Investing in startups is not like investing in the stock market. A good founding team will vet you in the same way as you are vetting them. If they don’t, you probably should think twice about investing in them as they might not be the kick-ass team you are looking for. Good cases usually have investors lining up and rounds tend to be overfilled.
In this post, I will walk you through why investors play a key role in extending the capabilities of the founding team. I will help you find out what you can bring to the table to make you a sought-after investor getting access to the most promising cases.
Startups should aim for more investors if the money is smart
There is a misconception amongst founders that startups don’t want to have too many actors on their cap table. But this is only true for dead equity which makes the case unattractive for future investors. What the startup wants is smart money!
The fact that you have an equity stake in the company fully aligns your incentives with the goals of the company unlike when the company hires the expertise for a fee. But you should be aware that the contributions from the investors likely will follow Prince’s Law and be Pareto distribution (more commonly called the 80 / 20 rule). It has been shown that the square root of the number of actors in a system (such as a company) will bring 50% of the value. Check out this YouTube video from Jordan Petersson for a more in-depth explanation.
Smart money means that the investor also contributes in other aspects than merely writing a check. Contributions come in three types: skills, network, and insights. Let’s go through them one by one.
Skills: It takes years to master
A founding team is limited in skills and networks due to its size. However exceptional the team is, no one is a jack of all trades. Usually, the team has abilities of different degrees to build and sell the product. But to expect to have all the capabilities of a mature company with all its specialists is not realistic.
The skills needed to build a company and what your particular case needs are naturally dependent on who the founders are and the type of product they are building but here are some areas where I’ve noticed the team could need support:
- Product Development Methodology – How to build the right product for the right people with an effective process.
- Design – How to make the product a joy to use and visually pleasing.
- Writing agreements – It takes experience to know what co-founder- and shareholder agreements as well as a supplier- and customer contracts should contain. Chances are good that you have seen more of these types of documents than the founders.
- Planning the long-term funding journey of the company – What milestones need to be met to raise what amount of money to which valuations?
- Recruitment and building a team – Bringing on the wrong people could be the most costly mistake you can make as a company.
- Marketing and branding – Knowing how to frame your product and what channels to use to promote it.
Faced with a shortage of skills the company is faced with some options.
Either learning the new skill needed which takes valuable time. Or to hire an expensive consultant who will not be as vested in the success of the company as the team and the investors. Not to mention it is very expensive and a startup is often strapped for cash.
A smarter choice is to have a group of friendly people to reach out to for support. This is you and your fellow investors!
Network: Introductions are invaluable when selling your company
Our society is based on networks of people. Your family, friends, community, country, and so on. The closer someone is to you the more you trust their opinion.
A startup is basically doing two things, building the product and selling the company. When I say selling the company I mean compelling others to join their cause in some way. This can take many forms:
- Recruiting to increase team size – Use your connections to make introductions.
- Finding customers and users – Bring them on as early users in pilots and/or buy the product.
- Raising money – Investors move in packs. You are a part of these packs.
- Gain access to industry experts – These people have insights that take years to obtain.
- Getting access to the best suppliers – You can make sure the startup gets a fair price and someone who knows what they are doing.
In all these aspects the network of the company is its strongest asset. Every investor that brings contacts and introductions to the team gives them the possibility to increase their reach exponentially in all the selling aspects.
Just think about the difference in your own reaction when you are approached cold on LinkedIn compared to when someone you know makes an introduction. Of course, you make time to do a short 30 min video talk when a friend asks you to.
Insights: Ideas are cheap but can turn out to be a game changers
The most precious resource of the startup is time. Time is a truly inelastic resource and once spent you can never get it back. If the team spends their time on the wrong things they will run out of funds and will struggle to raise more.
An investor provides another brain to diversify the view of the company’s situation. In this HBR article, you can read more about how cognitive diversity increases the speed of problem-solving for a team.
Insights can be in the form of:
- Ideas on how to improve the product
- Potential new segments of customers
- Where the space is moving
- What is the startup landscape looking like in your area
Remember that the team is busy building and selling the product which is a very tactical task. They seldom have the time to rise above the daily grind and look at the bigger landscape outside of their niche.
How can you contribute?
First of all, remember that you are an investor and not a part of the founding team. Building an investment portfolio takes a lot of energy and this should be your primary focus. Remember not to over-promise how much you will be able to contribute as this will reflect badly on your reputation.
With that said, spending a couple of hours every quarter giving advice is something you should prioritize. Not all investors are prepared to put down the effort and here you have a chance to stand out from the crowd.
On top of that, you should be very generous with introductions through your network. This is a no-brainer. Since you only invest in teams you believe in, you should be safe from the fact that the team makes you look bad in front of your network. Write a personal introduction specific to the case to break the ice.
If you are in doubt about the skills you can offer you should look at what you have done so far in your career. Spending 40 hours a week for years in a profession builds tremendous expertise that you most likely take for granted. Look at what you are doing daily. Ask your friends and colleagues what they think. I can promise that you will go way past “Mt Stupid” of the Dunning Kruger curve.