5 mistakes to avoid when pitching to investors

With most VCs, you will get just one chance to present your business case. VCs are usually a skeptical lot because they see a lot of bad presentations.

Here are some mistakes to avoid when pitching to investors

  • Poor assessment of the risks in your venture: All businesses have competition. VCs are not looking for businesses without risks… in the businesses they are in tested in, they are looking for teams who understand the risks and have a plan to manage the risks.
  • Poor assessment of the competition or assuming that there is no competition: If there is no one else doing what you are doing, how are the consumers currently solving the problem? E.g. in a online food ordering business, just because there is no other brand dos not mean that there is no competition. ‘Calling up the restaurants using menu cards available at home’ is your competition.
  • Exaggerating management strengths: Remember, most VCs will do due-diligence… and most are experienced enough to know what is practical and what is fluff. E.g. for a professional with 2-years experience to claim “In my role as Client Services Manager I was responsible for formulating strategy and operations planning for fortune 500 clients” is usually not going to be an accurate representation of your role. However, “was involved with” instead of “was responsible for” is perhaps closer to reality.

Also, giving the right picture of your current skill sets and capabilities helps investors understand what assistance they may need to bring to the table, in case they decide to invest.

Investors are not looking for ‘we know all and we have been there done that’ teams… those are rare to find. Investors are interested in honest teams who are passionate about the domain and are smart enough to learn the things that they currently don’t know.

  • Impractical and unrealistic growth projections: While aspiring for scale is important, planning ‘how’ you are going to achieve it is critical. Without a plan, aspirations of scale are merely a statement of intent. Investors invest in a team with pans… not just on statements of intent.
  • Don’t include names of ‘advisors’ if they are not genuinely involved. Plain show & tell names just because you know a few people don’t impress investors.

 

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The process of pitching to investors

Often first-time entrepreneurs underestimate the time it may take to raise funds for your startup. Unless you get seriously lucky or have easy access to a number of investors, it is prudent to estimate anywhere between 3 – 6 months to get funded. And that is if you have a good plan and a great team.

 

Well, its relatively easier with angel investors and much easier with angel groups like the Angel Investors Consortium. That’s primarily because they invest smaller amounts in a wider range of companies but also because individuals are making decisions and hence do not have to go through more complex processes of VC funds.

 

Here are a few steps that are involved and approximate time it could take with institutional investors:

Step 1 Identifying the right investors 2 weeks
Step 2 Getting the first meeting, including time taken for trying to reach someone to get meetings set up 1 – 2 weeks
Step 3 Meetings with the evaluation team 1 week
Step 4 Presentation to Investment committee 2 weeks
Step 5 Term sheet 1 week
Step 6 Term sheet agreements 1 week
Step 7 Due diligence and signing of documents 1 – 2 weeks
Step 8 Funds hit your bank  

Total time

9 – 12 weeks

 

Here are a few steps that are involved and approximate time it could take with institutional investors:

Step 1 Identifying the right investors 2 weeks
Step 2 Getting the first meeting, including time taken for trying to reach someone to get meetings set up 2 – 4 weeks
Step 3 Meetings with the first layer of filtering 2 weeks
Step 4 Meetings with the senior layer 2 weeks
Step 5 Internal presentation to Investment committee 2 – 4 weeks
Step 6 Term sheet 1 week
Step 7 Term sheet agreements 2 weeks
Step 8 Due diligence 2- 4 weeks
Step 9 Signing of documents 1 week
Step 10 Funds hit your bank  

Total time

16 – 20 weeks

And these are fairly optimistic timelines with the investors who finally fund you. There will be several you would meet who may, out of genuine interest to invest, progress the discussions but may not conclude the deal for several reasons. And there will also be many who may decline to invest in the first meeting itself but still it will have taken 4 – 8 weeks to get the “No” as an answer.

 

Given the lengthy process, the entrepreneur should try to be selective about which investors they should approach. Investors, especially VC funds are clear about the kind of companies, the stage and the domains they would invest in, and that information is usually available on their websites.

 

One of the first things that entrepreneurs need to do is make a shortlist of who the ‘right’ investors would be.

  • To begin with, you need to decide if you are ready for angel investors or for VCs. Click here to know more between VCs and Angel Investors.
  • When applying to investors, check their websites and see if they have invested in businesses similar to yours and if your domain is within their interest areas. E.g. if you are a life-sciences company, there is no point in approaching investors whose focus areas are Mobile & Internet and Consumer Businesses.
  • Check if there are synergies between any of their portfolio companies and your business, and if there are, then evaluate highlighting the same during your presentation.
  • From among the many people at the VC, identify who in their team is more likely to be excited about your idea. This is easy to find because most VCs will have profiles of their team members, including details of which companies or domains that person is involved with.

 

Once you have identified the investor, and the person who you are going to connect with, try seeking an appointment by making a call to the office. Most likely, you will be asked to send the presentation to a generic mail id used for receiving business plans. Well, this is not something that you can always avoid. The truth is that investors get so many calls and mails requesting for meetings that it is almost impossible to accept all requests.

In most VC offices, business plans received will be reviewed with some level of seriousness, though most probably by the junior most executives who may not necessarily be experienced at taking a gut feel call on what seems like a good business case. If you are lucky to get past this stage, you will be asked to come and meet an associate. And that’s just fine. This is the first line of filter in a VC fund and an associate is expected to do a thorough evaluation based on their internal criteria, and then if and found suitable, are expected to move the deal up to a partner who can decide if the deal is to be presented to the investment committee.

If you pass the first line of filter in a VC fund, and this can take a few meetings, you would have to present to the next level. This round, depending on the interest of the fund, could take a few meetings with revisions and discussions on strategy, scale, funding needs, etc.

Once there is broad agreement on key areas, and if the deal fits into the internal criteria of the fund, the deal will be discussed at the investment committee meeting where the terms of the term sheet will be outlined.

After presenting the term sheet, the entrepreneur is expected to run it past someone who knows the legal stuff around term sheets…. And when you ask someone’s opinion, the person feels it obligatory to suggest a few changes. It then takes a few meetings and discussions to finalize the term sheet and sign off.

NOTE: some VCs would discuss the terms of the term sheet offline over meetings and dinners, and therefore the draft presented to the entrepreneur on which there is an informal agreement on key points like valuations, control, vesting, rights and downside protection. However, the time taken would still be approximately be the same.

Once the term sheet is signed off, the due-diligence will start. Also, the startup may have to complete some tasks as part of the ‘conditions precedent’ and that could be things like filing for patents, getting an independent director on board, getting customer contracts signed, etc.

After all this is done, the final signing of the documents and receiving the cheque are the logical next steps.

 

Why do early stage investors not invest in a company’s later stage rounds even if the company is successful?

Well, different investors participate in different stages of a venture. These stages carry different risks, apart from being different in the amount of capital consumed.

At the very beginning, which is where angel investors or seed stage investors participate, is the highest risk-stage of the venture. I.e. at this stage the venture carries a concept risk [i.e. will the concept/product/service work, will the business model work] as well as the execution risk [i.e. will the team deliver] and scaling-up risk [i.e. will this model scale and can this team scale it]. Angel Investors work closely with the entrepreneurs complementing the skill set gaps in the current team. The role of the angel investors, apart from providing capital, is to help the team prove the concept and the business model.

As the venture progresses and the concept and business model is proven, the venture needs to prepare for scale and that is when additional capital is required. At this stage, angels usually step back as the venture needs larger capital, which is usually got from institutional investors like VCs.

Institutional investors typically assist the company in building the foundations for scaling up – organization structure, processes resources, infrastructure, etc.

Post this round, capital is usually required for scaling up. This is the stage when growth stage VCs or PEs come in. At this stage, the model is proven, the teams capability to execute is proven and now the capital is required to significantly scale the operations, and perhaps explore new revenue streams, new markets, etc.

