To successfully land outside investment for your startup, you’ll need to avoid a few misconceptions about how startup investors operate.
When I’m asked to advise a startup through their first fundraise, I consistently run into some major misconceptions about investors — misconceptions that lead to unforced errors. These errors can sometimes be the difference between whether the company gets fully funded or misses out on funding completely.
And since I spend a lot of my time fighting myths and misconceptions about entrepreneurs, I feel like I also need to poke a few holes in some equally misguided myths and misconceptions about investors.
Let’s attack conventional wisdom and keep you from making those unforced errors.
Investors Are Like Startups but With Money Instead of Product
One thing I figured out a long time ago is that there isn’t much of a difference between what an investor is trying to accomplish and what I’m trying to accomplish.
There are just as many moving parts in running a portfolio as there are in running a startup, and, in a lot of ways, the functions of those parts are similar.
Investors, especially venture capitalists, have a portfolio of startups they’ve invested in, and a perpetually shifting pipeline of startups they may someday invest in. Those two sets of startups are like your customers and your potential customers, respectively.
Investors make money by maximizing the return on their investment (profit on their product), and that starts by attracting the kinds of startups (customers) into their pipeline that will provide the best return (margins).
Investors sometimes have limited partners (investors), who also expect a return on the investments. Even if the investor doesn’t have investors, they always have a ceiling (runway).
Investors have a thesis (market) that they’re trying to address. Quick example: If your startup makes soap, you have no need for customers who are looking to buy motor oil. Yes, you could try to make motor oil out of soap for a single coveted potential customer, but it’s much more cost-effective to just sell more soap to customers who want soap.
Based on that thesis, investors have partners who help maximize the return on their portfolio, and they have buyers and acquirers who trigger the exit event — the moment when everyone makes money.
Once I saw the investing game in that light, it completely changed my approach to fundraising and investor relationships.
The thing about breaking down misconceptions is I don’t want to create a suite of opposite misconceptions. When I say that investors aren’t all Type A, that doesn’t imply that they’re all Type B. You should approach each investor individually, based on what you know about them, and you should never go in cold.
Myth #1: Investors Have a Bunch of Money to Throw Around
At some point, you or someone you know (or someone you’ve heard of) may have run into an investor with a ton of money and no expectations on the return. These are Bigfoot, Loch Ness Monster, Area 51 investors, in that they might exist, but I’ve never seen them with my own eyes.
As I said before, some-to-most of the investors in the startup universe have their own investors, and if they don’t, they all have limits. They also do the opposite of “throw money around,” and they probably have higher expectations than even you do as to what kind of return your company should be producing.
When you take money from an investor, you’re taking that money away from another investment opportunity, and they’re keenly aware of this.
Myth #2: Investors Like to Take Big Risks
They really don’t.
You could put five investors in a room and ask them, “Who wants to invest in this company?” Let’s say every single hand goes up. Then ask, “Who wants to be the lead?” Every hand will go back down.
Investors are as herd-driven as the rest of us, even the mavericks. It’s because they know that any idiot can ask someone to hold their beer and then take a big risk. The reason that an investor got to be in charge of that much money is because they’re not the beer-swilling risk-taker — they’re the spreadsheet-scouring mitigation machine.
Unmitigated risk-taking is a sign of desperation, whether you’re an entrepreneur or an investor.
Myth #3: They Can Be Swayed by the Fact That the Only Thing Standing in the Way of Your Company Becoming a Billion-Dollar Company Is Their Money
It’s the opposite.
To mitigate risk — in fact the only way to be successful as an investor in startups — is to find facts that give them assurance that your company will become a billion-dollar company without their money.
Maybe even in spite of their money.
It sounds unfair, but the startups in the best position for investment are the ones who need it the least. Smart outside investment is fuel for a fire that’s already burning.
Myth #4: They’ll Be Sorry If They Pass on You
They will not.
I have friends who are investors who have lost out on some pretty solid paydays, including a couple that did not invest in companies where I was involved.
It’s not keeping them up at night.
Investors have expectations that every startup they invest in will be a success. If they didn’t think this, they wouldn’t put money into it. So they’re sold into their thesis, their portfolio, and their pipeline. It’s not about gut for them; it’s about opportunity.
Let me put it this way. If you’re over 30 years old, you all had the opportunity to get in early on Bitcoin or Zoom, maybe even Amazon or Facebook. If you’ve never actually invested in a company, you might feel that pang of regret. But if you’re an active investor, you’re too busy looking for the next Amazon.
Myth #5: They Expect Some Companies to Fail, So Why Not Yours?
I’m surprised at how often this myth comes up, and it comes up in a very sidestep/roundabout way, usually related to the Bigfoot investor or hold-my-beer-risk-taker theory.
Again, investors don’t expect any company they invest in to fail. They’re just stuck in the reality that they’ve got about a one-in-10 shot at success. But that ratio doesn’t mean they pick nine marginal companies and one winner. They pick 10 winners, and then what happens is the reality of how hard it is to start and grow a company catches up to them.
Myth #6: If You Can Catch the Right Investor on the Right Day, You’re In
Investors all have LPs and boards and advisors and relationships with people who double and triple check their gut instincts and their math.
Think of it this way. First, you have to catch the right investor on the right day. But then they’ll only come in if you catch four more investors on four equally serendipitous days. Then some of the terms will be lousy, and some of the amounts will change. You’ll look oversubscribed and then you won’t be. Then you might be scrambling to close before the last of the seed money runs out.
Then you’ll read about some charming entrepreneur who raised $100 million off an app and the backs of several napkins. But you’ll already know there’s more myths to that story than you can count.
