Who is the Customer: The Investor or the Startup?

“You don’t need to know if the idea will succeed — just the person.” 
Jason Calacanis, Angel investor

When a startup pitches an investor, a logical assumption is that the investor is the customer. After all, the startup is asking for money, often traveling to the investor’s office, pitching their company, and responding quickly to the investor’s every follow-on request. This dynamic is especially true for corporate investors who are steeped in the practice of buying from suppliers.

Don’t be fooled. Investors are not the customers. Great startups, with talented people, disruptive technology, and innovative business models, are rare. Investors are selling to the startup — selling their value to the budding business in the hope of joining the journey of a winning founding team.

Even in the worst of economic times, great teams have their pick of the best investors and can avoid those that insist on more onerous deal terms. After the dot-com bust of 2000, when I was raising money for my startups, a double-dip, participating preferred liquidation preference was fashionable — one of these onerous deal terms.

This investor giveaway means that when a startup is sold, the investor first gets their original investment from the sale proceeds. Then, the investor converts to common shares and participates again from what’s left in proportion (i.e, pro-rata) to their as-converted common share percentage, along with the rest of the common shareholders. See Brad Feld’s excellent post for the details on participating preferred liquidation preferences. The best startups never needed to concede to terms like these.

Today, with a glut of capital available, it’s relatively easy for startups to attract investors on favorable terms, without the double-dip, participating preferred liquidation preference. Thus, such terms have gone out of fashion. Veteran investor Fred Wilson describes his evolution to a more founder-friendly position on the subject.

At Toyota AI Ventures, regardless of market conditions, we’re committed to a founder-friendly approach that means that we treat startups like valued customers — with respect, delivering quality and service. Specifically, we:

  • Behave with integrity and transparency to earn founders’ trust;
  • Operate on the startup’s timeline, even if that’s faster than ours; and
  • Execute “clean” deals (e.g., no participating preferred terms) so we don’t sabotage the startup’s future financings or exit.

At the CB Insights A-ha! conference last December, I was asked by The Washington Post’s Lizza Dwoskin why we had launched Toyota AI Ventures in July 2017, after many automakers had been investing for years. “Isn’t Toyota behind?,” she asked. I answered that startups are experiments in the marketplace. And, when an industry changes slowly, you can suffer second-hand knowledge and learn from competitive products, press accounts, and market reports. But when the pace of change accelerates dramatically, as it is now in the auto industry, you need first-hand knowledge based on direct experience with startups.

By investing in and partnering with the best entrepreneurs, Toyota has an opportunity to learn valuable lessons from these experiments, while leveraging our expertise and resources to increase their chances of success. And, by treating our portfolio entrepreneurs as customers, we attract the best startups. Roy Bahat, head of Bloomberg Beta, even gathers a Net Promoter Score to measure how well the firm is doing in service of its portfolio companies, an idea we’re adopting at Toyota AI Ventures. We measure our performance not just on strategic fit and financial returns, but on how well we deliver value to our portfolio company customers.

CB Insights A-ha! Conference, December 2017

Visit the Toyota AI Ventures site to learn more about our approach and the startups we’ve invested in.