Understanding Startup Investors

Welcome to Phase Two of our four-part Funding Series — all about Investor Selection!

Phase One - Structuring a Fundraise

Phase Two - Investor Selection

• Part 1 - Introduction to Startup Investors (←YOU ARE HERE 😀)

• Part 2 - How to find Startup Investors 

Phase Three - The Pitch

Phase Four - Investor Outreach

This article is an Introduction to Startup Investors. Let's dive in!

Whatever stage your business is in when you launch your fundraising efforts, you can find the investor support that you’re looking for. Now that you’ve determined the fundraise structure that matches your needs and goals, it’s all about finding the investors that make sense.

All investors are not created equal. 

They may all have capital, but the vast majority of investment professionals tend to have very specific targets for which types of investments they are looking at. 

They may be very early individual investors who tend to be the first money in a deal, looking for the biggest return on a small amount of capital.  They may be an ex-Founder who made her money in biotech and is only looking for similar industry opportunities.  They may be based in your local community and only prefer to invest in that area.

One thing is common – they all have very specific preferences.  If you don’t know what those preferences are before you start reaching out to prospects, you’re going to waste a ton of time. You want to focus on qualified investors.

The Three Key Investor Criteria

Investment Stage. 

Different investors invest at different stages of your startup’s growth.  It’s important to understand which stages exist so you know which to target and which ones to avoid.

Investor Type.  

From angels to private equity, look for certain requirements in the businesses they fund.  You’ll want to align your search with the investors likely to be interested in your type of startup.

Investor Preferences.  

Just because they fit your stage and type, it doesn’t mean they are interested in investing in your city.  Or they don't understand your industry.   The list goes on.  They are extremely picky so it helps to understand how their preferences work for or against you.

Finding investors

Once you understand each of the key selection criteria for finding your investors, the next step of course is to figure out where to find investors and how to build your contact list.  We’ll discuss each of the various sources for finding the best possible investors and how to do some solid research and prep.

Key Investment Stages

Startups raise money in a series of stages based on how much growth and evolution they have had.  

Think of it like a kid going to school.  There’s elementary, middle school, high school, and college.  Each of those stages represents an evolution of the student, and there are a number of teachers who specialize in helping students at each stage.

Startups are the same way.  If you’re just getting started (the Seed Stage) you’ll be talking to different investors than if you have already raised money previously and are in the Expansion stage.  

These aren’t strict definitions, mind you, but just general epochs a company goes through as they grow from the idea stage all the way to becoming a public company.

The Four Stages of Startup Investment

Most investors tend to gravitate toward a stage of a startup’s lifecycle that they are comfortable investing in.  It generally follows that the more money you want to invest, the later the stage that you invest.  

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You’ll notice a bit of a “hand-off” between investors and each stage.  Friends and Family may invest the first $50,000 because they know you personally, but the next $250k may come from professional investors who have more capital to put to work. 

Later on, if you look to raise $2 million, you’ll likely be talking to venture firms who are looking to take on riskier investments, but only once those companies have shown meaningful growth and promise.

Understanding Each Startup Investment Stage

The stage of your business pretty much tells you who you should be talking to.  More importantly, it tells you who you should avoid talking to since pitching  “Late Stage Investors” with the idea you had last night is going to be a huge waste of time!

Seed Stage (<$100k)

(Friends and Family, Angels, Incubators)

Seed Stage is the most formative stage of a startup.  Although it typically starts with the idea, the reality is most seed-stage startups looking to raise money have more than just an idea – they have already been working on a prototype of the product, have a business plan in mind, and have begun figuring out where they are going to acquire customers.  

Seed stage investors tend to be the first money in and often have some sort of connection or relationship with the Founder.  The investment amounts tend to be small because the idea is still in its infancy and therefore it is more of a bet on a general concept than an actual company.

