Entrepreneurs understand how important it is for them to raise funds from investors in order to grow. This acts as rocket fuel to help them scale up, so that they can lock in their first-mover advantage. Getting funds provides them with a lot of confidence and the fact that investors are willing to back their company with hard cash validates that they are on the right path, and have a good shot at being successful. However, in their anxiety to raise money, they underestimate the importance of finding the right investor.
Now, we all talk about dumb money and smart money, but it’s actually much more complicated. When you choose an investor you’re establishing a relationship which hopefully will last for many years. You need to be picky and choosy because a bad investor can create a lot of harm. Money comes with strings attached, whether you like it or not.
The Right Investor Checklist
You need to have a mental image of who your perfect investor would be, and then you need to go out and look for people who fit these criteria. Now, I’m not saying you’ll find the perfect match, but if you have a picture in your head, your ability to find the right person increases dramatically. This way you will not be tempted into saying yes to the first person who offers you money, because this is never a good idea.
The problem is that you can’t afford to waste too much time on finding the right investor either, because you do have a company to run! You need to find respectful investors who understand the value you bring to the table – and the value of your time as well. Good investors don’t keep you dangling and they don’t make you go through hoops in order to give you money.
This is why it’s a good idea to do a background check and talk to the other entrepreneurs whom they’ve funded. Their website will describe their investment thesis and their sweet spot – does this fit your criteria? Start a spreadsheet, and begin rating the investors you’ve spoken to.
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Many will not be the right fit for you. For example, if you want to raise a huge amount of money, then talking to a seed investor is pointless, so don’t waste your time (or theirs) approaching them.
You need to know how much money you’re going to ask for, and how much you think your company is worth. It’s not that someone will give you what you ask for, but at least that’s a starting point in the conversation. It’s very hard for investors to engage and have intelligent conversations unless you’ve thought these things through. If you are clueless, that’s actually worrisome, because this means you don’t know how to negotiate.
Deciding on a value for your company is extremely difficult – after all, how do you set a price on a baby? However, this is your responsibility, since this is your company, and you will need to learn how to do this. Your figure will be the starting point for a negotiation, and you will need to calibrate this over time as you meet other investors because you will soon get a better sense of what the market is willing to value you at.
This may be far less than what you think you are worth, and this may disappoint you, but you need to accept reality – this is not a game! Please don’t get misled by some of the metrics you read in the deals which get covered in the media – these are the outliers – not the median!
Thus, if some of your expectations are too outlandish or unrealistic, a lot of investors will say no quickly, so that you can reduce your valuations, and continue talking to others. The entire process will help you to become a little bit smarter, not only about your own company, but about what investors expect, so that you can fine-tune your pitch , in order to arouse investor interest.
It helps if you follow the principle called satisficing, as described by Herbert Simon, the Nobel prize-winning economist. The secretary problem provides a very useful algorithm, which can help you optimize your search. You need to use the ‘explore versus exploit framework’ to find the right match without wasting too much of your time and energy, rather than wait for the perfect investor, who many exist only in your dreams.
As your company matures, you will have to find different kinds of investors, as your funding requirements evolve. Seed stage investors, VC firms, and PE firms are all different animals, and have different perspectives, so you will need to keep on adapting as you grow.
While fund raising is always nerve wracking and time consuming, you will get better over time, so please be patient – it’s one of the other skills you will have to learn as a CEO.
And if you are in the fortunate position where you can pick and choose, I would suggest you give preference to the investor where the chemistry between the two of you is right, rather than the settle on the one who gives you a better valuation. Yes, this is an intangible, but being able to establish an emotional connect will help you and the right investor cope during the rough times which you are bound to encounter. Here’s a simple question you should ask yourself – Will I look forward to inviting him home for dinner (after he has signed the cheque)?
[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]