The writer is an investor in technology start-ups at Samos Investments
Any founder will tell you how gruelling fundraising can be: speaking to hundreds of investors, meeting after meeting, telling your story and hoping the person on the other side will connect, care and fund your venture. It’s not just emotionally exhausting, it’s also time away from your business.
Many of the investors you speak to seem like a good fit on paper. So when lucky entrepreneurs are faced with term sheets, how should they decide who to let into their company?
Co-founders and the team
This is the elephant in the room and often the first time you are forced to think about splitting equity. Some solo founders bring on co-founders at different stages of the business, but I believe the earlier this happens, the easier it is to have conversations about dividing equity. Michael Seibel, group partner of seed fund Y Combinator, advises founders to split equity equally, noting that their dynamic is critical to success and equality ensures trust.
There is also the question of giving employees ownership of the business as, typically, 10 per cent of equity is reserved for senior employees. It can be hard to decide who gets what. The Ownership app uses an algorithm to calculate the equity split between workers and investors, based on their contributions. For example, people log their hours worked, then the algorithm uses this information to generate a market valuation and cap-table in real time. Some experts question whether employee ownership boosts productivity: a Harvard Business Review study found that companies with employee stock ownership schemes grew “much faster” than they would have without such plans.
The dilution problem
It’s fairly normal to give away 20 to 25 per cent of your business during a fundraising round. That sounds like a lot — because it is. Sometimes you have to decide what to give away before you even have a product, which can feel scary. I encourage founders to think of it like subletting a room in your home. Whoever takes the space has the right to come around any time. They might ask you for food, have a look at your kitchen and call out your cleanliness standards.
Your investors will be sticking around for a while — even the small ones — so think about every slice of that pie carefully. Try not to give out equity too freely at the beginning to people who do not offer long-term value to the business. It can be tempting to offer equity for payment in exchange for advice, services or introductions, but it can be a slippery slope because you’re joined at the hip for a long time.
Who is at the table?
Imagine a dining table with all your investors sitting around it. They don’t have to get along, but you must know why they are there, beyond just capital. Your smallest investor, for example, may be the person who can secure your first paying customer or who coaches you to be a better leader.
Many founders forget that you will come back to every investor every time you want to fundraise, and they can become obstacles if you are not aligned. I have seen scenarios where investors have very different agendas for the company. This is where doing due diligence — on everyone from your lead investor to your angels — is critical.
Having the right level and blend of expertise is paramount too. Can your investors commit to the business? How have they behaved previously when things have not gone so well, for example? Have they removed founders or interfered? Speak to entrepreneurs in companies they have exited and written off. Remember that getting rid of an investor can be harder than getting a divorce.
As more founders make space for individuals to write smaller cheques, dealing with a long tail of investors can be cumbersome. Several platforms simplify managing your cap table, including AngelList Venture and Carta. Newcomers, Vauban and Odin also have set out to democratise access to cap tables.
Diversifying your cap table
We are seeing more angel networks professionalising and creating special purpose vehicles to invest in start-ups. Some of my favourite groups are: Alma Angels, which focuses on supporting female founders; Transact Global, a diverse community of emerging fund managers; Angel Investing School, which offers training on investing in start-ups; and Black Angel Group, a collective that invests in seed to series A start-ups around the world.
I’d love to see more ownership remain with the founders and more transparency throughout the fundraising process. As the table gets longer, and more personalities take a seat, the focus should always be prioritising the company’s success.