Key Requirements:

• Business Plan

• Minimum Viable Product

• Some Customers

• Founding Team

Early Stage ($10k - $1.5 million)

(Angel Investors, Venture Capital)

Early-stage companies have usually achieved at least MVP (minimum viable product), meaning their product or service is being provided to at least a small test subset of customers, and is meeting with customer approval. Early-stage companies are also often generating enough revenue to be worth talking about, although that varies from company to company.

Key Requirements:

• Functional Product

• Paying Customers

• Early Key Team Members

• Early Growth

Expansion Stage ($2 million - $50 million)

(Venture Capital, Private Equity Investors)

By the time you are searching for Expansion Stage capital amongst venture and private equity firms, it’s clear that your business has major upside potential.  You may not have strong revenues yet, but you may have just developed the next Facebook.  The potential investors at this stage are looking for companies that have proven they have found “lightning in a bottle” and just need a bit of a turbo boost to really accelerate.  

Key Requirements:

• Significant Revenue ($5m - $50m)

• Huge Market Potential ($100m - $1b+)

• Strong Market Leadership

Late Stage ($50m+)

(Private Equity, Investment Banks)

Once a company has built a product that’s become a darling in the market, that’s when the Private Equity and Investment Bankers show up.  These folks aren’t looking for a lot of risks – they let the angels and venture firms deal with that.  They are looking to put massive sums of money into private companies that are already winning to allow them to secure their leadership position.  If you make it to this stage – you’ve won!

Key Requirements:

• Significant Revenue ($50m+)

• Market Leadership Position

The Different Types of Investors

Whether you need to expand your team, pay for product development, or just feed yourself, at a certain point you may need to seek outside sources for a capital infusion.

Fortunately, there are many different avenues you can take to find funding as you build a successful startup.

While banks or federal or state governments may be suitable options for some companies, this playbook focuses on a few of the types of investors you can pursue when you’ve exhausted those options, such as friends and family, angel investors, and venture capitalists.

Friends and Family (<$100k)

While a bank, a VC firm,  or independent investors might be hesitant to risk money on your venture, your friends and family might be more willing to take a chance on your vision.

With individual funding rounds typically raising around $25,000 to $150,000, seeking most investments from your personal network can be an ideal way to raise pre-seed money to get your hypothetical business off the ground. These close circles generally consist of individuals most likely to feel a strong affinity for your brand -- or, simply, to you -- motivated more by loyalty and support than a return on investment alone or their belief in the business model. They’ll be more interested in your passion for the idea than the company valuation if they even understand what a company valuation is.

 Securing enough capital from friends and family can also act as an effective stepping stone toward future deals and additional funding, as it demonstrates to potential future backers that you’ve validated your business plan among those closest to you.

Friends and family rounds are increasingly being done via crowdfunding sites.

However, mixing business with family is notoriously risky, and for good reason. To that end, it is of the utmost importance that all investments are thoroughly documented. You should require that they sign a document acknowledging the risk and clarifying that they may not get their money back depending on future performance.

 Before accepting any money, do some soul-searching to be sure that your ties are strong enough to withstand any worst-case scenarios. Startups fail, even more so at the early stages. Have each party sign a promissory note spelling out the repayment terms or if you’re partnering with a friend or family member, sign a partnership agreement. Your family will be family forever, but it’s hard at the idea stage to know what the odds will be that your startup succeeds before your business begins.

Angel Investor ($10k - $250k each)

The best angel investors are high-net-worth individuals who invest directly into promising entrepreneurial businesses. This capital usually allows the startup to accomplish some of the early milestones like building out an MVP, generating revenue, etc. They may be accredited investors, but aren’t always. A large percentage only ever write one check - so your startup might represent their entire investment portfolio.

Quick facts about Angel Investments:

• There are over 300,000 active angels in the United States alone

• Median funding round size for angel investments: $950,000

• Median investment amount per angel group: $127,000

• Median pre-money valuation: $3.65MM.

