Here's the Scoop on Selecting the Right Investors Selecting the right partners to work with is as important as the first few employees you hire. Here are a few tips for choosing the right investor.
By Justin Vandehey Edited by Chelsea Brown
Opinions expressed by Entrepreneur contributors are their own.
When my brother Jeremy and I used to argue as kids about which of us got the largest portion of ice cream for dessert, our mother used to say, "You get what you get, and you don't get upset." As first-time founders, we often fall into the trap of the dreaded ice cream dessert debate. We begin the journey with less personal and reputational capital, less experience and less confidence.
That last point is more detrimental than either of the previous two, and as a result, it can cause expectations and standards to be lower when it comes to the investors we work with. To put it bluntly, we're only getting a half scoop of rum raisin ice cream — and who the heck wants rum raisin?
When entrepreneurs fight to keep a venture alive, the best source of financing is oftentimes the only source of financing. That said, building a real company takes longer than five years, and building a really big company will likely take ten years or more. The investors one decides to work with will be there for the entirety of that journey in one form or another, so selecting the right partners to work with is as important as the first few employees you hire. Here are a couple of things I learned in the process of working with our first group of professional investors.
Related: How to Choose the Right Investors For Your Startup
Partner with investors who have built real companies before
In the process of founding Disco, I've spoken with at least 50 freshly minted MBAs who were associates or analysts at a large consulting firm prior to jumping into venture. Half of the associates I spoke with during our seed raise suggested pivoting, and the other half suggested shutting down the company as "unsolicited advice."
Now, I don't want to give the impression that all freshly minted MBAs with their first career in venture have no idea what they're talking about, and I'm willing to learn from the experiences of absolutely anyone. However, I value the experiences of entrepreneurs who have gone through the process of building a business more than someone who, well, hasn't.
Entrepreneurs-turned-investors understand how fast market conditions can change. These venture partners can empathize with the challenges of building a team, finding product-market fit and selling. They have a true appreciation for the progress and the process it takes to get there. Our lead investor, Phil Libin — founder of mmhmm, All Turtles and Evernote — was the best example of this and one of our most important advocates throughout the process of building our company. Libin is like rocky road, dynamic with solid variety. Find a Phil Libin.
Choose investors and firms that have supported businesses tangential (but not competitive) in your space
Deep expertise in a category is very helpful, but it can also handcuff creativity. Oftentimes, investors who have previously backed or founded companies in your space hold biases that are no longer relevant. When we started working on Disco, I approached the CEO of one of the earliest recognition and feedback apps about joining our team as an investor and advisor to the company. His feedback on our app and approach was that he was interested and a believer in the category. However, "it wouldn't work" as designed, and our approach to our go-to-market was flawed. Again, the feedback and insights are valuable to consider, but we were closer to our customer and business at that point in time.
Market conditions change, technology paradigms shift, and in most instances, the first to market is never the company that takes the market. Had we taken our first money from this investor, I believe we would have spent a decent amount of time and capital attempting to validate something that we knew wasn't relevant any longer. What was great about our investment group at General Catalyst was that our investors had less direct experience in employee culture software. However, they knew a lot about the HCM market. They could provide high level strategy guidance on how the pieces fit together, but they trusted us in the trenches to make the right decisions for our business.
Related: The Importance of Recognizing the Right Investor
Observe how investors negotiate
Negotiating term sheets is never fun. However, experienced investors who see and do a high volume of deals know and understand what the major sticking points of any real agreement look like. What's more, they don't sweat small details or try to squeeze terms in or adjust terms at the last minute of a negotiation.
If you find yourself working with an investment group that attempts to cut a "side letter" for better terms or comes back after the general terms have been set with a different or new proposal, find someone to fill their spot. You've likely built up momentum with a solid core group of investors, and any sheisty or questionable negotiation behavior shouldn't be tolerated. Imagine what working with this partner will look like when it's time to evaluate an M&A term sheet. Or what if you're in a bind and need a small bridge to extend the runway until you hit profitability? Rum raisin.
Find investors at the right stage
When we went through the fundraising process for Disco's seed round of financing, we elected to include two firms that were traditionally better suited for Series A companies. Initially, we thought that these firms would be best to partner with, because they could paint us a picture of where we wanted to go, à la the Series A.
These were reputable firms and great partners to work with — however, there were very different expectations across our investment group of where Disco should be in terms of our growth. It made our board conversations more difficult to manage. It made important platform and product decisions challenging and contentious. Trying to stretch the scope of a Series A firm to your seed stage company can be detrimental, so try to build an investment group that meets you at the right stage, at the right time.
Related: 6 Ways to Know an Investor Is the Right Fit for Your Company
Partner with investors who share your values
This one is probably the most important one. One story that I love is Webflow CEO and co-founder Vlad Magdalin's "social contract," in which he requested that all of his investors sign. To summarize, Magdalin's social contract mandated that Webflow's investors would need to prioritize Webflow's mission and employees above revenue. That's not only exceptional leadership but also exceptional investor qualification.
In contrast, I once had an investor suggest that I skip Thanksgiving with my family to build out an outsourced sales team over the holiday weekend. I will never build or foster a culture that forces my employees away from their families, nor will I work with an investor who shares that mindset. That's in my social contract. Get clear on your own "social contract," and keep those principles front and center when building out your investment team and advisory board. Talk with other founders who share your values to gain their perspective on the firms that might be a good fit before making any commitments.
Resist the urge to take the first offer without doing proper diligence. Ask for the extra scoop. And for the love of God, don't get rum raisin.
