My observations of more than 60 unique founder-investor relationships at Speedinvest have made me realize how big an effect the personalities of the people involved have. In this blog series on the basics of a good founder-investor relationship, I want to share factors and best practices with the aim of ensuring that all founders get the same opportunities. Read the second part on how to do your investor due diligence here.
Many first-time founders don’t realize this, but it’s crucial to understand that an investment round is not only the investor choosing the startup to invest in, but also the other way around. Money is not a rare commodity in today’s environment: in 2017, European tech investment totalled a record $19.1bn, up from $4.1bn in 2012, and the number of investors increased from 527 to 1'952 during this time period (read more on the European tech landscape here). And there are lots of stories out there of founders choosing the wrong investor and having to live with the (dire) consequences (just one example here). Therefore, choose your investors based on the added value they can provide for your startup.
Make sure your investor is incentivized to support you all the way
The most important factor in choosing the right investor is that you’re both following the same goal: to make your company a success. While this might be obvious, it’s important to note that there are many different factors affecting this goal on the investor’s side.
The relation between management fee and carried interest matters
Foremost, it’s important to understand what drives an investor, and for venture capital funds specifically their fund model. The typical incentive scheme in VC is 2/20, meaning the partners get a 2% management fee p.a., which is fixed, and 20% carried interest (called “carry”), which is performance based. The carry is usually only paid out on the profit, i.e., it only becomes effective once the investors behind the fund (the limited partners) have received their total money paid-in back. In short, this means that most venture capitalists are incentivized mostly by the management fee they get regardless of their performance (read more about the problems of the typical fund model here).
At Speedinvest, we’ve created a slightly different venture capital model where partners participate directly in the success of every single portfolio company, i.e. not only after the limited partners have received 1x their invested money. This aligns the interest of founders and fund partners directly: we are incentivized to make your company as successful as possible and not by the management fee — think about it: a 2% management fee on a 100M fund for 12 partners is simply not very lucrative. So the only way the partners profit from their VC activity is by building a portfolio of highly successful companies.
Is your VC fund a group of tennis players or a soccer team?
Clement from Point Nine (with some envy: this guy produces great content) mentioned in his last post how VC firms are usually more like tennis players than soccer teams. This is true for most VC firms because partners are responsible for their own portfolio companies only. Because partners at Speedinvest are together dependent on the performance of every single portfolio company, I would claim that we actually behave more like a soccer team: we sometimes have to pass the ball to get to a successful outcome. We have cases where different partners share the investment manager duties and the operational tasks for one company. And sometimes, the partner who sourced and led the deal will not be the investment manager for this startup, simply because another partner might be more suitable and more able to provide value-add.
Follow-on restrictions can have an influence on how your investor will support you
Other fund properties will have an effect on incentives and you should try to get to the bottom of details, such as who has invested in the fund and how much of the total fund volume is reserved for follow-on funding. Most funds have a specified amount or ratio of initial portfolio companies they will follow-on in, e.g., only the top 50% of successful startups. That means you’ll have to look elsewhere for funding if you don’t make the cut. At Speedinvest, we pride ourselves with only having two write-offs so far, meaning we try to support all our companies as best as possible. On the positive side, this means we really support our startups in bad times — but critics could say that it takes away focus from the most successful candidates. We believe that if we’ve invested in the right founders and the right market, we can find a business model that will work (even if this takes multiple pivots). In fact, one of our most successful exits (and one of our most regretted anti-portfolio startups) started out with a different business model that was changed after several workshops together.
It’s up to you as the founder to choose your preferences, but make sure you truly understand the fund model of your investor.
Look for the experience/background fit that will help you reach your goal
Having ensured that you and your investor have a common goal and a way of reaching it, the next factor is to make sure your investor can help you reach this goal. The most important contributions an investor can make (in my opinion) are related to her know-how and network, which will be direct outcomes of her background.
The great thing about a good investor is that she will have extensive knowledge on how to scale companies the right way, either because she has first-hand experience from her own startup as founder or because she has already successfully supported many companies as investor.
Choice 1: VC partners vs. entrepreneurial partners
Most of our partners at Speedinvest have founded their own startup before switching to the investment side, and while actually not academically proven to have an effect on fund performance, we are convinced that it allows us to get a unique understanding of what our founders are experiencing, allowing us to support our founders better. Most of the founding partners at Speedinvest know each other from a startup called 3United, which ended up being a leading player in the European mobile space and was successfully sold to VeriSign, but this only came about after a lot of ups and downs (if you understand some German, read up on the founding story of Speedinvest here). Basically, they made all the mistakes so you don’t have to ;)
Having a lot of investment experience can be extremely valuable, too, so it’s again up to the founder’s priorities and background — that’s why I would always emphasize the word “fit” in this decision.
Choice 2: Network vs. know-how
In the end, the perfect investor should complement you in areas that you are not strong in. Do you already have strong operational experience in your area? Then it might be a good idea to look for an investor with strong connections to potential follow-on investors or strategic partners. Founded before, but in a different industry? An investor with industry know-how and network might benefit you most. First-time founder? Look for a combination of entrepreneurial and investment experience. And it’s always possible (and increasingly more common) to get a group of investors into your round.
Choice 3: “Good character”
Lastly, an aspect I will only touch upon briefly, though it is just as crucial, is personal fit. If you don’t believe me, take it from your startup colleagues: “good character” was listed as the number 1 factor for choosing their lead investor by first round portfolio companies. Make sure you at least answer that one question with yes before finally deciding on taking someone’s money: do you want to spend time with this person? (That’s the famous airport test consultants love to do in their application process.) In this decision, don’t forget that by choosing a VC fund you’re probably also choosing a specific investment manager within this firm.
The key message that I want you to take away is that the majority of investors are not “good” or “bad”, but there are investors that simply will be a better match. Make sure you find the investor that is right for your company.
In my other blog post “how to do your investor due diligence” I detail the process of finding the right investor.
Disclaimer: I’ll admit that I’m biased in my view of Speedinvest (simply because I truly believe in our team and model) and I’m happy to discuss all of these points. Send me your thoughts at firstname.lastname@example.org!