YEC Members on How to Vet Your Investors
YEC member Shilpi Sharma was living a first-time founder’s dream in 2012 when she landed a multibillion-dollar retail apparel company as a pilot customer for her startup. She and her co-founder had managed to bootstrap their company Kvantum, a data science-driven marketing platform, until then, but now they needed an estimated $1 million to complete the product and take it to the broader client base.
After numerous rejections from investors and with time running out, Sharma was ecstatic when her long-time business mentor’s company offered her funding. She never thought, however, that she’d be signing terms and conditions that would cause her to almost go bankrupt and lose her company.
“It was a painful experience and I hope no one finds themselves in that situation,” says Sharma.
Sharma’s friend and mentor was “co-CEO” of a consulting firm — an executive model rarely seen today. Sharma got her warm introduction through her mentor, who convinced his business partner that Kvantum would be a good investment for their company. His partnered agreed, and both seemed to be on the same page regarding the vision around the strategic investment — or so Sharma thought.
But not long after the investment was made, the two chief executives disagreed on the strategy of their company for leveraging Kvantum's IP.
Says Sharma: “That became a point of contention between them. There was a division in their company — some people were close with one CEO and some with the other. Things ended on a bad note for my mentor, and he was forced to leave the company … Maybe if there was only one CEO, things might have turned out differently. But we knew once our mentor left the investor company, things would end badly for us.”
Sharma was right. Her mentor’s business partner continued working with Kvantum as originally planned but decided after few months that they weren’t a good fit for each other, jeopardizing Kvantum’s future.
“It was a one-off scenario,” says Sharma. Kvantum is going strong today, but looking back at the terms and conditions she signed, Sharma says: “There were terms that worked in our favor and some that didn’t work in our favor. We reviewed these terms with our attorney and board of advisors, but none of us could foresee the scenario that actually occurred. You cannot control some events. What you can do is make the best out of the situation.”
Taking Sharma’s cue, we talked to several members who’ve experienced their own horror stories (as well as a few who’ve had healthy relationships with their investors) to find out what they learned along the way. Whether you’re preparing to raise money for the first time or have raised many successful rounds, consider these hard-earned lessons before you make your next deal.
Do You Need To Be Raising Money?
First things first. Why are you raising money, and is it absolutely necessary? YEC’er Lane Campbell, CEO of technology hiring platform June, is currently raising a round, so he’s speaking with other entrepreneurs in a similar position. “When I ask [them] why they’re raising money, their answers are really bad … Trying to raise a random figure without understanding why is the worst thing you can do,” he says. Early on, if you can bootstrap or take on a co-founder instead, you can save yourself a serious headache (learn about alternative methods of fundraising here).
Says Campbell: “The relative cost of starting a company is so low these days that I always suggest finding a co-founder before an investor in the early, early days.” Plus, not only would you have a partner to divvy up the workload when just starting out, you may find that he or she relieves a huge amount of stress when it comes to the decision-making and emotional toll of starting a company.
If you do find yourself having to raise a significant amount of money — for a capital-intensive company, for example — vet your investor carefully. Better yet, get a referral or two from someone you know.
Work Your Way to a Warm Introduction
Sharma still believes taking investment from her mentor's company was the natural next step — especially after numerous rejections from other investors — but she agrees, in hindsight, that she could have delayed the investment to identify potential investors better suited for Kvantum.
“There are a lot of tools these days … Search your competitors or like-minded companies, and see who’s investing in them. Follow the investors [on social], see what they’re talking about and find out their philosophy on investing,” says Sharma. “I think having a warm introduction by getting into their network is a better deal than going to your mentor and seeing who he knows. That will get you a limited network which may not be relevant to you.”
YEC member David Berry speaks on both the entrepreneur’s and investor’s side. He built and sold multiple technology companies, but joined Flagship Ventures in 2005 where he now focuses on investing. His suggestion is to attend conferences you know your potential investors are attending. “Find people who raise money for the people you’d want to raise money for,” he says. “Life partners and serial entrepreneurs all tend to hang out at the same conferences. Once you get the right intro and it becomes warm, the number of doors that open -- and the speed those doors open -- will astound a lot of people.”
YEC’er Ajay Yadav, Founder and CEO of Roomi, an app that matches roommates, had limited connections when he started fundraising. He researched investors by cold-calling the founders of companies they were investing in, who were more than happy to share their experiences.
Once Yadav had a vetted list of potential investors, he built his relationships from scratch by sending well-crafted emails to board members or mentors of the investor companies he admired, not asking for funding but just for advice. He then maintained communication with them for three to six months until friendships formed. By then, it felt like he was asking friends for support rather than investors for cash. Says Yadav, “These were people who I could see believed in my company. When I felt comfortable, I asked them, ‘hey, could you introduce me to your friends or someone who’d be a good fit for our company?’ and, they would do it!”
YEC member Douglas Hutchings, CEO of Picasolar, a solar technology company, echoes the sentiment of forming relationships whenever possible — but he didn’t always think this way. He met his seed-round investor through an acquaintance.
“I thought, ‘there’s no way this guy will ever write a check,’ and had effectively written him off,” says Hutchings. “He ended up writing our first check and started a three-year long journey that has turned out pretty amazing.”
His philosophy now? “Talk to as many people as you can. People warn you about giving away your intellectual property, but I have absolutely found that the likelihood of you [missing out] on an opportunity is infinitely higher.”
Watch for Red Flags
For the number of investors that might be a great fit for your company, there are infinitely more that are not. Reflecting on some of their bad experiences, several members recall telltale signs of bad investors.
