How Committed are your Investors?

Once upon  a time, VCs raised big funds and wrote big cheques. They talked about putting “money to work”, and looked to put $5M – $10M into every company they backed. There were many reasons why this strategy did not work that have been well documented. And while some funds were successful with it, the industry as a whole was not.

Today’s software startup does not need $5M to get going. 1/10 of that is more the case. So, we are seeing new breeds of investors from angels to super angels, micro VCs, etc.

One of the benefits of the “old” strategy was that, for better or worse, you had committed investors. They each owned big chunks of your company and had lots of capital invested in you. So, whether you wanted it or not, you had their attention.

To be clear, I think the super angel phenomenon is great. I think it is great for entrepreneurs as it gives them more choice and plugs them into investors with huge networks and data points because of all the deals they do. And I think it’s great for Limited Partners (the folks that give super angels their capital), because the super angels are building a well diversified portfolio with exposure to many companies, sectors, and in some cases geographies.

But, what happens when things go wrong? What if you’re running out of runway before getting enough milestones to truly be ready to raise a new “up” round? What if you need more time because you want to pivot in a new, exciting direction? What if you need to replace a key team member? The examples are endless.

When you had a small number of highly committed investors, I would say it is easier to convince them to continue to back you. After all, they are already “all in”. A few pennies more on top of that investment could give you the bridge you need. But how easy is it to convince investors who have 60, 80 or more other companies to spend the time needed to understand your new direction and back it? How much effort is required to get a large syndicate of many, disparate investors to re-up and bridge you?

If you were building a shopping mall, your 1st priority would be to secure an anchor tenant: a big brand that takes a big chunk of space and acts as a draw for shoppers and other merchants. You can’t build a mall without this. I think funding syndicates should follow a similar strategy. By all means, get angels, use Angellist, get super angels on board. But, I would say having a lead investor who takes a big chunk of the round and has the capital, brand and relationships to keep your syndicate together in good times and bad and influence it through its own actions is key. Without that, I think you create a lot of exposure  and set yourself up for a lot of work getting the group to come together if and when you need them again.

  • I struggle with the mentality that business owners have once they are funded. I have seen companies take investor funds and "go to town". Because it wasn't their money, they burned cash faster than ever before. It's very common for a small business to need more rounds of funding because they burned through the first two rounds and have little to show for it.

    A business needs to understand its burn rate and runway before ever taking any investor money. Then they need to manage that burn rate otherwise they start buying fancy desks and blowing it on untested marketing campaigns.

  • Thanks for the insight Mark, I never thought of this as a challenge. Both Angels and VC's have their pros and cons and depending on what stage your startup is one will always sound better than the other. Since angels are easier to access (due to less risk tolerance compared to VC's from my experience) they will be the first people to approach for first time entrepreneurs, because at least you get a chance to get to the stage of "things going wrong" instead of letting your idea not even get tried.

    My favorite quote comes to mind:

    • Hey Ali. Great quote. It's true, better to have had a chance to pay than not, but assuming you will get a chance to play, make sure you're playing with the Investors that can best help you win

  • Chris Arsenault

    The investor commitment you refer to above, seems to be one directly related to the amount of capital being invested, vs. the capacity for any given investor (angel of VC) to follow on in a round (because of growth or because of of facing challenges).

    I'm all for frugality , making the most with as little as possible, especially in the validation period (not necessary the right thing to do in hyper-growth mode). I agree that the cost to start a Company up, to build and launch a product, turn a business opportunity around and validate a business model is a fraction of what it use to cost a few years ago. Especially for software or web focused companies. Yet, I don't think that the cost associated to growing a Company into a large $100M Company changed that much. Growth Capital remains growth capital and it is costly to not only become the leader but to then remain the leader!. So any given startup needs the right type of investors at the right stage, and the commitment of such investors should be measured based on their capacity to follow through to the growth stage, but not necessary be required to be part of growth financing.

    Investor commitment should firstly be based on their understanding of the opportunity, the relationship they build with the founders/entrepreneurs as well as the role they can play in helping the entrepreneurs build the Company into a successful venture. Taking into account the stage the Company is in and the amount of capital the investor can set aside for the opportunity needs to be taken into account as of the first investment.

    • Great comments Chris. You are right that the cost to build a large growth company are as high as ever. And companies entering this phase will have highly committed Investors. What I worry about is the whole crop of new, very small startups being funded by large groups of Investors. They will undoubtedly hit many bumps before entreating the growth phase. I worry that these companies won't get the support face time and heavy lifting from investors that could help them take off.