The Good, The Bad and The Ugly; Dealing with Investors

Liz Karungi
Sep 7, 2018 · 8 min read
source: canva.com

Ah, investors! Love them or hate them, there comes the time in every entrepreneur’s journey when they have to decide whether or not to court them because, more often than not, you need them. The process of finding, courting and eventually getting into a partnership with an investor, however, is only the beginning. So, while you should celebrate once the deal is signed, there’s more to it than receiving the much-needed capital for the business. An investor relationship must be carefully handled because if things go sour, you will be in it together.

In 2010, Ben Lyon and Dylan Higgins co-founded and successfully ran Kopo Kopo in Kenya — a company that provides payment services to SMEs by partnering with financial institutions, mobile operators and major retailers. Unfortunately, at the end of 2015, the company was running out of money. The two co-founders had a plan though: fundraising. They gave themselves 6 months to raise 5 million dollars of Venture Capital, a process that had previously taken them 9 months. They assumed that because the company had been performing well, it would raise the money fast — a wrong assumption. The process ended up taking 9 months and they nearly ran out of money. The way this deal was structured was that all the involved investors had to invest at once, with a Lead Investor setting the terms and investing a partial amount of the funds being raised, leaving the rest to be invested by the others.

Two weeks before running out of cash, they were given a term sheet by a Lead Investor — a lifeline for the company! However, before they could celebrate, the lead investor pulled the proposed term sheet at the last minute without reason. This was a disaster because their Plan B wasn’t able to move as quickly as they needed!

“Our existing investors agreed to invest more money to save the company, but on their own terms,” Ben said.

Their offer was to recapitalize the company. This would mean that the company would have less value and therefore, the investors would invest a small amount of money for a significant share of the company. This also diluted the common shares, which included employees and founders. However, because they were running out of cash, they had no choice but to accept these terms and as a result, had to lay off 15 of 50 staff members. Following this, the co-founders also left the business.

“Dylan and I made decisions that ultimately led to this situation,” said Ben, “However, for the investors to push for what they did was short sighted because they lost talented employees and the founders which gravely affected the company.”

Hard Lessons learned

After Ben left Kopo Kopo, he went on to co-found another company, Hover Developer Services, based out of Seattle, Washington focused on South Asia and Sub-Saharan Africa. The experience with Kopo Kopo taught him not to let just anyone into the company. He learned the importance of understanding your investors enough to predict how they would behave when things go badly, which is inevitable.

“Our relationship with the investors at Kopo Kopo was based on trust,” Ben said, “Trust is nice to have, but it shouldn’t be the foundation of the relationship. Clear expectations should be set up front.”

However, Ben and Dylan also fully accept responsibility for the mistakes they made that led to the situation with Kopo Kopo.

“We should have done more mutual due diligence, but we should have also spent less and raised money sooner to avoid this situation in the first place.”

Once Bitten…

With Hover, Ben and the team are a lot more careful about who gets involved and have turned away investors they don’t think will add value to the company. He wants investors who have been entrepreneurs, understand the highs and lows of a startup and will stand by him in a crisis.

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Ben categorises investors according to their level of involvement and amount of knowledge or experience.

  • Dumb Active money is from an investor who is really involved but fundamentally doesn’t understand the business;
  • Dumb Passive money is from one who isn’t involved and doesn’t understand the business;
  • Smart Passive money is from one who isn’t involved and does understand the business while
  • Smart Active money is from one who is involved and understands the business.

The best thing an entrepreneur can do is get a Smart Active investor who specifically knows your industry, geography and can make introductions to other people that can add value to your business. It is particularly helpful if they were previously founders themselves, so they can help you solve problems because they understand you better and can empathize and draw from previous experience.

“The worst thing is Dumb Active money,” says Ben, “Dumb Passive money is okay, but they won’t be able to help you, while Smart Passive money is disappointing because they could do a lot more than just provide money. So, look for Smart Active money and desperately avoid Dumb Active money.”

