Since the second coming of startups began a few years ago, I’ve visited dozens of countries, presented to thousands of founders in keynotes and workshops, and mentored a couple of hundred one-on-one. Early in a startup’s lifecycle the most pressing questions always seem to be around fund raising. Unfortunately, most of these conversations also come with a sense of desperation where the founders are ready to sell their soul to the devil just to see their dreams come true.
From the only kind of experience that truly matters, personal, I can tell you that not all money is created equal. Most first time founders may think that all they need is the cash. In reality, this early money dries up MUCH faster than one might expect and having wrong investors on board will provide zero value in stressful situations, will likely just delay your startup’s death, AND waste your non-refundable lifetime in the process. It is crucial to take on investors who can and will help with experienced advice, connections, and personal empathy as you go through this near impossible startup journey.
Take heed, here are the types of investors to avoid at all costs… even if it means abandoning your startup with no other financing alternatives. After all, you only live once and have a limited time to become successful.
Friends and family investing for the wrong reasons
After you put in your own blood, sweat, tears, time, and cash, people who know you best will be your first investors. They will seldom do it for any other reason than the fact that they believe in you and want to support you. That said, anyone that can write a check for a relatively substantial amount (that they are likely to never see again) is a person that knows how to make money and has made other types of investments before. That means that this person has probably invested in stocks, mutual funds, real estate, or has had a business or two of their own. They may even fancy themselves a sophisticated investor. Yet angel investing in startups is a completely different animal with an entirely different investment risk profile.
Here is what you need to be careful with when friends and family are investing in your startup:
- Before you take their money, make sure they understand what they are getting in to. Including that fact that they can’t just sell their shares when they feel like it. Explain the risks. Show example deals. Educate them. Even if it scares them off the deal, your personal relationship is almost always FAR more valuable than their few thousand dollars.
- Don’t take money from someone trying to over-engineer the deal and turn a personal favor in to an episode of the Shark Tank. This will surely create animosity in the long term.
- Treat these people as you would any professional investor. Give them very good terms even if they don’t know enough to ask for them. These people have put their trust in you before anyone else.
3rd tier accelerators that provide no value
Accelerators are the new business school. They provide various levels of value much like the many choices of universities. At this point, it just may be more difficult for you to tell one from there other, especially if you don’t know what to look for.
Accelerators provide startups with mentorship, office space, a marketing push, and sometimes a bit of cash in exchange for a share of the company. The terms can vary wildly and the value an entrepreneur can extract can as well. While the likes of Y Combinator, TechStars, and 500 Startups are the Ivy League of accelerators, many are simply good at marketing themselves while providing little actual value.
Here is what you should think about when choosing the accelerator route:
- Your startup will be evaluated based on comparable company values. Likewise, you should understand the accelerator’s terms of participation and how they compare to other programs.
- Accelerators that don’t invest cash are educational programs or real estate arbitrage businesses and should not get equity in your company. Full stop. These are also programs that are usually funded by governments or other entities whose goals and motives don’t fully align with the mission of making your startup as successful as possible, as quickly as possible.
- Determine what you are looking to get out of the program and if this particular accelerator can give it to you. This can be: filling gaps in your team’s knowledge and experience, access to major players in your target industry, or a marketing push. Almost never should it be just the relatively little amount of cash you would get.
- Get in touch with the founders of startups that previously went through the program and ask them if it was a valuable investment of their time and equity. Did they get the type of help you are looking for? Were the partners and mentors vested in their success during the program and after they graduated?
- Review the mentor list. Will these people bring value to your startup? Send some emails. Make some calls. Find out how much time and effort these mentors actually spend with the program or if they are just letting the accelerator use their name for marketing as a favor.
- Think long and hard on if you really need to be part of an accelerator or if you are just getting swept into the hype. Can you accelerate your startup by surrounding it with advisors for exact areas you need help with?
Angels investing for the wrong reasons
Angel investors are usually been there, done that entrepreneurs who are investing both to make a return on their money and for other non-monetary reasons. Compared to other types of investments, investing in startups is very risky. This is why it is crucial for you to get to know your would-be angels and their reasons for investing before you take that check.
