Second blog in a series by Joy Lindsay, Managing Partner, Sofia Fund. View Blog I here.
As a startup looking for capital, due diligence done by an entrepreneur is as important as due diligence done by the investor looking to invest in the business. Both sides should search for the best fit, far beyond the financing. When the fit is found, chances for success greatly increase.
This blog is part two of a three-part series on what entrepreneurs should look for when searching for investors for their businesses. Each blog focuses on an attribute the right investor can bring to the relationship that goes beyond money.
My first blog reminds entrepreneurs to check on the potential investor’s business experience. If an investor is steeped in success in their own right, whether as an entrepreneur or corporate executive, the entrepreneur can benefit from their added insight and guidance.
This blog focuses on the second-best characteristic of a value-added investor: their ability to bring a financing and exit strategy to the table.
Plan for rounds of financing
Every startup should have an investment plan. Generally, that plan starts with friends/family or a seed round and progresses through each stage of growth. Each round of financing should raise enough capital for the company to reach the necessary milestones to attract new investors for the next round at a higher valuation. Many startups fail because they run out of funds before reaching their milestones and then they don’t have sufficient traction to raise the next round. Proper planning, often with the help of your early stage investor helps avoid this set back, which may even lead to the company’s demise.
A sophisticated investor can help an entrepreneur understand the full financing cycle, including the type of investor appropriate for each round and the milestones to plan for in order to attract investors. Milestones vary by industry and could range from getting the MVP in the market to signing the first customer to getting FDA approval.
Once an entrepreneur understands the financing strategy, it’s good to know how much “dry powder” the investor has — can the entrepreneur count on their participation in subsequent fundraising rounds? Having existing investors commit to the next round helps with “first money in” and signals confidence to other investors in the founder’s and the company’s growth.
Find a proven investor
Investor credibility and reputation is critical. Entrepreneurs should choose investors with a track record of success and a portfolio of strong companies. Successful (not just active) investors attract other angels and VCs to the company. Everyone wants to partner and co-invest with winners. Just as a round can fill out quickly with a strong entrepreneurial team, a round can also fill out quickly if it has a strong lead investor. When searching for this successful investor, ask who they’ve co-invested with and their track record of success. Angels and angel groups like to syndicate and share deals. If the lead investor is known to conduct thorough due diligence and is willing to share their findings with other angels or angel funds, an entrepreneur can get the financing round closed more quickly.
Proven early investors are also helpful in introducing VCs for the next round. Cold calling VCs is never easy, so having someone who knows how to open doors and get initial meetings is critical.
Keep the end in mind
Investors also add value by helping with the company’s exit strategy. Entrepreneurs should make sure they align with investors who share their vision for exiting the company. For example, are both the team and the investors looking for an early exit (1 – 3 years) and willing to take a lower sale price for a quick win? Or are both parties interested in growing the company and navigating through an IPO?
Investor calls and board meetings often become difficult when entrepreneurs and their investors don’t have common goals for the company. When aligning goals with VCs in particular, entrepreneurs may want to consider where that VC fund is in its lifecycle. Typically, a VC fund has a 10-year life. The first five years are spent making investments and the second five are spent working to help the companies grow and achieve exits. If a startup takes capital early in the VC fund’s 10-year cycle, the VC may be a little more patient with the exit timeline.
It’s never too early to start talking about the exit strategy and making connections with potential acquirers. Often these transactions are based on trust, which can’t be created overnight. An investor can be very helpful in introducing entrepreneurs to potential strategic acquirers – particularly if that investor has sold their own company, participated in the sale of other portfolio companies, or has worked in the company’s industry. They will also have contacts at investment banking firms or private equity firms should you go that route.
The right investor can provide so much more than just money for your startup whether it’s assisting with your financing strategy, helping to bring in co-investors, or execution of an exit plan. I know these strategies work, because I’ve used them with many companies. Together with my partners of the Sofia Fund, we have invested over $10 million in more than 60 companies. Of the nine investments in our first fund, we’ve had four successful exits including one IPO. One of the Sofia Fund’s recent exits was the sale of a tech company where the board members and observers (including a Sofia Fund representative) worked diligently to find the right VC firm for the company’s last round of financing. That round provided the company with both the cash runway and the investor experience they needed to lead to a very successful exit for everyone.
JOY LINDSAY IS MANAGING PARTNER AT SOFIA FUND. SHE’S BEEN MAKING INVESTMENTS IN WOMEN-LED BUSINESSES AND TECHNOLOGY COMPANIES BASED IN THE MIDWEST SINCE 1998.