Thinking Like Capital, Part 5: More Money Is Not Always Better

Thinking Like Capital 5 #AngelInvesting Angel investment is easier to discuss than venture capital because angels invest their own money in entrepreneurs out of belief, rather than because of results already achieved. They may provide hundreds of thousands or millions so you can build a basic prototype of what you have in mind. Having an angel investor also means an entrepreneur has begun building connections with the investment community. In subsequent Series A and Series B rounds, the angel will help approach the next round’s investors. Because most ventures are at such an early stage, angels usually assess the entrepreneur alone. Some, like Lei Jun, may invest only in people they know, or in former supervisors or colleagues. This is common. If you want angel investment, start with people to whom you have a connection. A business failure is reasonably acceptable to an angel: the investment is extremely risky, and the amount committed is small. Even if you have money yourself, it is still a good idea to bring an angel on board, if only to share the work of future fundraising. Robin: “Entrepreneurship is a lonely road. You need partners who will keep moving forward with you, along with different forms of support. Angel investment is one form of support and encouragement. Angels put real money behind you so you can build your own business, on the strength of trust alone. Do not let that trust down lightly.” ---- #YouAreTheProtagonistOfYourEntrepreneurialJourney On the entrepreneurial journey, you must make yourself the protagonist. Investors of every kind are there to serve you behind the scenes. They will offer as much help and as many resources as they can; some may even intervene in operations. Entrepreneurs must be very clear about their own needs, goals, and methods. They have the right to choose what to accept and what not to accept, and must know when to say no and stand their ground. ----- Entrepreneurs must seize every fundraising window and raise as much as possible. More money gives you autonomy. With less, you may soon need to raise again, and the private investment market is not always this buoyant. In 2019, for example, full-year investment in the private market fell by half, and many startups could die because their funding runs out. Your valuation will not necessarily keep rising either. When venture investing is booming, VCs offer higher valuations. Once the market cools, however, even a good business that can find an investor may see its valuation decline. Entrepreneurs who have not been investors usually underestimate the difficulties. They assume summer will last forever, without realizing that the VC market has its own changing seasons. There are not that many fundraising windows. Missing the good times often means missing a chance to survive. Entrepreneurs should try to raise more: multiply the amount you calculate you need by 1.5 to two. Do not fall just before dawn. Robin: “Seek a reasonable valuation, rather than a high one. Pursuing a high valuation is most likely to force you into a dead end when capital comes into play or the industry or company enters a downturn. Too much money can sometimes cloud your judgment. I think you should raise somewhat more than you currently need, rather than assume more is necessarily better. Moving forward in frequent small steps is another approach. But it all depends on the circumstances: plan carefully and respond prudently.” ---- #AllocatingEquity Many friends start a business together on the strength of personal ties and friendship, but cannot settle the equity allocation for a long time. At first, everyone says it does not matter because they are all friends. Yet this very loyalty between friends often becomes the most dangerous problem. Establish a hierarchy of ownership and clearly define who holds the principal stake. The worst structures are 50:50, or three people holding 33% each. Investors tend to feel uneasy when they see those arrangements. The most sound structures are generally something like 5:3:2. One person must have the final say. Sort out the shares before you start operating the company. Do not keep avoiding the subject: these issues will eventually become land mines. Many companies fall apart because clear conflicts of interest emerge once they begin making money. Equity also raises the question of an exit mechanism, which must be established in advance. Dreams and reality often differ. Everyone begins enthusiastically, but soon, because there is no profit or difficulties arise, some people start having second thoughts and may want to leave. Without a good exit mechanism, the breakup can cause major losses for the company. Suppose A, B, and C start a company with an ownership split of 6:3:1. As they work together, C loses interest and wants to leave. What happens to C’s 10% stake? If C leaves but keeps it, C gets a free ride, which is unfair to the others. You can therefore plan an equity-vesting system in advance: after a full year of work, you earn 25% of your allocation; after four years, you earn it all. For C, leaving after one year means taking only a 2.5% stake. Only by staying for four full years can C take the entire allocation. If someone leaves, the remaining shares can be allocated to the partners who stay, or used to bring in a replacement. #ThereAreManyWaysToDesignEquity #ConsiderExitAsWellAsPercentages #ConsiderProfitDistributionsAsWellAsExit #ConsultExperts --- #老齊的讀書圈 #LaoQisReadingCircle