Choosing The Right Investor

When you are accepting money from an investor, you are not accepting free money. You are giving up part of your company and potentially a board seat to an individual or an institutional VC fund for years to come. For your customers, employees and your own sakes this is an extremely important relationship to get right and you reserve the right to run your own due diligence on prospective investors almost as much as they do on you.

We believe that there are at least eight key characteristics of an investor that a prospective portfolio company should assess before accepting a cheque:

As we always harp on about, there are few reasons as to why a pre-seed or a seed-stage company should NOT pay fees to an investor for raising money to invest in your company. Fees reduce your runway and this creates additional risk for you and your other investors. Just to be fair to my broker friends, this may change as your progress through the lifecycle of your company (Series B and beyond), which is when the CEO's time becomes far more scarce.

Finally on this topic, we regard the ability to fundraise to be a mandatory skill that must be possessed by all of our founders and if you are using someone to augment this then we are not the right investor for you.

Let's explore this criteria in more detail:

Network

A well networked investor can derive value for their portfolio from three core categories:

• End customers. The introduction of qualified customers to your business is probably the most impactful thing that an investor can do for you and this has been a core focus of mine since I started in venture capital. It was so important to me that I launched an annual conference, in Los Angeles, that was solely focused on introducing seed stage companies to the major corporates in Southern California. If you are choosing from a group of investors for your company ask them for a list of introductions that they can make for you in the first 90 days after the round closes and then hold them to it! In fact, one of my US portfolio companies implemented a scorecard that ranked all of the members of their cap table by the number of customer introductions they made.

• Hiring. The hardest thing you will encounter when building a fast moving business is attracting, hiring and retaining top talent. Bar none. Some larger funds now have in-house recruiters to exclusively secure talent for their portfolio companies. If they don’t have this facility, a lot of fund GP’s take on this responsibility themselves and help at most if not all stages of the recruitment process. I particularly enjoy approaching potential talent directly and then getting involved in the interviewing process (mostly at the final stage). When you are selecting your investor ask them about their approach to helping you attract talent to your company and request examples on roles that they successfully helped to fill in the past.

• Growing culture. Culture defines companies. Helping founders sow the seeds of the cultural values of a company they are building is an essential role of an effective venture capital investor. Exploring your company values and role within the communities it serves is a core component of any investor at Hillfarrance. We are investing into partnerships and collaborations with leading minds in this field and I would encourage you to ask your prospective investors what they are doing to help their portfolio companies instill an effective culture within their business.

Fundraising

Let’s assume that you are in an enviable position and you have two investors offering you competing term sheets for your seed round. One is offering you a smaller cheque but slightly more favourable terms and will help you syndicate the remaining money left in the round. The other investor is offering you 90% of the amount you are raising at slightly less attractive terms but also promising to be a source of capital for the entire lifecycle of your business. As an operator-turned-investor, I would go with the former and not the latter. Here is why:

• Your seed round is probably the most important round of financing you will ever raise. The graduation rate of a seed stage startup to a Series A is less than 20%. To be on the positive side of these odds you need to gather as many minds, networks and resources as possible to help you with smashing your milestones. If you are raising a $2m seed round, I would recommend an investor cap table composition that looks a little like this:

This structure will put you in a strong position for success. You will have access to multiple professional investors and their networks. You will have room to include highly strategic individual investors who have specific experience that will be priceless to your business strategy. Finally, you will be helping the New Zealand venture community grow.

When multiple sources of capital generate returns from your success and reinvests them back into the market everyone in the ecosystem wins.

• Don’t tie yourself to one fund for the rest of your company’s life. Funds often focus on certain funding rounds (Series A, B, growth etc.) and they have structured their business model to help companies who are entering that specific phase. Large funds who are stage-agnostic often have to deploy large pools of capital and therefore want to take out entire rounds. I have seen this fail more times than it succeeds. Ask your prospective investors questions like these at the beginning of the courtship process:

1. How big is their fund?

2. How many companies do they intend to invest in from this fund?

3. At what stage do they tend to stop investing new capital into a company?

4. What is their target ownership of a portfolio company at the point of entry and exit?

5. Do they like investing alongside other investors?

• Ask both set of investors which funds they can introduce you to for future rounds of fundraising. Having warm introductions to later stage specialist funds will save you time, money and allow you to spend more time on building the business than on the fundraising trail. Feel free to even ask them for introductions to those investors before you commit to their term sheet.

Emotional Intelligence

Emotional intelligence is harder to quantify than other factors on this list but it’s just as important. Make sure you try and figure out how a particular VC firm or GP has handled emotional situations in the past. Whether it’s replacing executives, firing badly performing employees, or any other event that causes tension, a venture capitalist’s ability to communicate and understand the situation is critical. You should be able to cover this off in your reference checks with the fund’s other portfolio companies.

Attention Span

VC fund general partners do not tend to work a 9-5 day but they still have limits. If you have a particular GP who is leading the charge on investing into your company do not be afraid to inquire into their actual ability to offer you the attention you need and deserve. Here are some questions that may help you in assessing this:

1. How many other portfolio companies do they manage?

2. Within the next 3-5 years how many portfolio companies do they expect to oversee?

3. How many board seats do they have?

4. Can you call the GP whenever you like (within reason)? Being able to reach your investors when you need them should be welcomed and encouraged.

5. What has the individual GP (not the collective firm) done to help portfolio companies grow?

6. What happens if they leave the firm? Who will manage your relationship then?

Lifecycle

The life of the fund is also very important. You want to make sure that the time horizon of your startup company matches the lifecycle of the fund (they usually have a 10-12 year life span), or you may be in a situation where the VC is under pressure to exit or force you to move quicker, or doesn't have sufficient capital in reserve for follow-on funding. Make sure you ask for their follow-on funding policy.

Location

If you are raising from offshore funds then make sure you have clear in your mind about how much attention you will get. Whilst they may tend to write bigger cheques you may only see them in-person once per quarter at your board meetings. Considering how COVID has severly challenged or eliminated international travel for some time to come, having an investor that is 5,000 km away and 10 hours behind might not be the best choice for your lead.

This exemplifies the reason why it is important to diversify your professional investor cap table.

Integrity & Culture

This is a tough one to measure in a couple of weeks or months but this is something that is essential to include. You need to remember that most relationships with a VC or angel investors have a lifespan of over a decade and you need to make sure that you trust and like this person as they will be with you for a very long time. Here are some ideas on how to assess this:

1. Ask for character and professional references. I will happily introduce prospective portfolio company founders to entrepreneurs that I have funded in the past. I never sit in on those calls and I have no problem with you asking whatever you like about me. 

2. Ask other funds what they think of that GP and the fund they represent. Take and filter a portion of these responses with a degree of bias - this is a competitive industry! Try to find out how they play with other investors on a cap table and what value they have delivered to their other portfolio companies. You can usually see who they coinvested with by finding them on Crunchbase.

3. Go for lunch or dinner with the GP and his/her team. Try to avoid work talk and instead focus on who they are as people and their cultural values.

Are they successful investors?

It’s a common saying that success breeds success. That being said, how much success has the venture capital firm you’re considering generated in the past? Some firms prefer a shotgun approach, investing in many companies, hoping for a few big successes. Other venture capital funds take a more focused approach, working closely with each company they invest in. Regardless, these firms are going to have past successes and failures. It’s in your best interest to know about them.

Please let us know if you think there are other data points that we should include and we will gladly update this article.

Remember, this is a long-term relationship and choose wisely who you decide you share your equity with.

Best of luck!