Basic principles shared by an experienced investor for startup founders seeking funding to grow their business
As an investor, I have been lucky to meet many incredible startups and founders. For all the ones I have invested in, there are many that I have missed (Revolut in 2018 is the one that hurts me the most!). Over the past few months, I have found myself reflecting on these experiences and trying to identify commonalities.
Not surprisingly, there are parallels to the topics I regularly discuss with today’s founders, and so, with a strawberry daiquiri in hand (and a seat on my overused couch during the pandemic) the writing began. Of course, there is no single path to success, all I hope is that these 6 Basic Principles for Startup Founders address some of the questions that arise on that journey.
“How much capital should we raise?”
The current investment landscape is rich in capital, as funds have more dry powder than ever. I could write a much longer post about the dynamics of fundraising in today’s market (timing, transaction structure, etc.), but the main premise is that raising more capital than is needed (or knowing what to do) can lead to ineffective decisions. There is a misconception that «more capital = greater probability of success»but I would say that the equation should be “sufficient level of capital for growth plans = greater probability of success”.
Having a lot of cash in the bank can cause problems as management is more likely to make inefficient decisions. Do you want a pinball table in your kitchen? Done (okay, this isn’t a big deal). How about we triple the R&D budget to create random product features? (yes, this is a problem). The amount raised should be a direct result of your business plan. Yes, you have to be ambitious: you have to set ambitious objectives and use them to prepare a budget for 1 to 2 years… If you add a 10-20% margin, you have the need for financing.
From a financial point of view, big rounds = big valuations, and as Eamonn Carey, CEO of Techstars, explains very well here, big valuations can come back to haunt you if you don’t deliver.
The last consideration is dilution. As a founder, the more outside money you raise, the more business you will be giving away. It is probably better to wait for the valuation to develop and raise on more favorable terms.
«’Is it better to be number 1 in a market, or to have a weaker presence in several markets?» “Should we focus on a single flagship product, or use resources to develop a portfolio of products?”
I am a big believer in concentration and specialization. Borrowing Jim Collins’ hedgehog concept: «Foxes know many things, but the hedgehog knows one big thing». Many of the great thinkers and companies of our time have had a hedgehog mentality, which at its core is about understanding what you can be best at, along with the drive to make it happen.
When it comes to startups, I think you have to focus on the core business, build a defensive position with long-term growth prospects, and then go looking for other opportunities. I’d rather see one amazing product that resonates with a loyal customer base versus five average products. Likewise, I prefer to see a dominant position in one market versus a competitive presence in several.
I often meet founders who are happy to explain future growth opportunities and how this translates into a billion-dollar+ opportunity. Sounds great, but how long will it be diverted from core operations? If you show a well-planned roadmap with growth potential, I will be a happy investor (and believe in the vision). If you spend half the meeting talking about how you want to launch 5 new countries next year, it worries me. The best founders are able to walk the tightrope between laser focus and the bigger picture.
Most strategic decisions should focus on the customer, since they are the ones who use the product. With a proper feedback loop, you can know in near real time what’s working and what’s not, get new product ideas, and keep an eye on the competition.
When planning for growth, your customer base will give you the best indications of where you’re finding initial traction.
Thinking about which geography to get into? Chances are you already have the support of users in those places, and if not, the value proposition may not be right for that market. The same goes for product features and pricing strategy: follow the customer.
One of the key elements is the importance of data for decision making. In my experience, the best companies are obsessed with customer data. Consumer-facing startups should have clear lines of customer service, solicit feedback, and incentivize customers to provide suggestions. Startups with a relatively smaller customer base have it easier: they establish key account owners and meet regularly with each customer.
“Which investor or investors should we go with for this round?”
There is no shortage of capital for promising startups today, and strong founders can choose which investors they bring to the store. Choosing the right partners is a key decision and will increase your chances of success.
So, what should you take into account when selecting an investor?
Cultural fit: It is arguably the most important criterion. If all goes well, you will be with your investors for more than 5 years! A good investor is half friend and half advisor: someone you can share a drink with, but who also gives you the hard truths and a dose of reality.
Knowledge of the sector: Everyone who sits at the table must know the sector inside out and understand its business model in detail. The best investors will know the market almost as well as you 😉
Ability to add value: Capital is a commodity, and investors must provide more value than a balance sheet. The two real components here are the network and operational support. A strong network can help with client introductions, employee recruitment, marketing, and much more. Operational support can be a more hands-on approach, either with teams of internal experts or deep industry knowledge to help resolve bottlenecks and best practices.
Mind Sharing: This is investor-specific and everyone manages their time differently, but if your investor has more than 10 companies in their portfolio, how can you ensure your business gets the attention and focus it needs?
A criterion that does not seem important to me is that of “deep pockets” or investors who say that their value is having a lot of capital. The best investors raise new funds on a regular cadence and are unlikely to be unable to support at least a portion of your future funding needs. If they can’t, they will know other suitable investors who can. Deep pockets can facilitate internal funding rounds, which saves time and is certainly a positive, although I think it is outweighed by the above.
“Who are your main competitors and how are they different?”
This may be a bit controversial, but I think startups should focus on themselves before their competitors. According to YC’s Startup Advice Pocket Guide, “Ignore your competitors, you’re more likely to die from suicide than murder.”
To begin with, every good start-up idea must be based on intelligence. It’s unlikely that the founders haven’t already thoroughly researched their market, understand their positioning, and believe they have a right to win. If they have this, the biggest risk is that they will fail to execute, rather than being killed along the way by a competitor.
Investors tend to focus a lot on competition, as it is easy to point out other companies as a threat. Late-stage investors, in particular, spend much of their time understanding the competitive landscape (and sustainable competitive advantage is a key investment criterion). However, I would say that early stage investors should not be too hung up on this and recognize that the future is unknown.
There’s no guarantee those two or three competitors will exist five years from now, and who’s to say the market won’t grow to support multiple winners? I’ve seen investment committees turn down deals because of concerns about competition, and then those companies become huge successes (and the committees regret it). I’d rather support a promising team with a great idea in a slightly competitive market, than lose it completely.
By extension, startups can focus too much on competitors and lose sight of their own goals.
Keep an eye on your competitors, yes, but spend most of your time being the best you can be.
Being an entrepreneur is difficult: 9 out of 10 startups fail, and a large part of them do so in the first two years. However, these odds don’t deter the best founders or let bumps in the road stop their progress.
They have an almost fanatical belief that they will succeed, and this fire sustains them through difficult times. Success in any endeavor requires guts and perseverance, and entrepreneurship is no different. Founders must lead by example… inspiring employees and exciting investors about their vision. Not every founder has to be a charismatic genius, but everyone must believe strongly in what they do.
