Kim’s Korner is a series of articles by Ballard Spahr’s emerging company and venture capital attorneys. The column is not legal advice. The substance of the column is derived from our experience working with founders and details many of the current critical issues facing startups.
It does not matter what stage your company is at or how successful the venture has been to date, fundraising is hard and exhausting. However, that does not mean you should give in and accept capital from anyone who offers.
Just as investors spend a tremendous amount of time on diligence and getting to know you, your vision and your passion for bringing your vision to life, you, the founder, should also diligence and get to know your investor before accepting any capital. After all, accepting capital from an investor means entering into a commitment that will most likely last for years.
According to the National Venture Capital Association’s 2022 Yearbook (based on data collected from Pitchbook), there are currently 2,889 venture firms in the US. Such firms deployed approximately $332 billion as investments into 14,441 companies during the 2021 Fiscal Year. This record-breaking number of investments is expected to continue into 2022 as US venture firms, in the aggregate, are speculated to have amassed over $223 billion in dry powder (money to deploy) as they enter 2022.
So far, during the first quarter of 2022, venture firms have deployed around $70 billion to almost 5,000 companies. That does not include an additional $52.5 billion deployed by nontraditional investors and another $1 billion deployed by angel investors during the same period.
So, how do you, the founder, take control to make sure your values are aligned with your potential investors? First you have to define your personal goals and values. If your vision for the company is different from the vision that your potential investors have for the company, your partnership may not be as fruitful and as productive. Some questions you should think about in prioritizing your values:
- What is the purpose of your venture?
- What principles and ideologies are most important to you and your team?
- How much control of the company are you willing to part with (ownership percentage, board positions, involvement in management)?
- How fast and far are you determined to scale and grow?
- What are your objectives and exit plans?
- Are you willing to be bought out early or stay for the long term?
- What value-adds (other than capital) are you expecting from your investors?
Next, envision your ideal investor profile for your company. Investors can be passive or active in the business and some investors are consumed by the bottom line, while others have triple bottom goals. The ideal investor for you is someone who will be able to support your multi-faceted goals and will not undermine your vision.
Venture firms invest in companies with the understanding that 25% to 30% of the portfolio companies they invest in will fail. According to CB Insights, however, only 7% of startups fail due to disharmony between a founder and their investor(s). If you talk to an investor’s other portfolio company founders, make sure you talk to a few different founders.
The following diligence checklist will help you form a litmus test to diligence investors — and note that the answers you are seeking from capital raise to capital raise may vary:
- Does the investor understand the business of your company?
- Has the investor worked with other companies in the same or similar industry or with similar business models as your company?
- Does the investor have deep operational knowledge or investing experience working with companies to help you see around corners?
- Do they have non-investment team members who can help with operational support?
- Do they have a big enough fund to support you through multiple funding rounds? Does the investor want to make follow-on investments, or, if an investor cannot make follow-on investments, are they connected to other investors in the space (who are similar to such investor) and can make introductions to such investors?
- Does the investor provide a diverse and evolving perspective to the company?
- Does the investor have a broad network that it will make available to the company?
- Request references from founders in the investor’s portfolio, including founders from their portfolio companies that have had success and ones that have failed.
- Do they have any companies in their portfolio that may become or are a competitor?
- What are the experiences of other startups they have supported? How was cooperation when things were going well, and what happened when they encountered problems?
- Have the companies they have worked with before easily collected subsequent rounds of financing and become profitable, or did they sell themselves to strategic players?
- In addition to money, did the investor offer real value (i.e. connections to potential customers, outsourced CFO services, financial statement support and advice, support in hiring employees or strategic or operational support) or are they passive investors looking for periodic updates only?
- Who will be your point person for issues/questions and consents you may need to gather from the investor?
- Will the investor be available for meetings, advice, feedback and to discuss updates to the business as it progresses through various phases of its lifecycle?
- Finally, in the ever-digital world— who is the investor?
The last bullet point above is critical. Investors are increasingly represented by operational personnel, but funded by one or a group of individuals or entities. If a venture fund is investing in your company, you are allowed to ask what the fund’s archetypal LP (limited partner) is like. Who does the fund target? Is the fund composed strictly of alumni from a certain college? Is the fund composed of industry giants in the company’s industry (i.e. will there be a bunch of competitors in the investor’s portfolio and will that split loyalty to your mission)? Is the fund composed of political figureheads or foreign capital that may invite unwanted headlines with respect to the company’s raise?
Fundraising is hard, but remember, your primary goal is to bring your ideas and vision to fruition. Investors are, ultimately, your shareholders and occasionally have representation on your board of directors. As such, they may have opinions that differ from yours and may use their voting rights or board position to steer the company in a direction you may dislike. Sometimes, that friction and alternative perspective is productive, but you have to ensure that those investors believe in the company and share in your mission statement.
For that reason, and many others, make sure you take the time to learn and understand your investors, what they offer and how they intend to support your company beyond the dollars.-30-