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Why startups need to keep their investors sweet

Written by Josh Russell on Tuesday, 05 August 2014. Posted in Investment, Finance

Learning to meet the requirements of shareholders can be difficult for enterprises used to setting their own course. But the growth of a startup depends on a healthy relationship with its investors

Why startups need to keep their investors sweet

The beauty of running a startup is that an entrepreneur is in charge of their own destiny, offering a degree of self-determination that is simply unavailable in a standard executive role. However, once an enterprise takes on investment, it can be a significant adjustment to begin to deliver on external expectations. Making sure a relationship with an investor doesn’t sour once the cheque clears requires a clear understanding of the goals both parties are agreeing to.

Ironically, to begin a healthy investment journey, one often needs to give at least some consideration to the exit they are promising to investors. “When taking on VC funding, investors need to know that the founder has strong foresight,” says Philippe Gelis, CEO and co-founder of Kantox, the business currency exchange service. Being able to show that a startup is more than a flash in the pan and has the potential to offer a meaningful return on investment is vital for any entrepreneur seeking investment. “It is important to show that you have thought clearly about where your business is heading,” he continues.

However, an entrepreneur should be wary about throwing too many promises around about the exits they think they can deliver. “To focus solely on exit at the beginning is a recipe for disaster,” says Steve Jillings, CEO of TeleSign, the mobile identity authentication company. In an age dominated by disruption, it can be hard to guarantee any fledgling enterprise’s trajectory. “There are so many different types of startups these days and a lot of things which have never been done before,” he says. “It’s impossible to even look at that and go ‘here’s what this thing’s going to be worth’.”

But whilst cast-iron guarantees are inherently problematic, the stage an enterprise is at will effect how confidently it can gauge its future trajectory. “There are always some things that are proven and then there’s always a question mark over others,” says Richard Marsh, partner at DFJ Esprit, the venture capital firm. Early stage enterprises might have a proven technology or concept but lack the real litmus test of market experience. Conversely, later-stage enterprises that are seeking series B or C funding and have healthy growth then should be a lot more able to be confident to guarantee more of the same.

Whilst a huge amount of attention is paid in entrepreneurial circles to the process of gaining investment, the awarding of funding really is only just the beginning of a long-term relationship. While an investor might be quite closely involved with an enterprise during this relationship, it is important to understand there is a clear delineation of territory. “When you’re a board member as a VC or investor you have to be very clear: you are not running the business,” Marsh says. “You are not an executive.”

The actual level of involvement of an investor can vary wildly however, with one of the most significant factors being the experience level of the entrepreneurs involved. “It’s different for the company where the team is doing things first time versus a team where there’s already experience of growing and exiting businesses,” comments Marsh. “You’re talking first-time versus serial entrepreneurs.”

Whilst an investor won’t step in and manage things for an inexperienced entrepreneur, they will ensure there is a much more comprehensive framework in place so the startup has a structure upon which it can rely. “With a junior management team, it’s not uncommon for there to be at least weekly interactions,” says Jillings. This can range from a quick call, just to check how the startup is managing things, right up to weekly meetings to run through progress with the enterprise’s KPIs and weekly goals. “It can be a really hands-on approach.”

This can be a tricky transition for some however. For startups that are used to setting their own agendas, suddenly having to deliver on external expectations can be a shock to the system. “Adjusting to the level of reporting expected from VCs can be a challenge,” Gelis explains. Often investors will want to be kept abreast of all the details affecting a startup and will expect regular reporting to back this up. “It is important that founders seeking funding are prepared for this level of precision.”

Inevitably this means managing the expectations of investors will require an accurate handle on the metrics and KPIs that govern the business. “The simplest and clearest metric will generally be growth,” Marsh says. Year-on year top-line revenue growth will be one of the clearest indicators of an enterprise’s progress but different industries will also have other metrics that offer a more detailed measure. “If it’s an online business, they will be very focused on customer acquisition cost,” he explains. “They will also be very focused on the lifetime value (LTV) of the customer.”

When using this to guide future targets it’s important to be realistic – letting this over-inflate expectations will definitely lead to upset in the long run. “It is infinitely better to under-promise and over-deliver,” Jillings says. The biggest fallouts between investors and startups often come when those enterprises begin to believe their own hype and over-value what they can deliver. “At the end of the day, that’s not doing anybody any favours,” he says. “Put forward the most conservative, acceptable forecast possible so you’re not setting yourself up for failure.”

But the best laid schemes of mice and men often go awry and occasional poor performance can undermine even the most conservative targets. “Not every day’s a good day, not every week’s a good week, not every month’s a good month and not every quarter is a good quarter,” says Jillings.

The important thing is to be upfront when things aren’t going to plan. “VCs expect that things won’t always go to plan and issues will arise, but they hate bad surprises,” comments Gelis. “Don’t hide details, hoping you might find a solution before the investors notice.” However it is worth ensuring that you have a plan to deal with issues before you return to investors. “They will expect you to highlight the problem, along with a list of solutions you are already working on,” he says. “Be transparent and prove that you are tackling problems proactively.”

However, there are occasionally scenarios where the desires of investors and those of a startup aren’t always well aligned, with an investor’s agenda not agreeing with the ends an enterprise is trying to achieve. This becomes a particular problem in later stage enterprises where they may have multiple investors, all with wildly different expectations.

“If you’ve got four different investors with funds that are aged all over the map, you can potentially have big problems,” says Jillings. The example he gives is if an enterprise is courted for acquisition; whilst there might be a much higher potential return obtainable in the long run by holding onto the company, seeking a quick return is a much greater priority for the holder of an older fund than it is for all of the other stakeholders. “It just creates all this tension and issues on the board because they want to sell now to boost the returns on their old fund.”

For this reason, it is essential that every party involved is committed to the same plan. “It’s vital that everyone is bought into where the company is,” says Marsh. “It’s important to know what the plan is and whether it’s realistic.” Scenarios where stakeholders enter a meeting post-investment to find things are nowhere near on track often result from a failure to carefully align expectations. “If that’s happening, all parties are culpable because they haven’t levelled expectations and they haven’t been realistic,” adds Marsh.

Ultimately, ensuring a startup avoids friction with its investors comes down to making sure they’re always on the same page. “You have to make sure that you’re aligned,” says Jillings. For this reason, he feels it’s vital that enterprises spend time with their investors, meeting for drinks and making sure they’re aligned personally as well as professionally. Meanwhile, taking the time to give regular updates can also ensure that everybody knows where they stand. “Just shoot out a little quick update email with the highs and lows of the week,” he says. “It takes 15 minutes and then everyone feels like they’re in the loop.” 

About the Author

Josh Russell

Josh Russell

As editor, Russell is the man in charge of properly apostrophising our publication and ensuring Oxford commas are mercilessly excised. Our digital doyen, he’s also a Photoshop Pro, a dab hand with InDesign and the man to go to if you need a four-hour soliloquy about the UK's best silicon startups.

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