As an angel investor, advisor, tech executive, securities lawyer and an entrepreneur in my own right, I’ve been on many sides of the table when it comes to venture finance deals. I’ve seen and participated in some capacity for hundreds of startups that successfully got funded, and I’ve seen thousands of startup pitches that fell on deaf ears..
What are key differences between those startup founders and teams who achieve success attracting the third party capital that is wanted and needed to execute an ambitious business plan, and those who don’t? In my view, it is possible to identify certain prominent patterns and narrow it down to a few factors. Here is a short list of things that make a key difference, and a few things that create red flags.
The Right Mindset and Market Knowledge
Successful startup founders and teams don’t think in terms of “might” or “like to” or “next year.” They are focused and 100% committed, both in the present and over the long-term. If raising capital is required to take a big idea and make it a reality, then raising capital must be a top strategic priority. Many startup founders have learned that raising capital is hard: it takes time and money to raise money. Prospective investors want to see “skin in the game”, in terms of personal investment, focus and commitment. If the founder(s) is/are not at risk, that is a red flag to third party investors. Another risk factor is when a founder is only working part-time or spread too thin. Building a startup requires immense amounts of time, energy and creativity, and if a founder is juggling multiple projects/ventures (many different companies), the probability of success goes down. That’s a red flag.
When it comes to venture finance, the right mindset also means good self-awareness and an honest understanding of what is “market”. Successful startup founders and teams should be optimistic and ambitious, sure, but also realistic in terms of valuation, amounts and terms and conditions. Sophisticated providers of capital know what is “market”, and it is a serious red flag if a startup is pitching a deal that is not within a “ballpark” range.
When a startup founder or team claims that his or her idea and venture have no competitors, that is a red flag. This is usually a sign that the startup founder and team have/has either not done enough market research or is/are delusional. The competition is whoever or whatever is supplying the current solution to a problem, whether that is a third party solution or simply the status quo (i.e., “business as usual”). If a startup claims that its product or service has no competitors, then maybe there’s no real “customer problem” to be “solved” either. Of course, there are exceptional strategies that are “Blue Ocean” - creating and capturing uncontested market space and thereby making the competition irrelevant - but if a startup founder or team makes that claim, there better be back up to support it.
Finally, there are a lot of creative and innovative people who call themselves “startup founders” but are really more comfortable acting as “inventors”. Sometimes these people spend years and years pitching their invention or innovation as the key to a “soup to nuts” business plan to anyone who might be a source of capital, including business angels and other pre-seed sources of capital, without success. It has been my experience that sometimes, this type of entrepreneur may finally achieve success when they change their mindset from “startup founder” to “inventor”. Instead of trying to organize and capitalize a startup team to take the big idea from soup to nuts, they pivot their approach by staying lean and seek to find ways to collaborate with targeted corporations with existing distribution and customers. Such corporations may be happy to provide a dedicated budget (like an R&D expense for the corporation), and then commercialize the invention or innovation with the corporation through negotiated win/win arrangements.
Communication Skills and Empathy
Communication skills are important for any business leader, but they are especially key for startup founders and teams. That means a clear pitch using the right tools and mediums, including high quality offering materials and content that tell the story and express the business opportunity, capability and potential in a truly compelling way. This requires authenticity and truthfulness. Why are you the one person or team who is able to deliver this product or service? What do you know or have that the others don’t? What is your unique value or selling proposition?
In my experience, the most successful startup founders have charisma. Charisma requires a vision and a goal, and charismatic leaders are able to cast a spell over other people to project their vision in a way that attracts other people to want to join them on a journey. There is a difference between being charismatic and being a B.S. artist. If a startup founder is constantly changing the story, or engaging in gratuitous name dropping, that can be a major turnoff for prospective investors. Note also that charisma does not necessarily require charm; some of the most successful entrepreneurs and innovators in history were not, especially in their heyday, charming people.
Great communication requires listening and empathy. Sure, startup founders and teams need to do a lot of talking when making the pitch, but successful founders and teams also know it is valuable and important to design methods and mediums to receive feedback. They use this feedback to modify and iterate their product or service to better suit it to the market, and they also use this feedback to iterate their pitch. It’s a reciprocal process: many startup founders need risk capital to succeed and investors want to be sure that they are investing in a venture and team with high potential, including ability to adapt if necessary. This is sometimes referred to as “betting on the jockey not the horse.” Consider the situation with Covid-19 in 2020. How many startups slowed down or just stopped to wait out the storm, and how many iterated or even pivoted to offer products and services more suited to the dynamically changing market? Those who focused on listening to the customer and adapting to provide a better customer experience (which at its essence requires communication and empathy), are the ones most likely to be surviving and thriving today.
