When we talk about investors, we usually mean financial investors, but what are time investors? And what do they expect? Let’s explore the motivations behind being an investor in general and the difference between those that contribute time and those that contribute money.
Traditional financial investors include angels, venture capitalists, friends and family, banks, and so on. Time investors include mentors, staffs of accelerator programs, and the founders themselves. Some (but not all) time investors may be financial investors. Some (but not all) financial investors may be time investors. At a high level, all investors focus on achieving maximum return while minimizing (or at least moderating) risk.
What Investors of Time Expect
I’ve mentored many dozens of aspiring entrepreneurs and their startup companies. Personally, I do it for a very simple reason: I like seeing people succeed, and if I can contribute in any way, big or small, toward that success, I feel great. I expect nothing from my mentor time investment other than personal satisfaction of making a difference. In those occasional cases when the founders/officers believe that I can make a much longer-term contribution to the company (and I have available time) and they offer me a position as a member of the board of directors or advisors, then, I always prefer equity and/or options over cash compensation; that’s to better align all of our personal goals with the company’s goals.
I’ve been in executive positions in 5 startups . . . and counting. Some have been great successes and some miserable failures. I learned far more from my failures than my successes (although Iearned far more from my successes than my failures J). Good mentors should not be afraid to admit their failures; others can learn from the patterns of underlying mistakes.
All investors expect some type of commitment from founders/entrepreneurs. Whereas financial investors usually expect entrepreneurs to devote full-time to the startup, time investors (who are not also financial investors) are more likely to understand a founder’s need to balance life’s commitments.
What Financial Investors Expect
To no surprise, financial investors are primarily interested in financial returns. Investors want to know what their internal rate of return (IRR) will be for a given investment. IRR is the compounded annualized rate of return.
The IRR an early startup investor will achieve is a function of many factors, including:
- The rate of revenue growth (usually a function of the market size, “excitement” of products offered, strength of the marketing campaign, alignment of products with a significant pain felt by customers, and competition). The faster the growth, the higher the IRR.
- The profitability of the company.
- The level of merger and acquisition (M&A) activity in the space. This contributes to how quickly and how likely the company will experience a liquidity event.
- Typical multiples for the industry. When a company in this industry is acquired (or has a public offering), the acquirer (or the investment banker) will value the company. That valuation will be some multiple of revenues and some multiple of profits. The averages differ greatly based on the industry. See “Determining Future Valuation of a Startup.”
- The likelihood that the company will survive until a liquidity event. This is a function of many factors including the experience and knowledge of the team. Only 50% of startup companies survive 5 years; see “Eight Seemingly Harmless Things You Should Never Say to Investors.”.
- The likelihood that later investors will not severely dilute earlier investors with high liquidation preferences. See “Liquidation Preferences and Avoiding Dilution.”
As a result of the above factors, it is no surprise that investors in startups companies like to invest in
- High growth companies
- High M&A industries
- Industries with high multiples
- Teams that include experienced entrepreneurs or new entrepreneurs who have been through intensive accelerator programs.
Ultimately investors have goals that they need to meet and all entrepreneurs must demonstrate that they are the best horse to back. Those that can clearly articulate why investors should invest their time and money are demonstrating that they understand every element of their startup and their environment and have the knowledge needed to succeed.
About the Author
Dr. Al Davis is a mentor for Creative Startups in Albuquerque and Santa Fe, NM and was formerly a mentor for startups in the Colorado Springs Technology Incubator. He has published 100+ articles in journals, conferences and trade press. He is a passionate world traveler and has visited 8o countries.
He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He was a founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003. He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting and optimizing their business strategies. Click on the following to see a short video on Offtoa: