Only deal with good investors.
Can you spot a good investor? You might think it doesn’t matter whether an investor is good or bad, as long as you’re getting the money. But you would be wrong:
A bad investor can inflict a lot of damage: demanding (and obtaining) bad terms; imposing excessive dilution; using their power in the cap table and/or the board to set the company in the wrong direction; reacting badly to adverse circumstances and sinking the company as a result.
On the other hand, a good investor can make a real difference along the way: finding the right balance of power; making valuable introductions to top talent and later-stage investors; and in general being supportive rather than toxic when you need it the most.
But what, exactly, reveals a good investor? It’s a tricky question, even more so in lagging entrepreneurial ecosystems. Many make a lot of noise about that new fund they raised, yet it’s still too early to know anything about their ability to make the right deals and grow a valuable portfolio.
Indeed, once an investor is identified as successful based on actual performance, most limited partners (LPs—pension funds, mutual funds, endowments, sovereign funds) want to trust them with their money. But before actual performance has been assessed (that is, for about 10 years after raising a first fund), being backed by LPs, especially local ones, isn’t exactly correlated with being good at the job. The fact that an unproven investor plays golf with the right people on the LP side is in no way indicative of their ability to support you as you grow your company.
If you’re in one of those lagging ecosystems (that is, most of the world), here are three things you can look at to assess the quality of your interlocutors on the investing side:
First, even if the ecosystem is lagging behind, some firms have been doing it for a while. In this case, you can try and learn a few things about their past performance, which is actually predictive of how they’ll fare in the future. The thing that’s different about venture capital is not the extremely skewed returns (the fact that just a handful of companies return the fund several times over); rather, it’s the persistence of a firm’s returns over the long term.
Second, even if the firm doesn’t have a long track record, it’s unlikely that you’re the first founder to interact with a particular investor. In this case, perform due diligence and talk to your peers. Even in the absence of data, it’s easy to learn about how a venture capitalist behaves in the context of negotiating a deal and then in the context of growing a business. Make sure to ask about their behavior in the face of adverse circumstances!
Third, learn to spot the attributes of a good investor in general. For instance, are they decisive? Knowledge is a commodity and you can crunch numbers forever, but it all goes to waste if you never reach a decision, therefore a good investor will ask questions leading to a fast and clear decision. And then, are they good at selling themselves? If an investor you like says ‘yes’, it’s likely that others want to invest, too. It’s a good opportunity to assess their skills as salespeople!
What do you think? What’s your experience in assessing and dealing with investors? Let us know—and consider joining our next batch, which starts in September.