11 things you must know before you take your investor’s money
Seeking funding is an important aspect of startup culture all over the world, particularly in Silicon Valley. In Silicon Valley, virtually every day you get to hear shout outs of startups successfully raise funding from investors. This is not surprising since in Silicon Valley, there are more investors – angel investors and VCs compared to the rest of the world. Hence, this piece of land covering San Francisco and into the Valley till San Jose has one of the highest standards of living in the world.
Most startup entrepreneurs have this thought that getting investors to fund their startups means the beginning of a great journey. Even I was not spared. Every level of funds raised, puts you up in the pedestal in the startup world. However, not many realize that there are pitfalls in fund raising. It is the beginning of a HELL journey. At this stage, you have lost absolute control of your company and would need to share this control with your investors, bearing in mind that they were not even there when you painstakingly founded your startup. They are in your startup now as opportunists, which is a fair word in a capitalist world.
Of late, we have heard reports of investors from hell where startups could lose control of their companies due to unfavorable terms, hostile management takeover, investors took too much equity at very early stage and start exerting their minority rights, investors who couldn’t understand the businesses and start imposing themselves and many more…This is not what an investor-investee relationship should be. But then again, investors are there to make money. How much money they want to make is entrenched in their investment philosophy. They are opportunistic in nature. They will do anything to protect their investments. Therefore, they are not your friend or partner as you always want perceive them to be in your ignorant world. I am not saying that all investors are bad but most of them are. But I do know of some good investors who are there always to help. These are entrepreneurial investors, which means they were entrepreneurs before and they understand the world of startups and are willing to share their experiences to help their investee startups to grow like how they did.
Most of these issues can be avoided if startup entrepreneurs are aware and educated on what they must know before they take any investors’ money. This ranges from seeking the right investors, to valuation, term sheets, shareholders agreement and control. In this article, I would like to share with you a checklist of 10 items, which you MUST look into before you sign anything and before you take their money.
The 11 items are:
- Are you raising money too early and too little? If you are raising money too early, you may end up giving away too much equity for too little money. By doing so, you will face future hurdles in raising future funding rounds which you will end up being a minority owner in the future.
- Are you ready to take in an investor? It may be important for you to raise funds but is your startup and your team ready to have investors on board when they start to scrutinize everything that you and your team does? Is your startup ready to implement corporate governance and transparency? Is your team ready to execute the business plan that you propose to your investors? Make sure you can execute with precision; otherwise, your investors will be breathing down your neck.
- Do you know your potential investors well? What portfolios have they invested in? Are the people whom you are going to work with approachable? Have you done your homework in finding more about them? Were they entrepreneurs before? Or are they from the corporate side? Does your investors fit right into your corporate culture? Are they there to help you in your business and helping you to grow? Or are they just passive investors?
- Is your company’s valuation realistic? What stage are you in and on what basis are you making your valuation assumption? Is your business model proven? Or you are still validating your market? Can you justify your valuation model? Many startups make their mistakes on asking too high valuation. The usual justification is that this is what they will get if it is Silicon Valley. Hello! We are not in Silicon Valley. Secondly, you don’t even have a proven model. How can you compare?
- Do you have a compelling business model that will eventually help you to raise valuation and scale your business? If you do, that means you are raising money to fund growth, which is the ideal stage of fund raising.
- Do you do your monthly financial accounts? Make sure you have your company accounts up to date. Investors often do due diligence on your accounts before investing.
- Do you understand the terms of different investment instruments? Investment instruments such as preferred shares, convertible note, redeemable convertible preference shares, and common stock are structured differently. Make sure you know what they means.
- Do you have your own term sheets? Term sheets are letter of intents between two parties – investor and investee who agree in principle to make an investment and take an investment with certain conditions. Make sure you have your own term sheet drafted. You can produce it when the potential investors request for your term sheet. Try not to use the investor’s term sheet. Very likely it will work against you.
- Make sure you understand the standard legal terms of an investment agreement. You may want to have a lawyer vet through the agreement for you. If you cannot afford a lawyer, find a friend who is a lawyer (this means, you should befriend a lawyer). There are plenty of legal jargons that you may not be familiar of and could land you into serious trouble later on. Some legal jargons such as “affirmative vote”, first right of refusal, tagged along clause, minority rights, reserved matters and a lot more could work against you in future rounds of funding or in your daily operations.
- Once investment is sunk into the company, you will be asked to prepare monthly management reports. Are you ready for that? Is your accounting up to date? Make sure you are ready to produce management reports every month to your investors unless you want to be labeled a cheater and a liar. This also means that your financials must always be up-to-date.
- Make sure you have a clear understanding about board seats and shareholders’ majority rights. The control of a company is very key at the startup phase. Make sure you are in control all the time, which means, you have board majority and shareholders majority at all times. I overcame a hostile management takeover, thanks to my control of the board and shareholders.
Remember, investors are there to make money. Their only care is how much money they make and ensuring that they don’t lose too much of their money. They don’t care about you. They just want a good deal. They are not your friends and partners. So you as the startup entrepreneur, you must be aware. Seeking funding may be glamorous but let the entrepreneur beware!