Every business needs money to succeed. That’s where the investors come in. But should the goal be to leverage investors only as a source of funding? What else do they have to offer? A fast-growing startup has a million needs. There’s been a growing trend around Smart Investors and Smart Money Funding recently. To understand what it actually means, we interviewed Rick Tomfohrde, Vice Chairman of the PNW based Alliance of Angels and an active, highly experienced angel investor.
Rick, can you explain this concept of “Smart Investors”? How would you define it?
I think of Smart Investors as those bringing useful skills to the deal, beyond money. The ideal trifecta is a) knowledge and/or background in the sector, b) small business operational experience, and c) angel investing experience. Finding all 3 is a rare feat, having any portion can be most helpful. Building an investor base who understands and shares the company vision and then will work with you to achieve that vision is an asset far beyond just cash.
How can an entrepreneur benefit from having a Smart Investor on the Cap table? Can you share with us an example where having a Smart Investor on board saved the day for the startup?
Think of a smart investor as another helping hand in your success, offering expertise in dimensions you don’t already have. And ones that don’t take up room or cash on your payroll or hired services expenses. You get a wealth of operational knowledge, also industry contacts for customers, supply chain, and perhaps future acquirers.
I can recall an example of a company, which will remain unnamed, with a decent product and just beginning positive customer traction but on the verge of implosion for a variety of reasons, all dumb reasons I might add. The board of directors did not know all the answers but realized early on what the key problems were. The board and other smart investors stepped in, called in few outside friends with experience. With heavy mentoring from smart investors and outside help they got the ship righted and sold the business. Their smart investors helped turn an assured bankruptcy into a money-back scenario for investors and the employees were hired into a friendly acquirer. Not a 10X outcome, but still a quality save.
On the other side of the spectrum, we often talk about how wrong investors can run the company off the rails. Can you define what a ‘Wrong Investor’ means? Also, can you share a few examples where you have seen this happen?
Wrong investors, or sometimes I crudely call them “dumb money investors” are often naïve about the sector and how early-stage businesses operate. Far worse, sometimes they have personally selfish and short-term attitudes about their investment which conspire against the company's success.
I refrain from mentioning specific names so as not to offend the guilty. I'll share with you an example where having a wrong investor resulted in the demise of the company. This was a tech company, commercializing a complicated science from University. Founders and many early investors were extremely smart people in the tech industry. The board was packed with luminaries with lots of extra letters after their names from their academic accomplishments. Missing - because it was unwelcome - were meaningful voices from other investors on financial management, business operations and go to market strategy. Crystal clear to some of us was the need to work towards real revenue customers, vs some others who were head down raising more cash for the sake of more tech research. The over-valued company with no meaningful revenues or plan collapsed when the investors would not step up for yet another round. The painful financial lesson from this experience: it takes several types of talent to grow a successful business.
Another example that I recall was of a company that had been through multiple funding rounds, making slow but steady progress. A new major investor in the last round abruptly called their note rather than rolling it into equity per typical practice, bankrupting the company. The painful financial lesson: all investors should have the same goals and time horizons.
As a follow up question to that, how often do you see this happening – startups crashing and burning because of a wrong investor? Would it be more ideal or feasible to put things such as investment time horizon, values and ethos of the company, etc. in the pitch or in the investment docuuments to make sure everyone’s goals and visions align?
That’s a good question and interesting idea. I’ll go out on a limb and suggest that - under an impartial light - most startup failures are self-inflicted; some combination of bad management, bad execution, bad board/investor involvement. In the end these are all connected, and if they had been functioning properly would often have been a better outcome. I don’t know that we could routinely codify the goals and path in advance, as startups need flexibility to adapt and pivot over time. That said, there should be a tight bond and understanding between founders and investors on strategic plans, time expectations, future funding plans, what scenarios would constitute exit discussions. Open communications and working relationships help identify problems in advance, creating more timely and appropriate solutions.
What approach should entrepreneurs follow to seek Smart Investors? Do you have any directions that you can share with our readers here?
First, just ask! Articulate the kinds of advisory and support skills you think you need. Ask entrepreneurs and professional acquaintances in related fields. Look for similar sector-specific angel investors and angel organizations special interest sub-groups. Larger angel groups tend to have deep benches of talent in many areas, their managing directors are often happy to intro you. Getting them invested in your company early can help pull the rest of the group in.
