I often get asked by entrepreneurs about the investment and selection criteria of investors, so that they can tailor their pitches accordingly.
However, I think it is equally important that entrepreneurs have their own selection criteria of investors. Even in today’s environment, there is plenty of investment money going around, therefore a wise founder will want to choose their investors based on the added value they can provide for the startup, especially if several investors are vying for the startup’s attention.
In this article, we are going to focus on ways founders can pre-screen potential investors: from the research phase to signing the term sheet.
Before launching into the main story, however, I would like to explain how the topic came to occupy my mind in the first place.
I was talking to a Vietnamese startup founder who realized, all too late, that they have sold too much of their company in the first round of financing.
If you are wondering how much is too much, you are not alone. In my opinion, if what you have left by the second round of fundraise is less than 50%, you have sold too much of your company.
Around the same time I had a conversation with the founders of a company I had invested in. They asked me to take a look at the term sheet of another fund, which I found to be very complicated and disadvantageous to the founders. Among the many red flags was the stated intention to buy back 30-49% of the shares from the first round.
On top of that, they were asking for non-standardized rights, such as an anti-dilution clause allowing them to retain at least 20% ownership even if the company were to raise any additional capital in the future.
These conditions not only indirectly turn the founder into an "employee of the fund", but can make it very difficult for the founders to raise the next round of funding.
Before talking to investors, I strongly recommend that founders do their research. You can start here:
1. Which space does the fund invest in?
There are two main types of investment funds: generalist funds that are industry agnostic, and specialist ones that focus on a specific industry or segment.
Hustle Fund, for example, invests mainly in technology and software companies, regardless of industry, in North America and Southeast Asia, which makes us a generalist fund.
This information is often publicly available under the "About Us" section of the Venture funds' websites.
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2. Which stage does the fund invest at?
There are a number of commonly recognized business stages as they relate to venture capital, but most investment funds are divided into three main categories:
- Early stage (angel investment, pre-seed, seed)
- Growth stage (series A and B)
- Late stage / venture (series C +)
At Hustle Fund, we invest in the pre-seed / seed phase. This means that we are investors in the first round or the second round after you have raised capital with angel investors.
3. What are the investment terms?
The most important thing to keep in mind when negotiating your term sheet with investors is that conditions stipulated should benefit both sides, rather than only protecting investors from risks.
I highly recommend watching the video by Hustle Fund's Eric Bahn where he talks about fundraising during COVID-19.
One of the messages he tries to drive home is that under no circumstances should you sell more than 25% of the shares in the first round of funding. Anything above this level will mean high level of dilution for the founders’ shares down the road, making it less attractive for potential investors in the next round.
Also, try and keep things simple, especially in the early stages of fundraising. YC SAFE (YCombinator Simple Agreement for Future Equity) is a template that has become popular with angel investors and early-stage investment funds in Silicon Valley.
The Post-Money SAFE valuation also helps investors and startups quickly understand how much ownership they are exchanging for capital. Hustle Fund uses it too, as it allows startups to save on lawyers’ fees and eliminate any non-standardized, unfavorable terms.
4. Who are the investors at the fund?
The founder-investor relationship is a long-term one. So you need to consider whether they are willing to help when your company hits a rough patch and whether there is understanding, respect and genuine care from investors.
Another thing to keep in mind is that investors who were previously operators or entrepreneurs (as is the case with most Hustle Fund investors), generally can understand things from the founders' perspectives better and offer more support.
As a part of the due diligence process to help you make an informed decision, it’s recommended that you talk to the founders of the fund's portfolio companies to understand their experience working with the investors.
Eric Bahn of Hustle Fund hosts regular webinars that are a good reference source for founders who want to raise capital during these turbulent times.
As a parting word of wisdom, the investor-founder relationship is long-term and an important factor in the direction and success of your startup down the road, so I hope you will choose your investors wisely.
Mai Ho is a venture partner at Hustle Fund, covering the Vietnam and Southeast Asia markets. Mai was born and raised in Vietnam, and later graduated college in the U.S. with a double major in Accounting and Finance.
Mai has 10 years of experience working in London, Singapore, and San Francisco, from Equity Research at Goldman Sachs to Growth/User Acquisition in Silicon Valley. Previously, Mai also co-founded and exited e-commerce marketplace BigBalo.