The relationship between a founder and investor
Timeless Principles
The relationship between the founders of a startup and their investors is exactly that, a relationship. It is not a transaction limited to one point in time, but a long-term interaction which should evolve as the business grows and contribute to increasing the probability of its success. While picking the right investor can add significant value, the wrong one can erode value just as quickly. Ensuring ambitions, incentives, and expectations are aligned from the beginning and making sure they remain aligned is vital to achieving this. What starts with the due diligence process before an investment should continue for as long as that investor is part of your cap table and beyond if you want to raise capital for multiple ventures. This article lays out some of the principles Sturgeon Capital believes are timeless and significant for building and maintaining strong investor relationships.
Bridging the information asymmetry gap
The process of going through due diligence with an investor can seem like a never-ending merry-go-round of questions and back-and-forth. While understandably frustrating at times, there is a clear rationale for this. When you first start speaking with an investor, there is an almost complete information asymmetry gap. In less pretentious terms, that is to say, you know 100% about your business and they know close to nothing. The due diligence process is an investor bridging that gap so that they can build conviction around making an investment in your company. It is therefore on you as a founder to help them achieve this, and there are a couple of points that can help with this:
Data room. Make sure you have a data room ready before you start speaking to investors. This should be clearly structured and contain as much detail as possible that an investor might ask for about your business. The better the data room is, the less back-and-forth you should have with an investor.
Written responses. When an investor sends over questions, take the time to provide detailed written responses. A five-word answer isn’t going to help the investor and can appear flippant and dismissive. Taking the time to properly answer their questions gives them the information they need and plays an important role in building trust.
Momentum. Once you have an investor interested, it is vital that you maintain momentum in the conversation. Respond to their questions promptly, make time for calls when they request them, and follow up if you haven’t heard back within the time period that you were expecting. Letting things drift can be terminal.
Question an investor as much as they question you
Much as the due diligence process is about an investor learning more about your business, it is also your chance to get to know more about the investor. On one level this is a personal thing – are they someone that you feel you want to work with and who will actively contribute to your business? On another level, it relates to a fundamental risk for any startup to which founders, particularly first-time founders, often don’t attach enough significance to – funding risk. That is the risk that your company will not be able to raise the next round when you need it. There are two key points here:
Cap table construction. A messy cap table or one where the founder has been excessively diluted is off-putting for new investors. It raises questions about the incentivisation of a founder to allocate the time and effort needed. This risk increases the more rounds you raise – where possible, raise fewer, larger rounds from a smaller group of investors. Also be cognisant of any reputational risks associated with an investor that may put off later-stage investors, especially development institutions that have the deepest pockets of all investors in emerging markets.
Follow-on capacity. While angel investors and micro-VCs are great for those early rounds when you have little more than an idea in your head, they don’t have the capacity to allocate significant capital in later rounds. Work to bring on board investors who have this capacity and can allocate to multiple rounds. This reduces both the funding risk of those later rounds if you have a significant portion already committed from existing investors and reduces the time and effort you will need to spend on fundraising. Use the due diligence process to get a clear picture of a fund’s available capital and strategy for following on and keep this information up to date on an ongoing basis.
Finally, speak to a couple of the investor’s portfolio companies. These founders are your peers who understand what is important for you as a founder and can give you a realistic expectation of how the investor will contribute to your business. To avoid selection bias on the investor’s part, use their website to select a couple of companies and ask to speak with them directly – otherwise, you’ll get pushed towards the portfolio companies that they know will give positive feedback.
Overcommunicate
This relates to the point of bridging the information asymmetry gap and is to say that even once you have an investor onboard, overcommunicate with them about what you are doing. While you live your business day in, and day out, an investor has multiple portfolio companies, and their attention is inherently divided. The easier you make it for your investor to remain up to date on what you are doing, the challenges you are facing, and the opportunities on the horizon, the more likely they are to be able to support you through them. Two key areas for this:
Regular calls. For investors that have the capacity to deliver strategic value for your business, whether through their ability to follow on in later rounds or support in day-to-day operations, for example, make sure you have a regular cadence of calls. The length of these calls will vary depending on the stage and situation of the business, but they are the prime opportunity to lay out where the business is at that point and get their feedback. Intermittent calls increase the information asymmetry gap and decrease an investor's propensity to help you in times of need.
Monthly written updates. While calls are for discussion with major investors, monthly written updates are where you have the opportunity to present the business in depth to all the investors on your cap table. Take the time to structure a format that touches on the key points that will define the success of your business, and track progress against these. Writing things down is also an exercise in intellectual honesty and serves as a record that both you and your investors can judge your progress against. A shortened version of this monthly update should also be shared with other investors not on your cap table to keep them up to date on your progress, so when you approach them for a future round, they remember who you are and what you are doing.
Know your data
One of the key advantages for a technology company is the quality and quantity of data that you have access to. Many startups claim to be “data-driven”, but far fewer have the systems and frameworks in place to measure and manage the data that is important to their business. From the earliest opportunity, you should define the KPIs important for your startup's success. As your business grows and the more data you gather, you can increase the confidence levels of your assumptions and make more accurate forecasts for your company's short- and long-term prospects. Not knowing these KPIs not only negatively impacts your business internally, but also creates a negative impression for investors who want to see you have a firm grasp of your business and what will define its success.
It’s a team effort
Whether you’re a solo founder or a team of cofounders, make sure an investor speaks with the key team members who have responsibility for business-critical functions. There will almost always be one founder who presents particularly well and (should) lead the investor discussions. However, they won’t be the only ones building the business daily, and they probably aren’t best placed to respond thoroughly to an investor’s questions. So, during the due diligence process and once an investor is on board, make sure to show off your strong team members. This is particularly important at a later stage when the drive and ambition of the founders will not be enough to make a business a success, and you will need to hire talented individuals to accelerate development.
For more information please reach out to the team or visit STURGEONCAPITAL.COM.