What kind of startup investor are you talking to?
Raising money sucks. Yeah, you have probably heard that a million times, but I cannot emphasize how soul draining the process of startup fundraising can be. After a few years of pitching, begging, and hair pulling, I managed to raise a few million dollars, mostly from Angel investors. I met a lot of people and learned a lot about the very odd, fickle world of startup investing. One of the first skills I had to pick up was quickly identifying what type of investor I was talking to. Talking to the wrong type of investor would, at best, waste my time and at worst, become a nightmare for both my company and me.
The Startup Investor Magic Quadrant Chart
The first time I would meet with a potential investor, I needed to find an answer to a very simple question: Is the person I am talking to a real startup Angel investor or something else?
This seems like a rather easy task but the truth can be surprisingly elusive. I came up with my own “magic quadrant” chart that I had to place this particular “investor” in that I just met. The premise is simple, their risk tolerance (low to high) versus possible reward expectation (low to high). Four possibilities, three I ran away from and one I proceeded to the next step with.
Low Risk / Low Reward — The Boring Investor
Let’s start with the most common investor I encountered over the years, the low risk/low reward investor. This is the person who might have a lot of real investments but isn’t anywhere close to being an Angel investor. Their investments are all in nice, safe places and have a fairly predictable return. These types of investors may ask questions like “what kind of dividend can I expect with my investment?” They may make statements such as “I am afraid I am going to lose my money”. They are risk-averse and not ready for the rollercoaster of startup investing. You might think you can introduce them into the brave, risk-filled startup world, but you don’t want to be one of their first high-risk investments.
Why I avoided the Boring Investor — They were going to waste my time because they weren’t ever going to pull the trigger on an investment they may completely lose. Even if I convinced them to invest, their fear of losing their money would turn them into a huge pain-in-my-ass by constantly bugging me with fear-filled comments and questions that are counter-productive to growing a startup.
Low Risk/High Reward — The Delusional Investor
The absolute worst type of “investor” that I dealt with was the Delusional Investor who expected little risk of losing their money but an unlimited ceiling for returns. These can be some of the biggest douchebags in the startup world. Some of the investors that fall into this quadrant think they are so much smarter than the people they are investing in that they can get early-stage investment terms for a growth-stage company. Others are just simply delusional and believe they can always find investments that can return huge mulitples with no chance of going belly-up. Within this class of investor types you will find the fakers, the liars, and the con artists. They aren’t looking to help you, they are looking to take advantage of you.
Why I avoided the Delusional Investor — This was simply bad money. Bad terms, bad personalities, bad karma. If I gave the impression that my startup was anything but high-risk to any investor, then I would be mismanaging and setting up our relationship to fail right out of the gate. Bringing in one of these types using that kind of false pretense would have been an absolute nightmare. Being gullible enough to be taken advantage of by one of the charlatans would have likely shut the door on any future investments from desirable sources. No one wants to see a douchebag in your company or your cap table.
High Risk/Low Reward — The Bad Investor
Investing in a business that has high likelihood of failure combined with a low ROI sounds ridiculous yet happens way more often than it should. You might hear some people politely refer to these types as “not sophisticated investors”. A business that cannot scale rarely creates a return that does. When a potential investor would tell me about their other investments, and those investments were in low-ceiling service industries or no-scale family businesses, I would just cringe. These weren’t investors. They were donors with dead money in play and misguided expectations.
Why I avoided the Bad Investor — Chances are, they would never have invested and only wasted my time because my startup was a completely different type of investment than they were used to seeing (you know, the type of investment that had an actual chance of generating a real return). If they did invest, they would likely become very needy due to their unfamiliarity with the ups and downs of high-growth potential startups. Having the Bad Investor on your cap table may turn off some potential smart investors. Bottom line, they wouldn’t have been useful outside of their initial check, and the likelihood of regret was too high to seriously consider them as an investor.
High Risk/High Reward — The Startup Investor
All startups are high risk investments. The earlier stage, the higher the risk. Smart startup investors know that the potential return multiples should be proportional to the risk taken. The statistics will tell you that you are likely going to lose your money. But if your bet pays off, you could see huge multiples. This isn’t rocket science, but you would be surprised how few so-called startup investors get this. I had to make sure that the investor I was talking to understood this most fundamental concept of startup investing. No surprises. No promises of a huge return. No snake oil. High risk, high reward.
What happened after I found out someone was a legitimate Startup Investor — Unfortunately, just because the person I was talking to was a real Angel investor didn’t mean that 1) they wanted to invest in my startup or 2) that they were someone that I wanted to take money from. This was just the first step.