While certainly savvy businesspeople, angels are also less likely than venture capitalists to get caught up in bottom lines and profit margins, and might not be as apprehensive about the numerous unknowns that often come attached to seed-stage investments and have a much lighter due diligence process.

An angel investor can be an ideal fit for startups because they often act as mentors and coaches to their portfolio companies. Many angels also belong to networks of other investors. These networks, or “Angel Groups,” pool their money and invest as a group in the deals they like the best and get access to more investment recommendations. They often share investment opportunities posted via a funding portal specific to the angel network.  These networks are also beneficial to startups because they can make it much easier to raise larger amounts of capital.

Venture Capital Firms ($2 million - $50 million)

Venture firms, like Sequoia Capital or Upfront Ventures, tend to write the biggest checks with an average size of $2.6MM to seed-stage companies. Because they tend to have larger minimum investment criteria, they generally come in after a seed funding round in series a or series b funding rounds.

VCs are in the business of investing in new and emerging businesses. As a result, they look at a very high volume of deals, and on average only invest in startups at a rate of 1 out of every 100 investment opportunities they consider — compared to angels, who invest in 1 out of every 10 deals. Furthermore, VCs conduct significantly more due diligence than angels, spending an average of 5 months vetting each investment opportunity.

Venture capital is consistently an active, rather than passive, form of startup investing. These investors seek to add value, in addition to capital, to the companies in which they invest, both to help your company grow and to achieve a greater ROI. This means virtually all VCs will want a seat on the Board of Directors.

Although most VC firms will have a website or other means of sending in cold call solicitations, it is always best to have a referral to a VC by a mutual acquaintance.

This is one of the many benefits of equity crowdfunding: by asking your existing supporters to share your fundraise with their own networks, you open yourself up to the possibility of making connections that you may have previously thought were impossible.

Private Equity ($5 million - $100m+)

Private Equity (and investment banks) are designed for relatively mature companies that are beyond the “will this work?” business idea phase and are onto the “how big can this possibly be?” phase. They look as closely at past performance as potential future results. They operate massive funds that are more focused on smaller multiples than angels or venture capitalists, but more guaranteed returns because there is less risk involved in funding an already successful company.

Investment Preferences

Now that you know which type of investor you’re looking for, it’s important to determine if your startup is the type of investment they are looking for.  What you’ll find is most have specific preferences that tend to skew their focus when it comes to startup investing.  It’s important that you understand these preferences ahead of time so that you don’t waste time with any who simply don’t do your types of deals.

Geography

A lot of investors like deals in their area, but it’s not always a deal breaker. It is, however, advantageous to seek those local to you, especially for early-stage investments. For startups, time and money are always in short supply, and travel costs both. Some may even ask that you move your operation to their area as a condition of their investment, but this is more typical of later-stage startup investing.

Investment History

Many have a sweet spot, industry-wise, and concentrate on companies within a specific market. It’s good practice to thoroughly research and target investors that are active in your area. If you’re in the IoT industry, for example, you’ll have a much better chance of establishing a relationship with an investor who already has other IoT companies in their portfolio.

Founded Companies

Many investors were once Founders themselves.  Companies that an investor has founded or co-funded in the past can always be a good indication of potential interest. Depending on the successes and failures in their past, they will likely have a wealth of good advice for success and cautionary tales to avoid disaster.

Employers

Most startup investors didn’t get to the top by falling on it. Look at their current and past employers to see if they ever worked in the same company/job/industry as you before they made it big. This can be an indication of industry interest or just a connection you make with them by having the same ‘war stories’.

How to Find Investors

Now that you understand the various stages of investment, the various types, and the preferences that they have - it's time to go looking for them.  Be sure to continue reading our comprehensive guides on finding investors, how to leverage an investment platform, your investment strategy, and more.

And be sure to lean on us when you need help. We aren’t just here to talk about your future results, we’re here to help you achieve them.

Continue to Part 2 - How to find Startup Investors