As part of my work with Founder Collective and angel investing in general, I often get calls from entrepreneurs asking “who should I take money from.” It’s a fairly innocuous question but one that most entrepreneurs get pretty wrong. The usual criteria for venture-capital-firm selection (and the likely addition of an external board member) goes something like this:
- Maximize valuation.
- Maximize valuation from as good a brand name firm as possible.
- Maximize valuation from as good a brand name firm as possible and make sure that the selected firm/partner adds value to your business.
The problem: those are the wrong priorities. The No. 1 criteria for the selection of your next investor and/or board member should be: can I answer (with 100% confidence) that my new partner will not destroy value in the firm I created. Here’s why the question makes sense:
The success or failure of your entrepreneurial venture pretty much comes down to you and your team. If you succeed, it’s because you and the team nailed it. Maybe the failure was the result of your own screw-ups. Maybe it was driven by macro events. Either way, it comes down to you. On the other hand, investor impact on your venture is highly asymmetric. If you succeed, your investors may have added some value, but its highly unlikely that the value they added was even close to being among the top five contributors to your success. Of course, their capital was helpful and important, but in a world of capital abundance for good companies, it likely wasn’t their capital that made the difference. On the other hand, investors can absolutely screw up your company. They can lose faith in it during bad times and in the tight VC community, that perspective can get picked up by potential future investors – accelerating your demise. Investors can force an exit for reasons that are driven by personal considerations (like wanting to put a “win” on the board), even when that may be at odds with maximizing the longer term potential of your firm. They can create politics and become high maintenance board members – distracting you from core execution. I have seen board members bail on their founders, or recapitalize the company in their favor, or side with one part of the team over the other, or fail to approve routine investments and paralyze execution. The horror stories are many.
And yet there is nothing fundamental you can really do to protect yourself legally. Once your potential investor is a major shareholder, they have the ability to do enormous damage within the confines of even the most iron-clad shareholder agreement. Which brings me to the golden rule of board member selection: validate that you can totally trust your next board member – even in the most difficult of circumstances. First make sure there is no chance they destroy value; then optimize for price, brand and value-creation.
How do you validate that you can trust your next board member if you weren’t college buddies or business colleagues with them? Here are 10 steps to ensure your next Board Member will not destroy value:
1. Don’t run a shotgun investment process. Get to know potential investors before you ask them for money. And just as they will likely disqualify you if they believe you’re not the right leader or team, disqualify them if you feel like you’re not on the same wavelength. Do it pre-fundraising; when you’re not in the heat of the deal.
2. Ask your angel investors who they trust. They’ve likely seen many more deals than you have and they have a vested interest in protecting their investment.
3. Talk to other entrepreneurs who have taken money from your potential investors (ask them for references of companies where things went badly). Entrepreneurs can be pretty candid with other entrepreneurs.
4. If you can, err on the side of investors who have proven themselves. Minimize discussions with associates or principals. Much of the “bad behavior” comes from individuals within the firm that don’t fundamentally have career security or partnership pull.
5. Think about how your potential board member conducts himself or herself during the investment process. Are they overbearing? Are they largely unengaged? Is the due diligence painful or are their questions genuinely good ones? Are they transparent? Do they seem open to your perspective or rigid in applying their pattern-matching experience?
6. Invite them to meet your team and ask your team members what they think – often the team can see the bigger picture because they have not participated in 15 investment pitches.
7. Stick to reputable firms if you can – you always want to take money from people who worry as much about their reputation as you worry about yours.
8. Meet your future board member over dinner or a drink outside the confines of their office or yours. Do you find yourself having to “spin” as you talk to them (bad sign) or can you imagine them being your first call when the going gets tough (good sign)?
9. Don’t get bullied into artificial timelines. No reasonable investor that wants a 10x return walks away from a term sheet because of an artificial deadline. Take your time and do your diligence.
10. Trust your spidey sense. Pay attention to the small things. Are they throwing in last minute diligence items late in the process? Are they introducing you to a new partner after they told you the partnership was on board? Are they displaying data analysis paralysis? Are they failing to deliver on an intro they said they would make?
I have the good fortune of having an amazing group of investors and board members at BloomReach, from Bain Capital Ventures, Lightspeed Venture Partners and NEA. In addition to not being value destroyers, they are tremendous value creators – they’ve helped with recruiting, thinking through strategic forks in the road, customer introductions, challenging our thought process and picking us up when times are tough. I can count on them for crisp advice and yet also count on them to trust us to steer the ship. I wish that kind of partnership on all of you.