Therefore, in each of these three stages of a venture – i.e. concept stage, execution stage and scaling-up stage – different investors participate with different levels of involvement and different inputs required for these three different stages.

 

Terms of a term sheet

Term
Simple explanation
Implications to early stage companies
Liquidation preference Liquidation preference defines how monies received on liquidation are going to be split between different classes of shares. [Just like different categories of creditors will have different rights in terms of liquidation.]The term sheet will specify what ‘preference’ the investor will get over ‘common stock’ owned by the entrepreneur/founders/existing share holders. E.g. the term sheet may suggest that, in the case of a liquidation, the investor will get 2x their investment before the balance, if any, is split between common share holders.

A liquidation preference may also allow the investor to instead convert their holding into the proportionate % of common shares and sell, if it is higher than the money they would get on selling at the price they would get if sold at the preference value.

In some cases, if the term clarifies, the existing investor may be allowed to convert to common stock and hold their holding. They would do this if they believe that the new buyers of the company will increase the value of their holdings.

Liquidation is not necessarily only if the company fails. It could be merger or a strategic sale or whatever. In these situation, what level of preference multiple is offered will decide what is left for the entrepreneur [and other common share holders] in case of liquidation.In case where the investor is allowed the option of converting to common shares AND holding on to their shares, it may casue issues with the acquirer if they do not see value in the investor holding on or if there is a strategic interest clash.

As with every other term, the negotiating power of an entrepreneur with a proven track record [professional career record or previous successful entrepreneurship experiences] wil be higher than the negotiating power of a relatively newer entrepreneur. In bad times, the prefernce multiples asked could be ridiculous.

Drag Along This term requires the minority share holders to sell their equity to an acquirer if a majority of the shareholders agree to a sale.To illustrate with an example, if an entrepreneur owns 40% of the company with 2 VC firms holding the balance 60%, if they decide to sell their stake, this clause will force the entrepreneur to also offload his/her shares, even if he/she did not want to exit. Implications are obvious. If the company does not do well and if the investors decide to bail out with whatever value they can realize, the entrepreneur would be forced to sell his/her stake even if they believe that there is merit in continuing with the venture.Sometimes an investor may want to exit because the venture [or the domain] does not fit into their strategic thinking any more. In this case, if the investor wants to exit, even if the going is good, the entrepreneur may have to sell his/her stake.
Preference shares Preference shares are shares that enjoy more previliges than common shares. These could be in availining dividends before common share  or preference share holders may also have greater rights to the company’s asssets and proceeds in the event of liquidation. Here too, the implications on the entrepreneur are based on multiple factors including the multiple of liquiditation preference, if it is included, etc.In most cases, simple preference shares which give an investor rights over assets in case of liquidation and dividends before common share holders are not considered unfair by entrepreneurs as it represents only a fair demand that the investor is seeking to protect his/her capital and the entrepreneurs acceptance indicates a high level of confidence in the venture to allow an investor to protect his/her capital.
Indeminity Well, this is a pretty straight forward one in which the investor who sits on your board seeks an insurance cover to as an indeminity cover should there be a legal case and the investor needs to protect himself/herself. Depends on how much protection is sought and how much the insurance premium is, and how that amout is in relation to the amount that is raised.I.e. the investor and entrepreneur need to evaluate if and if yes, how much, indemnity insurance makes sense. Especially if it is going to cost a lot and if the amount of capital raised is little.

Also, if the capital is raised for, say, concept testing where the exposure to liability is nil or limited, then it may not make sense to invest in insurance premium [again, if the capital raised is limited]

Anti- Dilution Anti dilution protects the investor’s capital in case the entreprenur decides to, for reasons of market conditions or strategic relevance or whatever, to accept capital from a new investor at a valuation that is lower than that at which the investor had invested.In a situation where a subsequent round is raised at a lower valuation, anti dilution right allows the company to revalue the original valuation and thus issue additional shares to the investor. This, in my view, is a fair clause and entrepreneurs should be condifent enough and acccept it. Fighting this clause would necessarily mean lack of confidence in estimating a higher value for the equity in subsequent rounds.