The level of involvement of the investor should be determined by the CEO and the founder(s), not by the investors, therefore you should set expectations clearly. Founders or entrepreneurs don’t work for investors (unless investors own more than 50% of the company) but for customers — this should be their focus all the time. Investors who have been entrepreneurs should understand this and be respectful of the entrepreneur’s time.

With Hover, Ben is prioritizing getting Smart Active investors involved in the business.

“I want to have a real, active relationship with our investors because I need and appreciate their advice.”

He also keeps an active relationship with his investors because he doesn’t want them to be surprised by anything. If you don’t invest the time to send an update or have an occasional conversation with them, they are going to get anxious. If they are anxious, they will not talk to other investors about you for future investment, or think about getting customers for you.

What Capital Should You even Look for?

When thinking about financing your company, remember that your time as CEO is really expensive. If you are pitching the wrong type of funder, you will be wasting your time. An early-stage startup, for example, with no revenue shouldn’t pitch a Private Equity Fund because that’s the wrong type of capital for them. A family business passed on from generation to generation shouldn’t raise Venture Capital because Venture Capital Funds will come to a close. Ben recommends all entrepreneurs read the book Venture Deals before raising venture capital for them to understand how venture capital works.

“Before you even think about fundraising, however, ask yourself why you started the business and what you want out of it,” Ben says, “Do you want to be involved for a few years and then have someone buy the company so you can retire? If so, you need to raise Venture Capital. Do you want to be in the company for 10 to 20 years and have it listed on the stock exchange? Then you probably want to start with Venture Capital and raise Private Equity later.”

What you financially want out of the business is something entrepreneurs shouldn’t be shy about. Is it a big payout? Control forever? Know what you want and work backwards from there in order to select the type of capital to raise.

Many companies want to maintain ownership for decades. In that case, Private Equity and Venture Capital are likely not the best options. Consider debt (if possible), grants, angel investors or bootstrapping — where you fund the business yourself. However, Ben thinks the idea of maintaining 100% ownership is naive because you can achieve what you want faster with external capital. It’s better to own a smaller piece of huge pie than all of a tiny pie, for example.

“For a young company taking on a big loan, that loan is more likely to kill you than letting go of a little equity would. Someone with 10 or 20% of your business doesn’t give them control of the company. Don’t sell more than 49% of your business if you don’t want to lose control of it.”

There are ways you can manage your investors. Having them on your board of directors is a good thing because while you’re still in control, they will push you because they want the company to do better.

Building the Relationship with your Investors

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The founder(s) should control and communicate the narrative and vision of the company. He/she should be the one managing the shareholders, maintaining these relationships and making sure the investors know what they need to know. You know you are not doing this if you are constantly responding to your shareholders, instead of them responding to you.

Ben advises entrepreneurs to send their investors updates telling them everything they need to know before they ask. Do it on the same day every month so they can depend on you. He sends his investors a monthly update by an email in which he gives them a true snapshot of where the company is.

“I want them to know how we are thinking strategically. If you’re not profitable, tell them,” he says, “If the business is dying, say it. Don’t wait for them to ask. Tell them what you are doing to save it, but be honest.”

According to Ben, you are showing them respect by giving them this information — they took a bet on you with their money and therefore have a right to know what is happening with the business. If you’ve picked the right investors, they are on your side and want the business to do well.

There are other investors whose tactical help Ben values so he builds these relationships by staying in touch with them on a day-to-day basis. These relationships are really important especially for early stage companies.

Ultimately, you want your investors to feel involved, informed, valued and respected. However, you should be careful about inviting them to participate in the day-to-day operations of your business because you know this better than they ever will; it is your full time job. This business is everything for you as the founder, but it’s only part of a portfolio of businesses for your investors.

*Puppies and baby pandas to Ben for sharing the lessons he learned from his experience with us!

SHONA Insights

Liz Karungi

Written by

SHONA Insights

This platform will provide resources to facilitate an equitable distribution of knowledge among people with businesses, business ideas or a general interest in business in East Africa

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