The relationship between founders and their investors is forged during fundraising, and the goodwill that is generated when a deal closes is a brilliant platform to build on. When one side or the other doesn't understand this dynamic, things can go wrong...
The set up
Last year we came across a startup that was really in our sweet spot: a technology type we like and the type of impact we want to generate. We weren’t leading the round, but as part of our diligence we went up to see them and spent a day with the team. We liked them, but there were gaps in the model. There were three use cases for the technology, with different barriers to market adoption, and the biggest use case was attractive but very technical. We know when we need support, so we identified (and paid for) an expert with over 30 years in industry to spend a full day with the founders and their technical team. His analysis confirmed some of our doubts. That was useful, because it showed us exactly where they needed help.
The warning sign we excused
Communication is, as we’ve mentioned, a big deal. This startup was not always prompt in getting back to us, but in fundraising this can mean they haven’t made progress, so we read it as a sign. However, we received a request for a formal expression of interest. This is a good sign – the round is filling, and the team think they can close the round. We had sight of the term sheet from the lead, and we were comfortable with it. We submitted our indication within the requested 10 days and dropped them a note of encouragement, asking them to keep us posted as things progressed.
The point of fracture
Then, we waited. We didn’t get a confirmation of receipt, so we emailed to check. Nothing. They were due to come to one of our events a few weeks later. The night before, they emailed to say they had misunderstood the shape of the event and weren’t able to attend until the round closed.
It was a slow-moving outcome. In the intervening weeks, we had sent a couple of messages, made an intro to an FMCG company that had asked for it, and reached out to an advisor on their board to share the message that we thought their approach to investor relations wasn’t great practice. After a month we made it clear we would withdraw our expression of interest if the founders didn’t run the process better.
There are a lot of deals to choose from in our sector, and poor comms before we invest? A huge red flag.
We never heard from them again.
Some months later, we met up with their lead investor at an event we were both attending. They had been told we had decided not to invest for our own reasons. We were straight with them. We shared our experience.
We don’t badmouth startups, but we also respect other co-investors in our markets (a fairly small group of aligned funds) enough to be straight with them when asked.
The outcome
That startup had a golden opportunity, if they had had the experience to recognise it: investors who want to invest are predisposed to find ways to help a startup, because when the company does well, so do the investors. Even when they don’t invest, they can be your ally – sending intros your way, being a warm conversation for the next fundraise, building support in the ecosystem.
And when a round is oversubscribed, the investors who don’t get a seat at the table get FOMO. FOMO is a brilliant thing for a founder to foster ahead of the next raise. It builds momentum and makes potential investors work harder for the startup.
This round wasn’t actually oversubscribed, but the principle remains. If the founders had understood the value to them of good investor comms, they could have taken advantage of the interest shown by us and others. All it takes is an email saying, “We are grateful for your interest. We have decided to build the round with investors with a [strategic/technical/hardware/software – take your pick…] advantage to fulfil our immediate needs, but we would love to keep in touch for next time.” We would have been a warm investor for the round they are raising now.
The learnings (for us)
The main thing I took from this experience? I understood the founders better and gained a deeper insight into the gaps within their founding team that would likely have grown in substance and impact if we had invested. After all, if they misunderstood the investor/startup relationship at this stage, it’s likely that others will also have an experience which is sub-optimal, and when it comes to raising the next round, this is a problem. This startup had investors who were interested and had a lot of goodwill for next time round, which got lost as a result of poor comms. If this happens before the raise, what will comms be like after the round is closed and they stop trying to impress us?
Investors are watching at every stage of the process, and they are keen on clear communication, for obvious reasons. They also have so many potential investments on the horizon that, in the current environment, the balance of power lies squarely with them.
Closing the loop is so valuable in fostering goodwill after a fundraise. Even when the answer is “no”, there is an advantage to be gained and a relationship to be fostered, if you know how to make it work for you.