Here is what to look for:
- Do your homework and only talk to investors after you’ve determined an appropriate range of investment terms for your startup. They do this every day while this may be your first deal. Don’t come to a negotiation unprepared.
- How experienced is this person in angel investing? Studies have shown that for statistical models in angel investing to work, a portfolio needs to consist of at least 12–20 investments. Their experience level will say a lot about what kind of help you can expect from them, what kind of connections they can provide, and how they will react to inevitable realities like company setbacks.
- Look at the investor’s track record. Taking an investment from a well-know angel can send the same signal as choosing a well-known VC later in your company’s development. The signal can be very positive, come with notoriety baggage, or simply drag down your cap table.
- Assure that egos are in-check. Determine if this person is there to help you grown the company and will treat you with respect. If they are investing what are relatively small sums of money for a one-digit percentage ownership in your startup but in exchange you get a grumpy uncle–you never knew you wanted–think twice. Talk to other portfolio CEOs about the interpersonal relationship they have with this investor and what it is like to work with them. Breaking up with an investor can most certainly be a very acrimonious divorce that may kill your company.
- Don’t give away control of your company via majority ownership or exotic control provisions in the investment agreement. Doing so, will most surely screw you on the next round and will very likely scare off “good” investors later. If this angel insists on taking control, then they are no angel at all. They are going to undermine your company, make it uninvestible, and therefore shoot themselves in the foot all at the same time. Investing in startups is nothing like a lifestyle business such as a restaurant. Their only goal should be to get in early with a team they believe in and a business that will become huge.
Venture funds that only “co-invest”
Unlike angel investors, venture fund managers are professionals who invest other people’s money. They are trusted to do so because they have a particular insight and can attract a “deal flow” of high quality entrepreneurs and their startups. They should have a wealth of experience from serving as a member of the management or founding team of one or more successful startups or at the very least from years on the finance side of this particular investment asset class. They should most certainly be able to determine the profile of startups they are seeking to invest in and be able to make quick decisions.
If you encounter a venture fund that is only willing to co-invest in your startup, you should probably run in the other direction for the following reasons:
- It is their cowardly way of telling you “no” because they are afraid of being the dummy that is on the record turning down the next WhatsApp. If you do get interest from a big-name investor and let them in the round, they will look like geniuses. If you don’t, they can wash their hands and remain the nice guys. Either way, think twice on if you really want a fair-weather friend like this on your cap table and possibly in your boardroom.
- Their venture fund thesis may consist of piggybacking on the knowledge and experience of venture funds that actually know what they are doing. Clearly, this fund will provide zero non-cash value to your company right out of the gate, no support or resources when you hit a rough patch, and a negative signal in the next round where they are unlikely to be willing and able to continue investing.
Stage, region, or focus inappropriate venture funds
Raising a round will take much longer than you anticipate. The money you raise will likely dry up much faster than you expect. Who you raise money from will influence the fundraising timing, value, and terms if your startup is doing well and can kill it entirely if you are not.
If you are able to get a “yes” from a well-known and trusted firm, take it even if the valuation is not exactly what you had in mind. If you are forced to move on to lesser-known and trusted firms, here are the land mines to avoid:
- Big funds (with big names) writing you a substantially smaller check than their typical investment. Unless they are seeding your startup on the strength of the team and outline specific milestones that will make them write a bigger one, something is off. They may be exploring new segments or regions with no guaranteed long-term plans. You don’t want to be a guinea pig and risk sending a negative signal to prospective new investors when they don’t follow-on in your next round for no reason having to do with your company.
- Venture capitalists come with money, a network of contacts, and knowledge and experience in a particular region and/or business. If your industry or region doesn’t match up with their areas of expertise, a good investor will bow out of the deal. If they are willing to jump in for any other reason than the belief in the team, be wary. At best, they will prove to be of little help. At worst, they will cause havoc and require you to constantly educate them. Ultimately they will be dead weight on your cap table that you’ll have to deal with sooner or later.
Creating a startup is a marathon, not a sprint. Think carefully and strategically about whom you choose to partner with and if the short-term trade-off of taking the wrong money is worth the deal with the devil you’ll have to repay.
Got an investor horror story? Please share in the comments and feel free to name names