The investment world is buzzing about AngelList (Disclosure: I’m an individual investor in the company) and the impact that it will have on angels and VCs, However, part of the conversation that has been missing is the impact on startups. The obvious benefit is that there will be more options for startups to raise capital quickly and easily. But the potential downside is that choosing the right set of investors for a company may become much harder for entrepreneurs. While an abundance of capital options is wonderful, choosing investors should be based upon more than just valuation and dollars invested. After all, an investor is a long term partner for your business and the process of choosing the right partner should reflect the ongoing nature of this relationship. Startups spend hours upon hours vetting potential employees, abiding by the mantra of hiring slowly and firing quickly. Why wouldn’t even more diligence be conducted on potential investors — people who can’t be fired and actually often have the power to fire you! Here’s how to diligence potential investors:
Ask to talk to current and past portfolio company founders and CEOs. Be sure to talk to a couple from companies that failed. And definitely leverage your network to reach out to a couple references that the investor did not provide herself. Would the entrepreneurs take the investor’s money again? When there was bad news, how did the entrepreneur feel when telling the investor and how did the investor react? Ask for at least one instance when the investor helped with a critical company challenge and what specifically she did to help. If possible, consider talking to angels or VCs that the investor has worked with previously.
The Airport Test
You’re traveling with your investor and your flight is unexpectedly canceled. You’re stuck at the airport for the next few hours. Would you look forward to the time together or would you instantly fill with dread? A similar test is the Beer Test. At the end of a long day, would you enjoy grabbing a beer with the investor? Spend significant amounts of time with the investor, both inside and outside of the office, to answer these questions. The goal of these tests is to figure out whether you like and trust the investor. A good investor is going to be your toughest critic, your biggest cheerleader, your best salesperson and your most compassionate psychiatrist. You’d better be irrationally comfortable with that person and his passion, integrity and values before taking his money.
When choosing an investor you’re choosing a partner to help you build your business. Just as you would make sure you have alignment of expectations with a cofounder, you need to do the same with investors. What does the investor see as the key milestones before the next financing? What kind of financial outcome is the investor expecting? How frequently and in what ways does the investor expect to interact with you? Asking questions and sharing your perspectives ensures that there are no surprises for either side down the road and also helps set the stage for an honest, direct, collaborative relationship.
At Homebrew, we love hearing how entrepreneurs have gotten to where they are and the “Why” behind the founding of their companies. Similarly, we advise entrepreneurs that they should know the personal stories of their investors. You’re going to be working with your investors very closely and you’ll get to know each other both personally and professionally. Find out if you have common ground upon which to build a long relationship. Why is he an investor? How did he end up being one? What does he like most and least about being an investor? How does he think he can add value to your company?
Getting to know your investor well before the investment is critical because a financing is not a single, moment-in-time transaction but a long-term commitment to each other. The relationship after funding should feel like a continuation of the relationship pre-funding and not like something different now that the courtship period is over. As an entrepreneur, you’re adding to your team every time you choose an investor. Keep in mind that there is much more to consider than what can be captured in a term sheet.