Founders, Here’s What to Look for in an Investor
It sometimes can be better to turn down money than partner with the wrong investor.
Securing capital is a fundamental step for any startup founder intent on fueling growth. However, not all capital is created equal. The effectiveness of capital can vary dramatically based on the investor providing it. This guide will help you identify investors who are FAT — fair, aligned and transparent. These attributes build trust and ensure that both the terms of capital commitment and investor actions support your business’s long-term success.
4 Signs an Investor Is a Good Fit
1. They are aligned with your startup’s mission and goals.
2. They have expertise in your sector.
3. They are financially stable and credible.
4. They have experience with similar-size startups.
The peril of partnering with unsuitable investors can jeopardize your entire venture, potentially leading to wasted time, money, legal issues, damage to your reputation and limited growth. Sometimes, refusing an investment is a wiser option than accepting detrimental terms from incompatible partners.
4 Desirable Traits in an Investor
When you’re hunting for capital, consider not just the financial investment but also the strategic benefits that potential investors bring to the table. Here are essential attributes to seek.
Aligned Vision and Values
Select investors who demonstrate a strong alignment with your startup’s long-term goals, particularly concerning control and valuation. They should have realistic expectations for your company’s growth and be prepared to support you through its inevitable fluctuations over the long term. This alignment ensures they are true partners interested in sustainable development, rather than quick returns.
Domain Expertise and Network
Opt for investors who offer more than financial support by providing valuable industry-specific knowledge and operational experience. Their well-connected network should facilitate access to additional fundraising opportunities, strategic partnerships and critical resources like top-tier talent and cutting-edge technology. Such intellectual and social capital is indispensable for accelerating your startup’s development and enhancing its market position.
Financial Credibility
Choose investors based on their financial stability, evident from their historical funding activities, current reserves, and provisions for follow-on investments. Their ability to provide consistent support during critical phases such as scaling operations or entering new markets is crucial. This stability ensures they can back your startup effectively when it matters most.
Experience with Similar Stage Companies
Seek investors with a proven track record of guiding startups at similar developmental stages. Their familiarity with the challenges and needs of your growth phase can offer invaluable pragmatic advice and support. Such experience not only helps in navigating ups and downs but also in making strategic decisions that can be pivotal to your startup’s success.
9 Undesirable Traits in an Investor
Vetting potential investors is critical to avoid pitfalls that could derail your venture. Here are nine red flags to watch for.
Reliability and Good Faith Issues
Note any reliability issues or a failure to negotiate in good faith. This could include a lack of adherence to fair, aligned and transparent (FAT) principles, which are crucial for a healthy investor-founder relationship.
Time-Consuming Tire Kickers
Be cautious of investors who monopolize your time without offering substantial capital, guidance or connections. Their persistent inquiries and dependency can deplete your most precious resource — time — without propelling your objectives forward. Swiftly dismiss the perpetual maybes and you’ll spare yourself regrets. Remember, there’s a surplus of investors compared with startups. Prioritize accordingly.
Lack of Decision-Making Power
It’s essential to ensure that you are dealing directly with decision makers. Spending too much time with intermediaries can slow down the fundraising process and may lead to unproductive outcomes.
Excessive Concern with Current Valuation
Investors overly focused on valuation or the specifics of the current funding round, without a view to long-term implications, might not be suitable for a sustained partnership. Such a narrow focus can indicate a misalignment with your startup’s broader strategic objectives.
Over-Negotiation and Micromanagement
Be cautious of investors who demand overly specific terms or who exhibit micromanagement tendencies. This includes investors who are overly concerned with minor details that you are not familiar with, which might indicate a propensity to control rather than collaborate.
Conflicts of Interest
Exercise caution with investors who may have competing interests, such as investment or affiliation with your competitors. This dual involvement can lead to conflicts of interest or risks of strategic information leakage, which could disadvantage your startup.
Lack of Industry Insight
During negotiations and diligence, if an investor doesn’t ask informed questions about the industry, product or customers, it may indicate a lack of genuine interest or understanding of your business fundamentals.
Unreliable Financial Commitments
Be wary of investors with insufficient financial resources to follow through on funding commitments or those who show signs of financial instability. This could risk the continuity of their support.
Disproportionate Attention Needs
Smaller investors might demand more time and resources than is proportional to their investment. This can drain resources and focus away from your core operational goals.
How to Evaluate and Select the Right Investors
Choosing the right investors requires careful evaluation and a strategic approach.
Reaffirm FAT Criteria
Ensure that potential investors are fair, aligned and transparent. Their approach to funding should resonate with your startup’s long-term mission rather than being purely transactional.
Check References
Engage with other founders and service providers who have previously dealt with the investors. This is particularly valuable in scenarios where things didn’t go as planned, offering insights into how the investors handle adversity.
Do Your Due Diligence
Conduct comprehensive due diligence, including anti-money laundering (AML) and know your customer (KYC) checks. This helps verify the legitimacy and stability of their funds and ensures compliance with regulatory standards.
Check Certainty of Funding
Verify that investors have the financial capability to fulfill their commitments. This assurance is critical for your strategic planning and future growth projections.
Have a Trial Period
If feasible, start with smaller commitments to test the investor’s involvement and compatibility with your business model. This approach can help establish trust and operational synergy before scaling up their involvement.
Plan Exit Strategies
Plan potential exit strategies from the investment relationship to mitigate future complications. Even strong partnerships can sour, and having a predefined exit plan can provide a smooth transition or conclusion.
Choosing the right investors is as critical as the capital they bring to your startup. While it is important to reject investors who do not meet the FAT capital criteria, it is equally crucial to recognize and engage with those who do. The right partners do more than just fund you; they enhance your business, bringing expertise, network connectivity and strategic foresight that can transform your startup’s trajectory.
Zack Ellison, MBA, MS, CFA, CAIA is the founder and managing general partner of Applied Real Intelligence (A.R.I.) and the chief investment officer of the A.R.I. Senior Secured Growth Credit Fund, which provides debt financing solutions to premier VC-backed companies. He previously worked as a loan underwriter, investment banker, corporate bond trader, and fixed income portfolio manager at three firms with over $1 trillion in assets – Scotia Bank, Deutsche Bank, and Sun Life. Ellison holds an MBA from the University of Chicago, an MS in Risk Management from NYU, and is completing his Doctorate in Business Administration at the University of Florida.