Early Stage Investor Types — Evaluating Speed and Sophistication
As early stage investors, we’ve seen the good, the bad, and the ugly of how initial rounds come together.
A fundraising process not only leaves its imprint on the cap table going forward, but also reveals signs that can portend what type investor you’ll have along with you for the journey.
While there are many attributes to evaluate a potential investor’s fit for an early stage round (ie seed fund vs multi-stage, sector focus vs generalist, etc.), for the purpose of this post I thought it would be helpful to compare investors’ sophistication* level versus speed, and talk through some of the considerations for how they impact a fundraise.
1. Sophisticated investors who can move quickly.
Let’s start with the dream situation. These folks ideally know your space before even meeting you, and their key diligence is around your team and your approach to the problem you’ve presented. Or, they appreciate your background and want to make a bet that you will build a killer team and identify the right product in the market you’re targeting.
The benefit in either case is that the diligence process should be relatively clear, and the firm is structured to get you a quick decision, which will best utilize your time and bandwidth.
2. The sophisticated investor who is slow moving.
This one is tough. They may know your space well, which makes you think they understand you and your vision, but their diligence can drag on forever.
The root cause can be cultural within their firm, not having the right champion for your deal, or being busy with other deals that they view as a higher priority.
In this case, they could possibly be a good partner for you, but their speed can become an inherent risk to your remaining fundraising process. You don’t always know where you stand, and if you’re trying to run a competitive and efficient fundraising process, their timing and unique process milestones can make it difficult to parallel track things well with other investors.
They may get you excited that things are trending well, but may run into a hiccup in the 11th hour and be unable to proceed. If you played your cards wrong and downplayed other conversations because you thought you were basically locked in with this investor, it puts you in a jam.
The other angle to consider is what this signals about the firm. The best firms these days know how to operate effectively, but quickly. You see Sequoia, a16z, Benchmark and others duking it out for top deals, and you can bet that if they lose a deal simply because they’re too slow , someone gets an earful about it. So if the firm you’re speaking with can’t move in a timely manner, then be wary and keep conversations progressing with others.
3. The unsophisticated investor who moves quickly.
As we move into the top left quadrant, we have the unsophisticated investors who can move quickly. These are folks who are great for filling out rounds, but you don’t want them leading rounds and integrating themselves as front-seat, long-term partners.
Unsophisticated investors with capacity to lead an early financing round can cause trouble. Why? They may move quickly and have deep pockets, but the devil is in the details of their term sheets. Beware punitive and/or non-standard legal terms from these unsophisticated folks. They could set bad precedents that will compile and hurt you in the long run. Having a strong law firm by your side will protect you to ensure you don’t get caught off guard (we recommend Cooley to all of our portfolio companies).
The other downside to an unsophisticated investor is if you have a hiccup in your trajectory and need some additional financing to hit a key milestone, they may not want to (or even be able to) bridge that financing gap based on how they deploy capital (ie do they reserve follow-on capital, and if so what’s the decision process around it) and understand your market.
The other archetype in this quadrant is an unsophisticated angel investor who can move quickly and help fill out a round. These folks can be highly strategic partners and provide guidance and intros in their specific area of expertise, which ends up an incredible bang for your cap table buck. Just be wary of people who may overstep their bounds as an angel and instead of being helpful, end up being a drag on your time.
4. The unsophisticated investor who moves slowly.
This is an obvious one to avoid. These investors can be huge time sucks and bad long term partners. Avoid, avoid, avoid.
Takeaways for founders
Given the above archetypes, how can you as a founder identify the sophistication and speed of your investors? Here are 3 tips:
1. Ask upfront what diligence looks like. Who are the decision makers? What are all steps of the process? Are there milestones they can communicate along the way so that you’re kept in the loop of whether you’re moving along in process or just not a fit?
2. Ask if they have an existing perspective on your market. If so, does your product align to pain points they’ve seen? If they don’t, what would it take for them to get excited about the market size and timeliness of the opportunity?
Asking this question upfront is a key way to avoid the clichéd VC pass “we couldn’t get conviction that this is a big market” and get feedback from the get-go if that is an issue to work through with them)
3. Ask when you can do references on their firm. VCs will do references on you if they’re serious about your company, and every founder should do the same on the VC. Founders should connect with provided references and backchannel references on both the VC fund and the specific partner leading the deal.
A nice hack here is if you ask for this after a couple meetings, it puts the onus on the VC to get real about where you stand. They’ll either be gung ho about the opportunity and want to flaunt their references to try and close you in parallel to finishing up their work, or if they’re wishy washy then it’s a sign that they’re not sold on your company quite yet.
How we operate at Work-Bench
At Work-Bench, we’re exclusively focused on enterprise software investing. We’re thesis driven based on feedback from our Fortune 500 IT network, and we’re public about areas we’re exploring for potential investment. We’re focused on Seed II investment rounds and have ownership and valuation guidelines that we’re open with founders about.
By having large, timely market opportunities guide us, we’re able to be efficient when engaging with founders during diligence. So if you’re an enterprise founder and looking for go-to-market support in addition to capital, definitely reach out!
*Note: What I mean by sophistication here is a traditional venture capital fund focused on startup investing. While for instance groups like Corporate VC funds, Family Offices, and others sometimes dabble in early stage startup investing, it’s not their core competency.