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. Go back to the first part on why startups should choose their investors wisely here.
Mutual trust is without doubt the most important pillar for any relationship, be that between partners, friends, colleagues or other collaborators. We’ve all read about HBS professor Noam Wasserman’s research that found 65% of startups fail as a result of co-founder conflict. Google research found that trust is the most important factor for effectiveness of teams. Take that as a scientific proof that working relationships are key in the highly competitive, high-pace startup environment. This blog post explores why trusting your investor is key and how to build this trust.
When and why trusting your investor can be important
Should you even trust your investor? This question is especially crucial for first-time founders who do not have a lot of business experience and have never structured an investment round, as you basically have to rely completely on external advice. Often, you see that the first round was done together with angel investors who had the best intentions but simply not enough investment experience. I’ve talked to too many founders who’ve given away too much of their company already in the pre-Seed round, making future investment rounds very complicated (to that point: the founders should optimally still own around 60–70% after the Seed round). So, the first step should be to choose the right investor you can and should trust (read all about that in part I and part II). Assuming you’ve done your homework and have closed your investment round with a knowledgeable investor who shares your goals, the answer to that first question is yes (i.e. you should trust your investor).
The problem with a lack of trust is that you’re inclined to not believe the other person’s advice. And if you don’t factor your investor’s advice into your decision-making, why should you bother taking “smart money” at all?
In good times, this might not be an issue, because you mostly agree with your investor’s advice (confirmation bias at play). The true importance of having made a close and trusted ally will show itself when things stop running smoothly (which they will) and you have to make difficult decisions. The things that can go wrong are unfortunately endless for early stage startups, but let’s dive into a few specific examples of how a trusted investor can help you there.
What happens when you run out of money
One of the most stressful, but albeit very common, issues for early stage startups is running out of money. This doesn’t necessarily happen because the business idea isn’t working out, but it can also occur because of sudden problems with a supplier or even simple cash-flow mistakes, which makes this reason for failure even more frustrating. You really, really don’t want an investor that will screw you over in a situation like this: there are too many stories out there of investors demanding repayment of their convertible notes at maturity date, often during times of crises (people in the GSA region will be familiar with the recent story of what happened to move24). If you’ve done your investor due diligence right, you should already know some stories of how your investors act when things get difficult. Can you trust them to give up on some of their rights or even support you actively? At Speedinvest we’ve had more than a few startups in that situation and have issued the odd bridge financing (even from the partners’ private money) because we truly believed in the founders. We’re not the only fund that provides this level of trust and support in startups that we believe in — but make sure your investor is one of them.
Your investor can be a trusted third-party in co-founder disagreements
As mentioned, more than half of all startups fail because of co-founder disagreements. This is an area where your investor can act as a trusted ally because she has an objective view of what is best for the company. If you can’t agree with your co-founder on the strategic future of your company, try involving your investor in finding a solution. Of course, the investor shouldn’t become the mediator who watches you carry out your personal fights, but she can be instrumental in helping you reach a decision. If conflicts reach a chronic stage and a working relationship is not possible anymore, your investor can help you find a solution that will enable the company to survive further. Unfortunately, we have already had to support this kind of issue for our startups, and while there is no perfect solution, I’m positive we were instrumental in reaching the best outcome possible.
Other stressful situations where your investor can be essential, and where trust is key, include dealing with cap table issues, team restructuring or preparing for and negotiating an M&A deal.
Establishing a connection
So, you’ve chosen the right investor and have understood the importance of building a trust relationship. It’s up to both parties to establish how to build that trust and work together now.
I always recommend that founders ask for meetings outside of the office. There is plenty scientific proof on the benefits of workplace socializing, and you’re likely doing this with your team — why should this not apply to other important stakeholders? Meet up for coffee or drinks, or if family (or other) obligations don’t allow for that, schedule lunch (most people eat lunch, so it doesn’t actually take away time). Board meetings can also be a good opportunity to establish a connection, especially if you’re not in the same city. Follow your board meeting with dinner or a fun activity. My coolest board meetings have involved driving up to a hut in the Tyrolean Alps (compliment to Valentin Schütz) and sailing at Attersee. You don’t have to become friends, but understanding how the other person thinks and what is important to them can be key to understanding their attitude and preferences, creating the basis for good cooperation.
Can you recover lost trust?
Of course, there will be times when both sides have slightly different interests in mind, e.g., when it comes to optimizing terms during a round. But the core of the investor’s decisions should always be to do what’s best for the company, and in terms of that goal, you should always be aligned (it should be noted here that what’s best for the company might not always be best for the founder; as Seed-stage investors, we fortunately very rarely have that problem though).
I’m personally a huge fan of speaking openly about problems and voicing concerns as soon as they occur (or, better: even before), and as such, I believe you should confront your investor directly when you start feeling that your incentives do not seem aligned. More often than not, you will realize the disagreement or misunderstanding was simply a communication error or due to a lack of experience.
What do you do when this bad feeling intensifies? If you’ve voiced your concerns openly, but your investor does not explain her reasoning or change her approach in a sufficient manner, I would ask for an emergency meeting together with all investors. If you’ve always been open in your communication and center the goal for the meeting on very specific output, this meeting can be very constructive and does not have to be insulting to any party (again, keep in mind that people are involved, so make sure to never point fingers). If (and only if, because this will be a huge waste of time and will take away valuable resources you need to grow your startup) none of your efforts have an impact and you still do not see yourself being able to continue the working relationship with your investor, you should start considering an investor buyout or secondary.
However, if you actually did your homework before your investment round, it shouldn’t come to that. So, assuming you’re in a working relationship with your investor, stay tuned for my next blog post on the most effective communication processes.
Disclaimer: I’ll admit that I’m biased in my view of Speedinvest (simply because I truly believe in our team and model), so I’m happy to get your thoughts at firstname.lastname@example.org.