A key challenge for new entrepreneurs is balancing the need for capital for development and the patience to find the right investor. This is known as the capital paradox.
Choosing investors is more than just selecting the ones who will provide the most money with the least equity. To determine which investors are right for you, consider your business objectives and negotiate accordingly. Two major topics to consider are your founder type and your chosen business model.
To start, consider what type of founder you want to be. Entrepreneurs start new ventures for a variety of reasons, and you will need to decide what you want out of your experience to make fundraising decisions. The Founder's Dilemma is an important concept to consider. Do you want to be "Rich" or "King"?
This concept refers to the paradox created by fundraising external capital. Investors typically want some level of control, such as a board seat and equity in the organization. The challenge is deciding what you are willing to give up in the long term - control of your company or equity of your company.
The "Rich" mindset means that you prefer to have more equity in a successful company, even if you don't necessarily control it (even if a new CEO replaces you). In contrast, the "King" mindset means that you want to control the future of the company and be a key decision-maker in the company's future. Think of well-known tech entrepreneurs like Musk, Zuckerberg, and Bezos as examples of the "King" mentality. You might say, "Aren't they really rich too?" Yes, they are, but not every company can be founded and scaled by the same person.
If it's a future problem, why think about it now?
The details of your term sheet (which we cover in the guide) will depend on your preferences. Entrepreneurs focused on wealth will prioritize the highest payout, with less regard for controlling and voting rights in the company. In other words, owning 30-40% of something that scales but which you don't control is more valuable than owning 40-50% of something you have to scale yourself. However, money isn't everything. Entrepreneurs focused on power will want to retain more control over the organization to ensure their vision is realized. Let's explore the differences between the "Power" and "Wealth" mindsets of an entrepreneur.
Implications of a Power Mindset
The Wealth mindset is often seen as reasonable, while the Power mindset is considered narcissistic. However, those with the Power mindset want to control the company's direction for as long as possible. Since it's their company, they may prefer to solve problems in their own way. While this approach may limit the venture's growth potential, it also ensures it stays true to its original purpose. Entrepreneurs who identify with this mindset prefer to retain maximum control and voting rights. They tend to seek out investors who share their dreams and vision and who will not interfere with the founder's plans.
Implications of a Rich Mindset
Entrepreneurs with a Rich mindset understand that they cannot bring their venture to its full potential alone. The skills necessary for a successful startup are often not the same skills needed to scale and expand the company. Typically, the original founder will either move into a C-Suite position (CTO, COO) or become the Chairman, allowing more experienced leadership to grow the organization. This usually happens in later funding rounds (Series B, C, or D) when the company is more established.
Alignment with the Business Model
The second topic for strategic alignment concerns the business model. It is useful to identify any gaps that need to be filled on your team and determine how to approach investors who will understand and support your vision for the business. Your investors should be able to provide not only financial backing but also strategic support for growth, technical development, and your team.
To best match with the right investor, I encourage entrepreneurs to take a serious look at what they are strong in and what might be more of a relative weak spot as it relates to their proposed business model. An excellent engineer will need a business-oriented mind to help grow and develop the business model and vice versa. For traditional consumer products, there needs to be an understanding of unit economics and B2B2C retail sales from your investors to support your model. Similarly, for a SaaS or PaaS business model, it's important to understand the development costs, customer acquisition costs, lifetime value, and subscription models. Although you can sell the software at a high margin, the upfront investment can also be very high.
A traditional consumer product company would not want a SaaS investor, and vice versa. Having an investor with deep pockets but no understanding of your business model is a recipe for unnecessary conflict, which can distract from growing the business.
That's why knowing what factors to consider when taking on funding is crucial. It's not just about finding the party offering the most money but also the one that provides the most value. Look for someone who comprehends your business.
How to Connect Your Investment Approach
This article focuses on taking a step back before moving forward with an investment. When you invest in a venture, you enter into a long-term relationship where you will work closely with others. It's important to remember that people are on both sides of this transaction, not just numbers.
Before entering into agreements with investors, it's important to focus on who you are and what your goals are with your venture. While it may be tempting to take the easiest and cheapest capital available, that approach will likely lead to long-term troubles. Take a moment to reflect and ask yourself, "What do I want from this venture? What are my strengths and weaknesses? How will my specific business model need to be financed?" Only then can you find investors that fit your vision and expertise.
Steve Femino is the author of Early Stage Fundraising Guide.