Investors and entrepreneurs began 2022 bright-eyed and optimistic as startups raised nearly $13 billion in the first quarter, making it the fifth-highest quarter for funding on record.
However, talk of a pullback in global venture capital has become louder and more widespread of late. It’s clear that the cash is not flowing as freely as it once was, and that has changed the landscape for ambitious startups looking to build and scale their propositions.
However, a challenging economic climate doesn’t necessarily mean that startups should accept the first offer that comes along, settle for lower valuations or bring on investors that have different values and ambitions for the business. It is now more important than ever for every party to approach the negotiating table with clear questions and expectations.
Here are three firm but fair questions that founders should consider asking their potential investors:
What value can you provide besides money?
It is important to remember that VCs don’t have an endless pot of money — they are at the mercy of their LPs’ liquidity.
Most investors worth their salt will demonstrate that they come with more than just deep pockets — value such as sector expertise, business experience or a global network. Founders should feel confident about proactively asking about what an investor can provide, particularly the networks and introductions potential investors can facilitate.
There is a significant difference between an introduction that was facilitated via an email and a clear handoff to someone whose relationship with the investor is deep and based on many levels of trust. Many investors pride themselves on having a robust and lucrative contact list, but not all introductions are the same — a LinkedIn profile rarely demonstrates the depth and quality of an investor’s network or knowledge.
My advice is to be clear about your commercial goals and push potential investors to offer names of individuals or organizations that will deliver the impact you’re looking for. For example, we recently introduced one of our portfolio companies to an $80 billion infrastructure firm with which we had developed deep relationships in order to set up pilots in a number of regions.
Introductions should not just forge connections; they should deliver tangible commercial impact.
How secure is your cash?
It always surprises me how many founders believe VCs are sitting on piles of cash that they are ready to distribute at any moment.
It is important to remember that VCs don’t have an endless pot of money — they are at the mercy of their LPs’ liquidity. It is therefore sensible (and necessary) to have answers to three key questions:
- How secure are your potential investors’ funds?
- Will they be in a position to continue supporting the company along its growth path?
- What, if any, proportion of the funds are put aside for follow-on opportunities?
During investment negotiations, investors will always interrogate a startup on the extent of its existing investors’ participation and will want to know why if they are met with a negative response. The reputational risk of existing investors deciding not to follow on can be significant and skew the way future funding rounds play out.
Just as an investor runs vital due diligence on a startup, founders shouldn’t be afraid to turn the tables and gather as much information as possible about an investor’s financial readiness and the security of their funds.
What are your exit plans?
Founders should value investors’ support beyond the immediate cash injection.
With most startups raising capital every 12 to 18 months, founders must ensure the investors they bring on board are aligned with their growth plans, particularly when it comes to the exit.
For example, the exit timeline for startups developing software is much shorter than a company developing hardware, so startups that need a longer timeframe should ensure their investors don’t have a six- to eight-year exit horizon.
But if your preferred investors do have a firm timeline, it’s worth asking if they have growth vehicles to support startups after the early-stage fund is out.
In short, try and ensure that your growth plans match from the outset to avoid an investor liquidating their position early.
Strive for an equal power dynamic
The relationship between an investor and founder has often been likened to marriage. In other words, there’s a binding agreement and understanding that the parties will be there during the good times and provide support during the bad times.
Of course, not all marriages go the distance, and it’s worth applying this analogy to the relationship between founders and investors. Is this a “marriage” of convenience? The “right now” versus the “right one”? Startups potentially enter into a number of “marriages,” and it’s worth considering what new parties bring to the arrangement and what their intentions are.
A tough economic climate doesn’t mean the power dynamic automatically tips in favor of those with the cash. The best working relationships are those built on an equitable footing with honesty and clarity.
My biggest piece of advice to founders is to know your worth. If you are confident that you have a strong, scalable business and a good term sheet, then you can be bold in your due diligence and go after the investors who will prove mutually beneficial in terms of both hard and soft value.