When founders think about raising capital my observation is they nearly always start with the question of ‘how much?’, when they would often be better served to first ask ‘who?’
It’s useful, although rare, to try and understand the various things that might motivate different investors to be tempted by your venture at the stage you’re at, because it makes a big difference to how you might present the opportunity to them.
Some investors are attracted by the apparent glamour of early-stage ventures. They like to be able to tell their friends and colleagues that they are investors in something that seems more exciting than their day jobs.
You need to offer these investors a role where they will get some recognition for their involvement.
Some investors are looking for something to spend their time on, and prefer to be able to leverage that investment with a financial stake.
You need to offer these investors a role where they can feel they are involved and making a difference.
Some investors are simply looking for a return on investment – that is, at some point in the future they want you to give them back more than they gave you, plus some extra for the risk they took and the period of time that you had the benefits of their money – that could be on-going dividends or cash on exit.
You need to understand what sort of return they are expecting (this will likely depend on their personal circumstances and how early they are investing), and you need a spreadsheet which shows them the numbers to give them confidence that if things go well this is possible in your case.
Some investors who invest a fund on behalf of others are compensated based on the size of the fund and the overall capital gain they produce for their funders – e.g. a VC will typically receive 2% + 20%, meaning they are paid 2% of the total value of the fund they manage every year (this is used to cover the fixed costs of running the fund) and 20% of the gains. See: http://avc.com/2008/08/venture-fund-1/
You need to convince these investors that you have a chance of knocking it out of the park – because they are investing in a portfolio of companies alongside yours, there is not much difference for them between a complete failure and a mild success, so they will expect you to be swinging for the fences.
Some investors who invest a fund on behalf of others are compensated based on the current value of those investments – e.g. a hedge fund will typically pay managers a bonus every year based on the increase over that time. This effectively means they buy the shares again every year.
You need to show these investors that you can steadily increase the value of your business over time and avoid any nasty shocks which could cause the value to drop from one year to the next.
Think about what sort of investor is appropriate for you, given the stage you’re at and your own ambitions for the future. It’s surprising how often there is a complete mis-match between the motivations of founders and investors as a venture grows.
If you’re just getting started and need a small amount to cover your costs while you explore the opportunity, then you’ll probably struggle to get larger investors excited, given they generally prefer to invest bigger amounts once there is an obvious way that this money can be used to remove constraints. More than this, it can actually be toxic to get a high profile investor on-board in your first round – in your next round other investors will take the lead from them, and if they choose not to continue investing, for any reason, then you’ll likely struggle.
Likewise, once you’ve proven the venture and are ready larger amounts of capital to help you accelerate, then you’re probably wasting your time if you’re still pitching investors who are mostly interested in the story or contributing their time, but who normally don’t write big cheques.
And, if you just want to create a great business that will pay a good salary for you and maybe a few friends, then you’re creating a future headache for yourself if you raise money from more institutional investors.
I’d encourage you to have the conversation explicitly in advance with potential investors. If it’s not clear which type of investor you’re talking to then take some time to understand what is attracting them to your venture.
What are the other types of investors and motivations that you’ve seen?