Speedinvest’s Managing Partner, Oliver Holle tells readers how to choose a ‘follow on’ investor…
Let me set the scene. You’re running a fully-fledged business with employees on your payroll and a paying customer base. You’re on an upward trajectory, investing in your growth. Over time, your cash runway is running its course. Your existing investors may be business angels or specialised seed funds, neither would be able to lead the next round. It’s time to raise some money!
The good news: the private investment market has never been more competitive, with more VCs raising funds than ever. But with the global economic situation worsening, potentially tough business conditions await. Choosing the right follow-on investor could be crucial to the long-term prosperity of your business.
Investors examine businesses through a lens of extensive fund management experience and expertise in the field, with a team that will rigorously assess you on your numbers. Therefore, it makes sense to assess your investors with the same rigour.
In a best case, your investors’ vision can completely change the trajectory of your business. With proper advice and influential connections, a leading investor can facilitate the transition from a good product-market fit to a fast-growing business machine. Still, the terms of the investment matter a lot. The valuation they put on your company can dictate your media attention and how you are viewed by future investors. The deal terms they ask for can directly affect your cap table attractiveness, which, in turn, could be the dealbreaker in your next funding round and possibly even the timing of your exit.
In a worst case scenario, your follow-on investor could be debilitating, by pausing your growth or vetoing strategic decisions. They could even kick you out of the business you founded, if you give out too much power.
Let’s break down a potential investment into three aspects for you to consider: the firm, the partner and the deal itself.
There is no ‘typical’ follow-on investor, but in broad terms, they tend to have deeper pockets than specialist seed or angel investors. As a result, most follow-on investors tend to be an institution (as opposed to an individual), and therefore will have its own structures, rules and protocols for you to consider.
If a VC has raised money recently, it will have a greater availability of capital, and more time to invest and reinvest. On the other hand, the more companies in the VC portfolio, the less significant your business will be.
Choosing a VC with demonstrable expertise in your field can be important if you’re looking for a more active partner. Ultimately, the best proof of an investor’s quality are tangible results. No one can predict the future, so the next best thing is past results – which should be easy enough to find.
Similar to other fields of finance, household names in VC are top-performing and well-run institutions. In our industry, brand is cultivated by reputation, media attention and other forms of publicity – often for the star companies the fund has backed. In turn, media attention comes with million-dollar exits and unicorn valuation rounds. Another proxy for performance are any co-investors that the firm has partnered with, showing reputation within the industry. A VC with a strong network is hugely beneficial, and can facilitate the introduction to future investors or partners.
Finally, it’s worth finding out how the VC is run. Are there any internal power dynamics that will affect you? Are decisions made in a majoritarian, consensus or veto system? How fast or slow is the process? A couple of questions never hurt.
2. The investor
Along with selecting a VC firm, you will also be choosing a dedicated Partner. This is the person who will advocate for your company within the fund and make sure you get the (human and financial) resources you need and deserve. So forming a strong and meaningful relationship with them from the beginning is key. It is not a coincidence that they are called Partners; venture capital is a people business.
Ensuring there is a good founder-investor fit is one aspect of this – chemistry and cultural fit can significantly impact your collaboration in the coming years, so put the hours into building relationships with potential investors as far in advance as possible. Beyond this personal relationship, however, is going to be their standing within your business. You want a partner who is going to be vocal and active in your boardroom discussions – look for that passion and commitment if you can.
More important than anything is Partner experience; it’s not the case that you must choose an investor with a doctorate in your specific field, or 25+ years’ experience, but it is crucial that they are fluent in your technicals. The VC world is dominated by its own language and can feel impenetrable, so take references and ask people you trust about potential investors. Don’t rely on the title and LinkedIn profile.
3. The deal
Finally, it’s the deal itself. The key here is the most obvious piece of advice: keep your eyes open and read the term sheet closely. You do not want any last minute surprises.
It is a top priority to be careful who to take on your cap table; in order to safeguard your ownership and control in the future, term sheet negotiations are critical. My advice: negotiate all critical clauses before you sign that paper – afterwards, power dynamics typically shift to the investor. Be careful with performance clauses – ensure you align behind realistic goals with appropriate investor/founder incentives, and similarly, consider your valuation. Raising finance is a continuous game, not a single point in time – unrealistic valuations will cause you problems in the long run.
Despite the caution and warnings I’ve laid out here, I would still encourage founders to view the process of raising money optimistically. In my experience, the world of European VC is friendly and supportive. Just reciprocate the exhaustive due diligence your prospective investors do on your company, as you are not the only buyer in this transaction.
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