If you are not reading Gotham Gal’s blog, you are really losing out because there is a lot of good stuff there about entrepreneurs and angel investing culled from her own experiences. She recently posted a real gem, helping entrepreneurs recognize when an investor is really saying no regarding an investment. I highly recommend you read the post and subscribe to her updates.
Anyway, I often wondered why investors never just said no directly. It was mystifying to me during my own fund raising efforts years ago when VC’s and angel investors would hem and haw and push off making a decision. When asked directly if they were interested, instead of a simple yes or no, I would get a whole lot of excuses about needing time or too busy with other deals or some other reason. On the surface, it would seem easier just to cut bait, but they always insisted they were genuinely interested and wanted to keep the conversation going.
Now that I am on the other side, it is pretty clear why investors lead on entrepreneurs. It is no Machiavellian plot or evil twisted scheme to destroy startups and crush founder’s dreams. It is because many investors exist in a cloud of indecision and imperfect information. Investing in startups is extremely challenging and daunting task for the very fact that there are no fool-proof or easy ways to assess startups and startup teams early on. So in the vacuum of uncertainty, investors try to fill the void with as much information as possible. This insatiable quest for information however rarely works to the benefit of entrepreneurs.
During fund raising, investors and entrepreneurs have vastly different perspectives of time. Entrepreneurs are on the clock to identify interested investors, secure funding commitments, negotiate terms, prepare documents, get signatures, and collect the money. The shorter the process is for the entrepreneur the better because it shows momentum and lowers the potential for investors to back out. More importantly though is that the faster the process, the higher the likelihood that the startup survives before running out of money. Time is the enemy of the entrepreneur.
The investors on the other hand tend to stretch time. There is little that compels an investor to make an investment by a certain time, so they wait while they collect information. Not only do they want information for due diligence purposes, they also want to build relationships and see progress. This speaks to Mark Suster’s point about investing in lines, not dots. The investor wants as wide a slice of time as possible to gauge traction, monitor market reaction, and observe the team dynamic. This gives them salient data points to determine whether a particular startup is investment material. However, they cannot do that in just a couple of meetings over a week. Thus time is the friend of the investor.
It is not only a matter of time however. There is also the question of process, experience, and motivation. VC’s operate in hierarchies that push deals bottom up from analysts to partners. This is done to create filters that ensure partners only focus their time on the most promising deals. The result is that startups gets stuck in an endless cycle of analyst meetings that only serve to create a deal flow funnel, and the only way to escape the loop is to get solid support from one of the partners, and even that is not a guarantee. Every deal gets vetted, discussed, debated, and agreed to by all of the firm’s partners (some firms do work differently, but there is still a process). So until that happens, you are in limbo.
Experience comes to play when working with non-professional investors. The challenge here is that they know even less about the fund raising process than you do, or they simply have a different way of getting deals done. I see this occur most often with big corporations that do such deals on the side as part of a corporate development that do “strategic partnerships”. They do not typically understand the constraints that early stage startups are under so they continue to operate at their slow and steady pace and go through all of their proper corporate processes to approve a deal. At the other extreme is the novice angel investor that negotiates every single term on a standard term sheet and browbeats the startup into accepting a wildly lopsided deal. You waste precious time and credibility with other investors when you get caught up in these discussions.
This leads us into motivation, which is the realm of angel investors. VC’s may be maddening to deal with, but angel investors can be much worse. It is not a process thing or even an experience thing. Angels do not have some fiduciary responsibility to invest like funds do; they invest for their own personal reasons, some altruistic and some vain. They also are generally not doing angel investing as a full-time job. The point is that these folks have no obligations to invest; they do what they like, when they like. I even recommend to angel investors that they take their time and not fall for the hoopla and succumb to FOMO. While this obviously does not benefit entrepreneurs, it does ensure that both investor and entrepreneur are entering into a deal with eyes wide open and minimizes the “investor’s remorse” that occurs often in lightning fast rounds.
With the interests of entrepreneurs and investors diametrically opposed, it would seem that investors have the upper hand. However, in recent years with the uptick in investment activity, the greater interest in tech startups, and more and more ways to seamlessly connect entrepreneurs to investors, entrepreneurs have been gaining leverage. Even still, except for the handful of exceptional startups, most startups have to fight the battle of time, process, experience, and motivation. Next week, I’ll talk about some of the ways you can work through some of these barriers if you are not necessarily one of those red hot startups.