It might be surprising to the avid investor, that the start-up to be invested in is not always that much (part) of a deal. Sometimes, the interests are more.
Understanding the network effect of deal making
A good investor with a track record of success will acknowledge the simple laws of the long tail. No matter how perfect the set-up, if the laws of large numbers apply and the statistics kick in, that is just what it is. You have to accept reality.
Once you understand that concept, the question becomes: how do you maximize value out of your activity in this field.
Let’s look at some basic forms of value in a bullet list:
- Investing into a founder or team for the future, independent of the current investment.
- Tapping into one of the founders family business and making deals on the side.
- Having a chance to meet, greet, mingle and craft deals with the other board members and investors.
- Or – why some old people date young people – just enjoy the show and display of bare youth.
What is the caveat here? Investors also do what they do for personal and irrational reasons. And if they are in for the long run, the relationships, learning effects and information gathering in any such investment may mean as much as the deal itself. Just think about it from a deal mechanic point of view. Investing 250k in 100 start-ups if your net worth is 1 billion is equal to 2,5% of your wealth. But the connections to otherwise unreachable individuals that you make as investor in such a company may be invaluable and worth far more than the 25 million you might at maximum tank. If you have a decent portfolio return of at least 1 times money, you get a lot fo connections and revenue streams out of your investment portfolio for absolutely free. Think about it!
It should hence come at no surprise, that some Angel investors really do not care much about you and your company. But care much more about who else is eating at the table. This can be used for structuring rounds.
E.g. if you want to drive up valuations for your institutional investors, have some strong angels battle them on board seats or any form of participation, as long as you represent a valuable opportunity to mingle. Get an angel interested in India, China, Brazil or what not together with a VC from that area with the right industry focus.
Another takeaway is that some start-ups are really not too much about the start-up success. They are more about forging bonds. Once founders and executives understand this, things can get weirdly interesting. Environments become more opportunistic – who can take most out of the company for private benefit -, which alliances and loyalties form to have a good time and learn and mingle and network, which impressions are formed with the gate keepers of whatever happens besides or after the investment. Those are the things of relevance. In such contexts, everybody becomes aware that he has to sell his stakeholders on sufficiently trying to make the company work – the founders to employees, customers and investors, the investors to their LPs, etc. People use the existence of the long-tail to sneak out of a bad and already lost opportunity. Nobody will ever admit it. The game remains open and has to be plaid. But it becomes self-evident that nobody at some point still cares about the business.
Stars still make it rain
Noteworthy in the context of the above network effects is that it very likely what almost any Seed or Start-Up investor will see. It is just how the game is played and it is natural to have these considerations dominate in the face of a possible burn out of a start-up. It is so common that it is not even worth mentioning. Noteworthy is, however, that this is exactly where and how stars are made. When employees and executives are fighting to give up the company and want it to succeed. And when the do so hard enough that in the end they do turn the company around and make it work.
It is exactly that moment when founders learned a few valuable skills:
a) it is good to let go of their own company if they want to save it.
b) if you can repeat this, you can build several companies without much effort from your side, you just need to find the champions to run your companies after you incubated them.
Hence this is the birth of a serial entrepreneur.
And on the other side, the individuals that drive this change in development are being born as executives. Not yet as entrepreneurs – for that, they need to be founders first. But they are the ones that learn how to pull something out of dirt and the pull towards oblivion into a working business.
Both exit the scenario as stars. The born serial entrepreneur will enjoy lots of good dinners and invitations as thought leader and will entertain relationships with investors who will try to be in on his next „gig“. The born executive will enjoy wealthy executive compesation, a lifetime of one executive gig after the other.
Understanding these two key elements is also crucial for investors. Someone with the gut and gumption to incubate a business and raise money and find executives is somewhat completely different from someone joining later and taking over the executive function of running the business.
Coming back to fundraising
A. Raising a proper syndicate
Having a hobo with inherited uncle money or someone that won the lottery throw in some Angel money isn’t going to cut it for you. It’s dumb money. Having someone with a vested interest in either you or your company or whoever else your company might attract will be far more valuable. The more powerful and connected and value-added the angel is, the better. – in theory
Controlling that vested interest is another thing. If your investors are after your family’s business, that is easier to control. If someone owes you, or you have any other means of control, also good. Bad if you become a clown and a meaningless side figure of the business and replaced quickly.
Protective measures also may be sheer incredible execution. Finding extraordinary exceptional talent and making it work well beyond expectations. Filing patent after patent in a lucractive domain. Getting feet into very large doors. Likely it is those protective measures that make some founders jump through loops and run sprints and marathons to remote mountains and why visions are painted to a level where they have absolutely nothing to do with reality. As long as there is this star-like sprinkling in the eyes. As long as everyone believes to have found a pot of gold of a human being or team.
Beyond attracting and controlling vested interest, the key is also to understand how to leverage and engineer the architecture of vested interests that creates value for everyone. As long as everyone gets enough value out of the entire deal as long as the status quo is kept alive, nobody will memorize the investment as a bad deal. And that is the key for building and engineering a career as serial entrepreneur.
However, the access to players and the engineering of their interests is something beyond this article.
B. Moving to later stage
It sounds like later stage investors like pedigree. „Oh, this very important due X is in the cap table. Must be a good investment.“ sounds like a need for validation and pedigree. But it is more. It means the engineering in A. has been done well. The sweet spot metrics are there. The investment might make sense.
So having good people on the cap table is not only a sign of validation that others believed in the company as an attractive investment. The synnergy and similarity of tier 1 investors across the board create a level of maturity, shared understanding,trust and opportunity that is far beyond what a company and its product and employees may express.