House in Order
Maybe the product or service is ground-breaking. Maybe the market size is massive and growing exponentially. Maybe the team is A+, with relevant industry experience. Maybe the story and the pitch is truly compelling. Even with all that, however, if the startup does not have its “house in order”, it is unlikely to survive the due diligence investigation required before any investor worth his, her or its salt will authorize the wire transfer of money. It’s possible that a strong pre-existing relationship of trust (e.g., a family member or close friend), may be enough to collect the money with a promise to clean everything up later. But for unaffiliated investors, that will not, in my experience, be good enough, especially among professional or sophisticated sources of capital. And if the startup does not have everything in order, and it looks like it will be a lot of work to clean everything up, then confidence in the startup founder’s and team’s competence will suffer, frequently leading to “walk away” aka “no deal”.
The principal reason some startup founders and teams get funded, and others don’t, is strategy and preparation: investing time, energy and money to prepare the company for investment from the right sources of capital before making the pitch. That means that the company has been properly organized, with all the customary agreements in place among founders, consultants, developers, advisors, customers and the like. For companies trying to raise capital across borders (fairly common for startups founded by residents outside the USA), you may need to be prepared to address choice of jurisdiction and choice of entity issues, including ability to “flip” to other jurisdictions, as that may be something that certain investors prefer or even make a condition to closing.
Financial statements should be clean and in good order, and the company should not have a trail of tears in terms of delinquent taxes, bad credit, liens or other red flags. For startups looking to raise money by selling equity or convertible securities (such as convertible debt or a simple agreement for future equity or the like), it is important to make sure the capitalization table reflects all issued, outstanding and promised equity interests. With respect to intellectual property, a major red flag for investors is finding out that one or more founders or developers has not assigned the IP to the company. Any “related party transactions” should be properly documented and disclosed. Does the company have any pending or threatened litigation, liens, poor credit ratings or long-term obligations that could impair flexibility or encumber intended use of proceeds? In short, a major difference between startup founders and teams that are successful at raising capital from third parties and those that are not; the former almost always have their house in order, and the latter frequently do not.
In my experience, startup founders and teams who assemble an advisory board tend to have more success raising capital from third parties than those who do not. Advisors can fill critical gaps in specific areas like hiring, finance, product development, product management, marketing, regulatory affairs and other industry specific knowledge. Unlike mentors (who are typically unpaid) or consultants (who are typically hired for specific tasks and paid in cash), advisors consult with the founders and management team one-on-one (at least) and through formal advisory board meetings (preferable). Advisors typically sign an agreement with the company, specifying duties and responsibilities and are paid in the form of equity compensation, not cash. Unlike directors of a corporation, advisors have no fiduciary duties under corporate statutes.
In my experience serving as an advisor to dozens of tech startups globally over the last 25+ years, a board of advisors can, if properly constituted and managed, have an extremely positive impact on a startup founder’s (and team’s) ability to successfully raise capital from third parties.. Having said that, if the advisors are merely “window dressing” (i.e., not meaningfully involved) for the pitch deck, that is definitely not true. If the advisors are truly engaged, individually, at least, and as a group, preferably, then the advisory board acts as a strategic sounding board and collaborative, objective and valuable feedback loop.
I currently Chair the Advisory Board of a pre-seed tech startup with a diverse group of eight seasoned professionals residing in five countries, with standing (optional) invitations to meetings to three outside board directors, all co-founders and select managers. We have monthly advisory board meetings for 90 minutes via Zoom, with a defined meeting agenda set by the CEO that addresses one or two specific strategic matters, and each meeting includes preparation materials and meeting outputs and asks. The CEO of this startup recently told me that he believes our advisory board has been perhaps the single most impactful initiative for the startup, including meaningful engagement, feedback, co-creation and collaboration in generating a written mission, vision, culture, product roadmap, and investor pitch deck and offering materials. Not surprising, as the startup’s story, team and value proposition gets stronger, the advisory board has been the source of more and more quality referrals and warm introductions to prospective investors, customers, talent and strategic partners. This advisory board methodology creates value.
Social Proof and Buzz
Sources of capital, whether they are investors or customers, adapt their behavior according to what other people are saying and doing. In the venture finance arena, it is common knowledge that social proof can and does dramatically influence the ability of startups to successfully raise capital. It’s like a line of customers outside a restaurant or bar - it’s proof that others think the food and atmosphere is worth the wait. If a startup founder and team appears to be attracting interest and investment from the “smart money”, it is a strong signal that this is a train or ship you want to get onboard.
Some of the ways startups create social proof and buzz include:
- experts’ stamp of approval, such as thought leader approval in the form of blogging, social media or the like;
- celebrity endorsements, especially if unpaid;
- user testimonials, such as ratings, reviews and case studies;
- business credentials, such as industry awards and certifications, and even founder educational degrees;
- earned media, such as articles and backlinks;
- social media, such as significant numbers of shares, followers and likes;
- wisdom of crowds, such as significant numbers of customers or end users; and
- wisdom of friends and colleagues, such as positive recommendations, endorsements and references.