We know that customers don’t buy technology. They buy a solution to their problem (pain solver) or something that makes them look, work, feel, live better (gain creator). Building something, be it a product, a service, or an experience that brings authentic value to a customer requires deep insight into the problems or opportunities they face, and why these problems or opportunities haven’t been addressed yet. I have seen hundreds of investor pitches. I am left with an important question that must be answered.
Why do we treat investors any differently than our customers? Many investors are pitched in this way:
- We saw this problem in the “market”;
- We realized it is a problem [insert huge number] of people have;
- We built this [insert thing] to solve that problem;
- We have [insert small number] of users/customers, and will grow;
- If you invest just [$$], you will get [multiple $$] in some years;
This pitch plays out hundreds of times per year for an average investor, and reveals a deeply flawed mental model by the entrepreneur of the investor’s reason for why invest, or more likely not. There is plenty of discussion about value proposition with respect to customers. Investors have their own value propositions that must be considered. Here are some criteria investors have that we think entrepreneurs need to think about more:
- What is the investment hypothesis? If an entrepreneur can articulate their theory of value concisely and compellingly, and if they have done the requisite homework to communicate why, the timing, synergy, and economics of the opportunity make sense for this investor (not “investors” in general) now (not in general, opportunity is not atemporal) then we say they have a solid “investment hypothesis”. Essentially a good value proposition but specific to a particular investor. The rest is about your relationship with them.
- Did this entrepreneur come through a channel/contract I trust? The average venture capital firm with 5 managing partners will get approximately 5000 leads per year. They will look at 500. take 50 meetings, and invest in only 5, maybe 10. Yes, you read that right. You have just a 0.1% chance of investment if you go through “proper” channels. So don’t. Go through a channel the investor will trust. Other investors they co-invest with are good. Even better is a CEO of a company they invested in that is performing. If the investor gets a call from this CEO saying, “you need to meet with this entrepreneur, because [insert anything],” you go from 1 in 5000 to 1 in 50, or even 1 in 10. Beyond that you now have the inside scoop on what the decision making logic is for that investor and have a built in coach to help you position yourself and your company to fit the mold.
- Team, team, product, and some more team. Over and over, investors admit that they base a disproportionate amount of their decisions on the strength of the team. What they don’t say is that in addition to experience, domain expertise, and board members, they are ultimately, judging the team on how well the team has considered the previous questions.
- How actively am I investing? Is my fund spoken for? Investors will still hear your pitch, even if they aren’t looking for new investment. We hear entrepreneurs express frustration about being “strung along” the just-a-little-bit-more-information due diligence merry-go-round unfortunately while we know that particular firm may have made that fund’s last investment months ago. You must know how much “dry powder” they have — if hit the target number of investments and are more than halfway through the life of the fund they may not be investing. It does not mean it is not worth the meeting, but know the time is not conducive to funding.
- What direction is my fund heading? or Why this portfolio focus now?Many entrepreneurs think an investor will invest in them if they have invested similarly in the past, but this requires more careful analysis. If an investor invested in three on-demand applications in 2011 and 2012 and nothing since, this probably means they are moving in a new direction years later. A more useful insight would be determining what the investor’s “aspirational” fund is currently. What deals are they looking at? Which investments are they picking up now? Is there any relationship? What can be inferred by past and current co-investments?
- Who do I co-invest with and how? Investors rarely act alone. It benefits you to consider: if I’m seeing a seed investment from this investor, which firms have traditionally co-invested? Is this firm consistently a lead investor or do they tend to follow another firm? Which investors tend to back companies in the next round? If companies from this portfolio tend to be backed in the Series A by [VC firm], that has bearing on the deal terms, your pitch, and your fit with the investors. It will considerably focus your target list for investors to talk with and will also help with pattern matching since you would be following what the investor has said yes to in the past.
- Does this benefit my portfolio? Investors think about financial ROI, of course, but an entrepreneur must know that investors also thinks about whether your company creates other leverage for their portfolio. For example, if an investor has backed an “internet of things” sensor company, perhaps you will be considered a better fit if your company has a data collection and aggregation platform. This creates new value for the investor’s portfolio, and would be worth more to them as a result. Be wary — investors you meet with may already be invested in a company like yours, and may wine and dine you finding out all your secrets only to pass them along to their portfolio company. They are not evil, you just need to know before you go in. There is a fine line between “partner/collaborator” and “direct competitor”.
- What did other similar companies look like at this stage? This may be one of the most important questions, as well as the least understood. Investors look for patterns just like anyone else. If they invested in a company that returned money back to the fund, they will (consciously or subconsciously) compare each deal they see after that to the past successful one. Ask yourself: what do previous investments from this fund look like? What metrics will this investor care about? Adjudicating on which metrics or milestones are on the investor’s checklist and how to communicate the the idiosyncratic value of what you are building is paramount. Look at similar companies in adjacent markets/industries in a specific investor’s portfolios. This will yield a set of “investor-validated” benchmarks against which you can frame your venture. No investor can know your company as well as you do, so give them “best practice” examples to anchor the conversation around.
- Does this entrepreneur understand the “investor algorithm?”Valuation is endlessly debatable, but the equation an investor uses to determine whether an investment makes sense economically is relatively simple. At the seed/angel stage I want 20–30%, can I get 10x at series A? At the Series A/VC stage I want 30–40%, can I get a 3–7x at Series B or acquisition? Similarly, the easiest place to look to get a reasonable valuation is from competitors, similar companies in adjacent markets, and especially companies in this investor’s portfolio. Knowing this can transform what can be the most needlessly frustrating and protracted discussion between investors and entrepreneurs into a logical conversation grounded in historical evidence. Knowing VC math and speaking the same language immediately elevates the conversation.
- What is this company’s theory of sustained value creation and growth? A company does not exist in a vacuum. An investor will be looking to see that an entrepreneur understands the macroscopic market forces that drive their industry, and that the entrepreneur has strategically identified which assets and partners are most conducive to profiting in this industry.
These questions, if researched well, should help you speak the language of investors. They should save you time and help you find the right investor partners. They should elevate the authenticity, utility, and value of the conversation. They will help you realized that after all, investors are in fact human, and have their own complex set of financial, social, and emotional drives. Know this, and “fundraising” might actually be fun.
Thanks to Andrew Pagels and the people at Investable who constantly push me forward.