One of the most crippling decisions that a startup can make is choosing the wrong investor.  In my first startup, we had the right idea: we were looking for an investment partner that shared our values and our vision for the future.  We researched each possible investment source and quickly disqualified many because they did not believe in our company’s vision or core values.  The foundering team members had all worked for too many people that “just didn’t get it” in the past, and we believed that a key source of difficulties with the 10-year-old startup where we working when we met was an investor that was not a good match for the company… and we were loath to repeat their mistake.

Instead, we kept searching for the “right” investor.  While we searched, we worked hard with what few resources we could find and eventually burned them all up, forcing us to shut down our operations.  After I made the decision to close our doors and began looking back to see what could be learned from the experience, I only second guessed a few of the decisions that I had made, but the biggest doubt I carried with me was that I might have been too picky when engaging with investors.  I chalked it up to the naiveté of a first-time startup CEO and moved forward, but I admit that I questioned this pickiness for several years.

Now that I am a little older and a little wiser, I have realized that my pickiness with investors was totally warranted, and – in fact – probably kept me from getting us into an even worse situation after the company had to shut down!  These are the things that I now look for when seeking investment in a startup: agreement with our mission/values/values, risk tolerance, risk comprehension, and the interpersonal relationship.

They must understand the mission, believe in the vision, and share the core values

Any startup worth funding has a clear mission, even it is not written down.  If prospective investors do not share your view on what mission it should achieve, then it will be hard for them to understand the value that your startup will create.  The investment courtship process is often intense and requires a lot effort; if an investor is interested in the company but believes that you should have a different mission, then the due diligence process is likely to be quite painful and significantly less likely to end successfully.  If you still manage to close a deal with someone that doesn’t believe in the mission of the company, then you will likely be fighting them at every board meeting as they try to steer the company in a different direction than the founding team.

The vision of the company is probably less developed than the mission; after all the mission should be really simple and straightforward, but the vision of how you are going to achieve that mission may be significantly more complex.  During the funding process, I am always open to adjustment to the vision that I have for the company, but an ideal investor should be willing to start with the established vision and help to enhance it, rather than just throwing it out the window.  Adversarial relationships don’t come simply from mismatched ideas of the direction of the company, they also come from wanting to get to the same place but through radically different paths.  Since investors are going to be part of your team moving forward, it is best if they can augment and amplify your journey, rather than resisting it.

The mission and the vision are heavily influenced by the values of your organization, and – in a well-conceived startup – should flow from your the core values of the team.  If your organization has a strong belief “the best work is done when people have time to be creative” but your investor has the belief that “great things are only achieved when you put in long hours of hard work”, it is likely that you are going to end up with a lot of problems with your choice of personnel, compensation structure, and work environment.  Things can go very wrong very quickly if you don’t share core values.  Another easy-to-see example is that of a “typical” banker that adheres to a strict 9-5 schedule and a “typical” programmer-genius that likes to sleep until noon and then code until 5 in the morning; if they can’t agree on some shared values about when it is fair to work together, it could lead to hard feelings and lowered performance on both sides of the boardroom table.

When a startup team and an investor do not see eye-to-eye on the mission, vision, and values, problems can arise even when the company is achieving their goals as expected.  Thus, understanding the mission, believing in the vision, and sharing the values are key qualities that I seek in every investment partner.

They must be able to afford losing every penny

It is only fair to protect your investors.  When investing in a large company (especially a large public corporation), an investor can usually “eject” from ownership, if certain bad things start to happen.  For instance, every public stock that I have owned has had a standing sell order (called a stop-loss) for each security in my brokerage accounts that activates if the price were ever to fall to a certain level.  The reason I am relatively safe and know that I cannot lose too much money is that I have a large amount of liquidity when I own shares in a large corporation.  In this way, liquidity can can offer partial protection for public equity investments, but when someone invests in a small startup there is no real liquidity to the investment.

Sophisticated investors often demand a different class of preferred stock, which allows the investors to recover some money if the startup goes under.  As an example, a recent LLC that I was involved with gave me an ownership share with preferential liquidation rights, meaning that I would get paid before anybody else, even if the company went under and had to sell all of its leftover assets to pay bills.  Another type of investment that some investors use is called a partially-secured convertible bond.  Convertible bonds are loans that the company must pay back, but the investor has the option to convert the bond to a stock purchase at a later date if the company is successful.  Often times, the bond is secured with some property of the founders, so you may be at risk to lose your house or car if the company does not achieve some success.  The problem is that most small startups have virtually nothing to liquidate if they fail.

But the most important reason to make sure that your investor can afford to lose their entire investment is that you tend to make decisions in a less rational (and less successful) way when you cannot afford to lose.  It may have worked for Cortés when he came to the Americas, but he was invading two continents, not trying to make the best decisions while creating a value-generating business!  In his Pulitzer Prize winning book “The Soul of a New Machine”, Tracy Kidder points out that everyone started making better decisions at Data General after the CEO, Edson de Castro, forced everyone with stock to sell enough to purchase their house, so that nobody would be making decisions while worried about their house instead of worrying about what was good for the company.  In a startup (especially a first startup), it is highly likely that the founders will be acting as if retreat is never an option, but this attitude needs to be balanced by reasonable investors that are capable of thinking more reasonably.

They must fully understand the risk

Sometimes investors get so deeply behind your ideas that they believe that you cannot fail.  This seems great, because it means they really believe in you, but it is critical that they understand that they can lose every single bit of what they are investing.  If you were to ever misrepresent the risk – even a little –you could be held legally liable (civilly and criminally) for fraud or violation of securities laws.

Even though investing looks easy, there are many, many things to consider when deciding whether or not to invest in a startup company.  Regardless of the legality of taking investment from sources that don’t understand the risk, you also risk ruining your relationships and your reputation.  If there is even an appearance of impropriety after an investment goes south, word is likely to get around, and it is unlikely that you will ever be able to find an investor willing to work with you in the future.

They must be people that are likable enough to be around for the next 3 to 5 years

Typical investment sources (angels, incubators, startup funds, investment trusts … even VCs) are full of people, and those people are going to be around for a long time if you take their investment.  Venture capitalists will often layout the length of time they want to be involved, and will establish a clear exit strategy, but it is almost always in the range of 3-5 years.  Angels, trusts, and incubators may want to stay with you for a much longer time.  Not only do you have to worry about the investor themselves, but also the company that they keep.  In essence, you are not only “marrying the investor”, you are also “marrying into the investor’s family”.  Taking investment is a long-term commitment with people you will be seeing a lot of.

While one of my startups, NuWave Technology, was looking for funding, we met with an investor that believed in our mission, vision and (ostensibly) our values, but I just didn’t like the guy.  He got along great with the other two founders, in the beginning, but he was rude and dismissive with me.  He was interested in making an investment, but continued to treat me inappropriately, so our CEO called off the negotiation.  He re-engaged and sweetened the offer to the company, but required that I move my entire technical team to Alberta, Canada (even though they were all happily living in United States) and sign a contract to live there for three years.  It just didn’t feel right, and we all started to just – well – dislike this investor, so we turned down the deal.  Shortly afterward, I met some other people that had taken investment from him and learned that they absolutely dreaded their weekly meetings; my gut feelings had steered us away from misery!

For these reasons and more, I recommend limiting any startups funding searches to investors with these qualities: correspondence with the mission, vision, and values, tolerance for the risk, understanding of the risk, and interpersonal likability.

“Investment Growth” by Pictures of Money is licensed under CC BY 2.0
“Money” by Pictures of Money is licensed under CC BY 2.0