Make sure you are investing into a closing of a round that gets the company somewhere--at least 12 and preferably 18 months of lifespan, time enough to hit real milestones after the inevitable operational slips. Many entrepreneurs want you to write them a check right now, because they need the money right now. They are "piecemealing" their fundraising, grabbing money when and where they can. This usually leads to a bad outcome for the investor, because you dramatically increase the financing risk the company faces. Instead of being 100% focused on execution, the entrepreneur is 90% focused on fundraising.
The typical minimum investment for a seed round in the Bay Area is $25k. The company will often waive the minimum if you can show that you will add some additional value. For the company, having a large number of investors is a hassle.
Convertible debt still seems to be the norm for most deals, which frustrates me. Equity makes much more sense in my mind. There is a good summary of the discussion here. I will lay my thoughts out on this in a separate post soon.
Companies face many perils on the road to success. It is why only about 10% of startups are successful (and that percentage is probably dropping in the current environment). Among the many execution risks are:
- Team--Is this the right team to make the company work?
- Market--Is the market ready? Can you reach your target customers efficiently?
- Product--Will you get product/market fit? Can you build a scalable product/service model?
- Financing--you can do everything right, and just run out of cash. Just because you hit your milestones does not mean you will be able to raise money. Series A capital, the follow on to a seed round, is particularly hard to come by these days. How much cash do you think you need? Uhm, no, you need more.
Once you have written your check, you have the right to sit back and cheer. Unless you are putting in a significant amount (eg. $100k), you generally do not have the right to get financial information or sit in on board meetings. Don't call every week for an update.
If you prove to be helpful, you will be invited to participate, and the entrepreneur will call you.
Whether or not you are helpful, you will get a call when the startup needs a top up of cash. This is more common than not, especially in the current Series A Crunch. I often see a 3-6 month slip in the business plan, which means that right at the company is starting to get the traction they are hoping for, they are running out of cash. They have not achieved the success necessary to get a Series A round done. At this point, they turn to their investors and ask for more. Top ups are generally done on the same terms as the original seed round.
Just doing top up rounds is an interesting business model, because you get the same deal after seeing a year of execution. But, finding them is tricky as they tend to be "inside rounds", done entirely by existing investors.
I believe that no one has the magical ability to pick winners. You need to have a portfolio of investments unless you plan on Luck being your core investment strategy. Most experienced venture capitalists I know will admit to being wrong about which of the companies they back was going to be their big winner. The key is to invest in a few companies that have that potential.
A word of warning--it will get dark before the dawn. The losers in your portfolio will usually show up first. Companies fail quickly, but they generally take years to achieve a successful liquidity event. While you may see increases in the valuation in subsequent rounds, until you have cash in hand, don't go yacht shopping.