One of these members is Tammy Leigh Kahn, who currently works as the VP of business development at inSegment. Back when she was raising money for her technology startup (which she would later sell in 2014), her VC withdrew two weeks from closing, forcing her to take a lower valuation at another firm. Says Kahn: “I was blinded by my excitement to see the warning sign: they delayed communication a lot.” She later discovered her VC was running out of funds.
Member Erik Severinghaus, Founder and CEO of SimpleRelevance, has a particularly absurd investor story. “We were waiting on the final document sign-off when my investor calls and tells me, ‘I was looking at the term sheet while I was at the beach and haven’t been paying much attention. We’re going to need to renegotiate these provisions,’” says Severinghaus. “I’m not kidding.” Clearly, his investor’s unprofessionalism speaks for itself. Any sign of aloofness or erratic behavior is a definite red flag.
YEC’er Faraz Khan, COO of marketing agency Go Direct Lead Generation, had the opposite — but not necessarily better — problem with a careless investor. One of his investors would incessantly text him, often late at night, asking for information. Khan wisely told him they would need to sit down and talk through everything at an appropriate time. “If I gave him the information via text message, things could have been miscommunicated,” says Khan.
Hire a Good Lawyer
Prevention is key, so it’s important to have legal counsel before things go wrong. Founder and President of Minton Law Group, P.C., YEC member Peter Minton is an attorney whose clients have been both investors and entrepreneurs raising money. In light of precautionary measures, he says, “Any lawyer will tell you to get it right from the beginning.”
Having a paper trail is the first step to keeping yourself protected. Says Minton, “I prefer to do all my communication through writing. It’s also great for showing any examples. When you’re talking about something complicated — like a weighted (average) ratchet, for example — you can run through the numbers, attach a spreadsheet, and everyone will know how the system works.” In short, clear, documented writing keeps everybody on the same page and limits ambiguity.
If you’re in the process of going over legal documents, review each provision carefully. “Even if it’s as simple as a convertible note round, ask yourself: what is the purpose here? How will this come across to our investors who are on the wrong side of it?” Minton says.
In the midst of discussing how to protect yourself, Minton stresses that it’s not about pitting entrepreneurs against their investors. It’s best for both parties to be honest when things go wrong.
Says Minton: “Good investors want you to succeed not only for their own bottom line, but because they’re interested in helping a startup grow … There are no companies that go from day one to unicorn status without hiccups — you just have a plan in place for addressing them.”
Keep Clear Lines of Communication
Clear communication — whether it’s over the phone, in person or via email — goes beyond legal protection. It’s crucial for maintaining any healthy relationship, especially when deciding whether an investor is a good match for you — as well as after you’ve closed the deal.
Hutchings’ company, Picasolar, is based in Arkansas, so he rarely gets a chance to talk to investors in person. “I rely on emails quite a bit, since we’re cut off from the East and West Coasts,” he says. It’s trained him to recap every meeting and, if applicable, list specific next steps. Being able to search email threads in your inbox is also hugely helpful for making sense of communication among multiple potential investors.
When you think you’ve found the right investor or when emails and documents don’t cut it, meet in person. When you do, keep in mind that first impressions are pivotal. Says Kahn: “Talk is cheap. It’s more about how you go in. It’s knowing what you want and deciding if they can offer it.” Be focused and confident during your meeting.
Hutchings has even made last-minute flights to the Bay Area or the Boston area to take advantage of an introduction. When he speaks to potential investors, he’s honest about his company’s strength and weaknesses. “I have a tendency to lay things on the table,” says Hutchings. Have a great pitch, by all means, but masking challenges or risks will only blindside your investor later on. Being honest is one of the best ways to ensure you’re bringing the right investor on board.
After you close, make sure to keep both parties updated and share information as clearly as possible. Khan prefers bullet points in his emails. They’re easy for his busy investors to read. After summarizing his account, he asks his investors: “Did you get anything else from the meeting? If so, let me know.” It’s a clear doorway for them to add whatever they feel is missing.
Mike Kelly, CEO of app development company Ora Interactive, swears by writing a three- or four-page long template that he sends to his investors. “It gives them a high-level look that isn’t always covered in the day-to-day emails.”
Salvage a Bad Situation
When Sharma’s investor wanted the rest of his money back, like any good business owner, she was able to save her company by thinking quickly on her feet. She and her co-founder sought legal counsel to see where each possible outcome would lead them. Not wanting to go bankrupt, she sold the rights to one of her two products to an acquiring company and was able to get just enough money to repay her debt to the investor.
“I think it was the best thing we could have done in that situation given the possible outcomes,” Sharma says.
This, of course, was unique to Sharma’s situation. For other entrepreneurs who find themselves trying to mitigate damages, she recommends maintaining transparency with co-founders and board members. “In pressured situations, everyone has their own framework which may be different from yours … Don’t hide your concerns or what you agree or disagree with.”
Even if you feel you’ve been slighted, how you handle yourself for the remainder of your partnership is paramount. Since Sharma’s investor was no longer interested in Kvantum’s product, it wasn’t a relationship she thought was worth continuing. Still, she wanted a clean exit strategy. She notified her investor that she hired an attorney to come up with the best way to return the investor’s money and presented the possible solutions. Her investor agreed to resign Kvantum’s board if Sharma sold her product and gave him the cash.
Considering the ordeal, Sharma is happy with the outcome. It’s a test of her company’s resiliency as well as her own. Plus, she believes that having one product brings a laser focus to the company.
Says Sharma: “We’ll buy the rest of our equity back and the cap table will be open again. We got ourselves out of a bad situation. We’re self-sustainable, and we have a very good story to tell now that we’re looking looking for better investors.”