Pick your investors carefully
It’s hard for newly hatched founders to know what they should be looking for in an investor. While there will be some nuance in what is appropriate for each company depending on their industry and near-term goals, there are some over-arching principles that they should be thinking about. I’ve spent enough time working with start-ups to see that there can be issues further down the road if they don’t get the initial set-up right.
Corporate governance refers to the collection of “mechanisms, processes and relations by which corporations are controlled and operated.” The general take on this in relation to start-ups is that it doesn’t matter. This can be the case if we’re talking about a rocket ship that has immense pricing power as money can pave over many missteps. That isn’t the case for most start-ups in Southeast Asia. Founders need to negotiate a maze of problems with dead-ends that lead to ghosts and ghouls. Having oversight from those that have trodden the path before can be useful to avoid getting stuck in a life threatening situation.
Generally, the lead investors in the initial round will form a meaningful part of the advisory panel or Board of Directors with reserved matters (a list of things that a start-up cannot do). For the purposes of this post, I’ll use the terms “Investor” and “Board” or “Corporate Governance” interchangeably. Please note that investors that following follow-on or small angels won’t necessarily have as large of an impact but could still be influential to outcomes if they have a view that they want expressed and acknowledged.
The Good, the Bad, and the Ugly
Founders need to be mindful of what type of investors they work with in the early stages. You would hope that most investors are neutral or add value. This could create a ratio that looks something like 60:40 (neutral investors ):(good investors). However, the proportion of investors that are able to detract or distract from the core business, which I’ll call “bad investors”, isn’t a rounding error.
From my experience (I’m unsure if this is a poor sample set and indicative of the people that I attract or the local market in general), the proportion of investors that can create materially negative post-investment outcomes would create a skew closer to 40:40:20 (bad investors):(neutral investors): (good investors).
If we accept that compounding (growth of product and top line) and speed (decisions and action) are two of the critical factors of success for start-ups. Moving fast while making good decisions will dramatically increase the potential for success. Inverted, this means that bad decisions (or no decisions) compounded is a recipe for imminent failure.
But how can you tell who is who? Fund-raising is like searching for Wally in “Where’s Wally/Waldo?” when you’re colour blind, sometimes you end up with Odlaw and you just don’t know it.
Who do you trust?
Obviously, you’re going to be sold the bull story when you initially go out to fund-raise. Everyone is “value-add” and will do everything that they can to ensure that you’re successful. There are three things that you could do to reduce the risk that you’re getting in bed with the wrong sugar daddy.
1. Work with them first
As you’re going through the due diligence process, start working with them in more detail. Leverage their networks and resources. Are they actually able to help you or are they all talk? If they say that they will be able to help you only when the documents are signed, I’d treat that as a warning sign. Are they actually able to help you or are they all bark and no bite? Early-stage investors should have a number of different ways to help growing companies. After all, there are a number of dead ends that need to be negotiated.
2. Get references
Get references from their portfolio companies. During the due diligence process, they will likely be talking to your customers and suppliers. You should be able to ask their portfolio companies how they have found the investor that you’re talking to. You could leverage this further and ask other founders which investors they favour working with.
3. Play favourites
As you’re meeting with investors, you could ask which other investors they like working with. In early-stage, there’s generally some overlap in investor’s portfolio companies. You will see some investors working together more than others.
Personally, I’ve had some experience with companies that have had subsequent issues with their early-stage investors and board members. The issues have ranged from a board level decision that led to a change in strategy at the 11th hour, which left the company out of runway; to an overly zealous investor that wanted to know why actuals weren’t following the projected numbers to the dollar. There have also been other companies that I’ve spoken with who don’t have a sufficiently strong Board, which meant that they didn’t have advice about their options when they needed it and missed opportunities or otherwise capped their growth potential.
What about when?
Another question that I regularly get is “When should start-ups approach series A/B or later-stage investors?” This leads to a range of questions, such as: Should later-stage investors be a part of earlier rounds? Does this make later-stage investors more likely to become cornerstone investors in follow-on rounds?
In my view, having later-stage investors involved in earlier rounds isn’t necessarily good or bad. If later-stage investors participate in an early round and don’t participate in a subsequent round for internal reasons (fund fully deployed, mandate requirements, etc), the aesthetics will obviously be poor. Further, they won’t necessarily be able to provide more value as they’re used to working with companies that have a little more structure/maturity. There is also the possibility that their involvement at the early-stage could limit the amount of other later-stage investors that could be interested because of perceived conflicts.
As a founder, if you’re able to maintain the channels of communication and keep later-stage investors engaged with what you’re doing, they will generally keep the door open for investment later. Unless the investor is particularly vindictive and wants to fund the next copy-cat that comes along, there is limited downside to waiting until there’s an appropriate fit with start-up maturity and investor focus.
That said, if the later-stage investor has a track of investing in early-stage companies and is able to provide the support that you need, this changes things. You could get the same benefits as you would partnering with an early-stage investor with some promise of potential follow-on funding.
The early-stage investors that you partner with will give guidance through their corporate governance role. The investors that founders decide to partner with will have a dramatic impact on the start-ups potential and success in relatively short order. As a founder, run your due diligence on the investors that you’re talking to; work with them, get references from their portfolio companies, and find out who other investors like working with. Work out who has the company’s interests at heart (n.b. sometimes the interests of the company and founders might diverge). Find your Wally/Waldo that will be able to help you avoid the ghosts, ghouls, and dead-ends.
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