We almost always talk about things angels look at before investing in an idea or business. Can we have a similar framework that an entrepreneur can use to best identify if an investor is the right one for their startup?
In a perfect world, entrepreneurs can select ideal investors from an infinite supply. In reality, money is scarce and you often have to take what’s out there. Hopefully, you can find enough smarter and helpful money to offset and defend against unhelpful others. Talk with early potential investors. Cultivate relationships with those you feel understand you and your business. Leverage them to bring in others and help manage and set expectations.
Some early-stage startups rely on smart investors with a skillset or background that their exec team doesn't fill right now. What are your thoughts around this and how can an entrepreneur go about doing that?
Successful companies grow through many phases and require various talents along the way. Those talent needs don’t normally arrive in convenient full-time payroll chunks, but rather ebb and flow. Smart investors can often pitch in directly early on when the need is light. Then can expedite the search for more substantial skills as those needs develop. They have your back, because it’s their back too.
How can an entrepreneur strike a balance between just raising money and/or raising money right? Is it worth the extra effort? What could be the pros and cons that the entrepreneur should analyze?
Friends and Family stage investments normally come with no strings attached, the entrepreneur gets to do whatever based on trust. Free rein, but often that source is insufficient over the course of time. Once you take outside arm’s length angel investments, your new shareholders are part owners of your business, legally, and will rightfully require some involvement to protect their investments. These are not charitable donations, and you are no longer King. Knowing you are going to get oversight - whether you want it or not - it’s best to organize for maximum company benefit. Quality investors who share your vision and are on same side of table as you are a great accelerant. Internal conflicts with investors are as bad or worse than with employees. So yes, it’s definitely worth the effort. (By the way, the Alliance of Angels is a great place to find smart investors who bring valuable experience in a wide range of industries and skill sets. You can learn more at www.allianceofangels.com )
What kind of tactical help during the natural cycle of growth of a startup can an entrepreneur expect from Smart Investors?
Lots. Your formal board of directors is charged with governance and strategy. However your smart investors can supplement the board in many ways, i.e. introductions to potential customers, supplier recommendations, advice on fundraising, providing industry insights, pressure testing your strategies and many more depending on your company’s needs.
I’m a big fan of advisory boards, a less formal structure of tactical helpers, which may change over the course based on need. Most angels are happy to serve in this capacity. Your job as an entrepreneur is to cultivate these advisory relationships (whether formalized on an advisory board or just an occasional contact for advice) and call on them when you have a challenge. You can probably figure out many things yourself but you certainly won’t get it all right on your own. It’s great to have a bench of experience who have already been there, especially when they are your biggest boosters.
Do you have any additional advice on this subject for first-time entrepreneurs?
Most first time entrepreneurs tend to be tinkerers or hackers. Brilliant energetic people, maybe pigeonholed in larger corporate structures and now breaking out with a wonderful new idea. Unfortunately, their understanding of the broader business world is often limited due to their previous experiences.
Some examples of blind spots for first-tie entrepreneurs: their depth of operating skills beyond product development might be lacking, they may not understand how finance really works, they may have never built a quality compliant product that needs to perform perfectly every time, or they may not know how to properly hire staff within current regulations. And the big one which is a really common failure point – especially for first-time tech entrepreneurs – is not having team members and advisors with actual deep experience selling products/services to your industry. Customers won’t just show up on their own and make a fast decision as you might hope. First-time entrepreneurs often understatement the time and challenges involved in selling – and then run out of money because of that glaring blind spot. Please don’t underestimate this point!
So it’s pretty much impossible for first-time entrepreneurs to have the experience needed to succeed in all these areas. Most of this is simply beyond what you’ve seen before. It takes more than one discipline to build and operate a successful company. So for the first-time entrepreneur you need to recognize that you will need a team with diverse skills to make your business succeed end to end. Lean on your board and smart investors here for guidance and seek their help interviewing talent when it’s an area that you are not experienced in.
Any last thoughts? Something our entrepreneur friends should take away from this conversation- in a few sentences.
Angel investors can and should bring more than money. Get to know them and their backgrounds – not just their checkbooks. Ask them who they know and how else they can help. As your business evolves and needs to grow, keep asking. We’re all in this together…a greater long-term success is in everyone’s best interest!
The Alliance of Angels (AoA) is the largest angel group in the PNW with 160+ members. AoA members provide invaluable business support and connections to help our portfolio companies succeed. To learn more about the Alliance of Angels go to https://www.allianceofangels.com