Startup School #3: How to Choose an Investor
A Guide for Seed to Series A Startups
This blog is a translation of Plug and Play Japan’s Executive Advisor Zak Murase’s blog「Startup School #3 | 投資家の選び方（シード〜シリーズA以降）」published on, 2021. Check out the original here (JP).
Previously, I wrote about choosing investors in the early phase of starting a business to Pre-Seed.
This article is for those who are looking for investors in the early stage, from Seed to post Series A.
In Seed or Series A equity financing, you will be choosing the lead investor. Lead investors at this stage may have around 10–20% of your shares and can also be part of the board, with voting rights that have a significant impact on the company’s important decisions. In the previous article, I mentioned that “relationships with lead investors are sometimes likened to marriage.” As a companion in growing the company, you and your lead investor will be committed to each other for a long time. However, unlike marriage, you cannot easily divorce a lead investor. Choosing the wrong person can be irreparable.
On the other hand, it is also the investors who have the potential to contribute significantly to the growth of your business not only in terms of funds but also in other aspects. Here are some points to consider depending on your company’s stage.
Seed Stage
Many startups will aim for PMF (Product Market Fit) by procuring Seed rounds. In other words, PMF is not yet achieved or visible when procuring Seeds. Above all, it is a very important period of time that you should rely on investors who are highly experienced. Recently, the number of VCs that specialize in Seeds or targeting Seeds is on the rise in Japan. These Seed VCs will give you advice that could potentially help your company in achieving PMF from an objective point of view, to you, as CEO, who is only thinking about your company’s business. Especially experienced Seed VCs have seen not only successes of various startups, but far more failures. They may be quick to point out the signs when you are going in the wrong direction.
Another reason to choose an experienced Seed investor is to organize your funding rounds with the right corporate value and investment terms. Although the number has decreased recently, there are still some Seed investors who offer investment conditions that are extremely favorable to themselves. When procuring by equity, it is essential for the entrepreneur to set up a consultation with a lawyer, but with experienced investors, interactions can proceed extremely smoothly.
It is relatively easy to approach VCs that specialize in Seed-stage startups. Many VCs are easily reachable from their websites and you’ll find most capitalists individually on Twitter. Some capitalists will happily consult with you even if you don’t have a solid business model yet. I highly recommend you receive feedback on your business casually so that you can get an idea of who they are.
Another important value Seed VCs offer is their connection to Series A investors.
Series A
It is no exaggeration to say that Series A lead investors are the most important investors for startups. Series A investors will play a huge role in the key aspects of achieving PMF and scaling the business in the future.
Seed investors are unlikely to continue to lead your Series A funding. They will introduce you to the experienced and proven Series A investors that will maximize the value of your company. This is part of something that Seed investors do to maximize their returns, but Series A investors who get recommended by those who have seen the startup’s Seed-stage history up close are highly reliable than investors you find on your own. This is because the investors who make such referrals, and the investors who are referred, are involved in each other’s reputation and cannot act to damage their reputation. Of course, it’s up to each investor to decide whether or not to invest just because they were introduced, and you do have to talk to them and do your research to decide if they really suit you. However, given the effort and time saved in finding an investor, a referral from your Seed investor can be very valuable.
So how should you choose a series A investor when you don’t have any referral from your Seed investor? Here are some tips.
First, timing matters.
Seed rounds will secure working capital for about a year to a year and a half, but you should start talking to potential investors at least six months before the funds run out. After the Seed round, I understand that you would want to focus on your product for a while, but funding is one of the CEO’s most important tasks. You have to manage your team on the assumption that you will be devoted to financing for a certain amount of time. I would recommend that you list and approach Series A investor candidates as soon as possible. Of course, you are not ready to be considered investments yet at this point. But if you can share the milestones and estimated schedule with Series A investors, they will be able to take more time to see the business progress, so it becomes easier to move when it is time to procure. Once you’ve connected with your investors, email them regularly to update your progress. The frequency should be at least once a month.
This continuous email communication is far more effective than the pitch you hear for the first time when investors make investment decisions. This is also a good way for entrepreneurs to get to know the investors. If they’re a good investor, they’ll be willing to respond if they see potential in your business.
Another thing to consider at this stage is whether to accept investors from major corporations as leads. Major corporations or CVC funds usually do not take leads but sometimes they do. You want to keep in mind that accepting a certain major corporation as a lead investor in Series A can make it difficult for you to take on the competitor of that company as a customer, or they may give you some difficult investment terms that can affect the rounds after Series B.
* Please also refer to Startup School # 1 “Working with Major Corporations”.
After Series B
After Series B, you will naturally be able to see what kind of investors you should receive investment from, so there are no particular points to be aware of, but be sure to take reference at any stage. VCs usually publish their portfolios, so it would be nice to have some references, including what worked and what didn’t.
Finally, although VCs and major corporations are investing as an organization, unlike angel investors, it is the individual capitalists who ultimately determine whether or not the investor is suitable for you. No matter how good the VC is, if the capitalist in charge is someone who doesn’t fit you, you should think carefully. Of course, it’s a pleasure to be chosen by investors, but don’t forget that you are too, in a position to choose.
Plug and Play is built for startup companies of all sizes. If you’re raising your seed round or your Series C, we can help you elevate your company to that next level. Contact us here.
