revenues and a product I love. I have good motivation to invest, but I will wait until the last possible opportunity to do so (this is simply human nature). But if you say there’s only one investment slot left and the round is closing tomorrow, I will jump through all sorts of hoops to be that final investor.
The mistake many founders make is creating a false sense of FOMO. Rather than stick to their word, they push back the deadline or accepting more investment after saying the round is closed. Thus undermines your credibility entirely and pisses off early investors in your round. Thus, you should only rely on FOMO when the scarcity is real.
If you can light up the board on all four motivations with each of your investors, you win. It’s that simple. But most of the time, investors will only light up on one or two.
As a fundraising founder, your job is to understand the exact mix of motivations of everyone prospective investor you speak to. And don’t wait until the second meeting to find out. That just wastes everyone’s time.
If you don’t like the motivations of the investors you can attract at this point in time, then don’t fundraise right now. The second worst mistakes you can make as a founder is spending too much time fundraising and not enough time building your business. The biggest mistake is accepting investment from misaligned investors.