The Pros and Cons of Rando Rich People Investing in Your Startup
Say what you will about VCs, but we’re a mostly predictable bunch. You know what our incentives are and we care enough about our reputation within the ecosystem to not do anything too terrible—usually.
Still, there are a lot of downsides to taking venture money—the push to grow at all costs, our desire to be all up in your business, literally, and sometimes, we’re kind of obnoxious.
That’s why when you come upon someone outside the traditional ecosystem, there might be a lot of compelling reasons to take their money. I’m not talking about active angels. I’m talking about what someone I know recently referred to as “dentists”. These are people that didn’t make their money through a tech startup or startup investing. They might not have even made their own money. Perhaps they inherited it. Maybe they hit the lottery.
Some of these folks are founders and CEOs, but not at high-growth tech startups. They could be in real estate or CPG—something much more focused on cash flow than growth, with a very different risk profile attached to it and an ecosystem dynamic unlike what we see in tech startups now.
Expectations
On the plus side, they might be easier money—less focused on price. While they might be generally smart, they’re unsophisticated investors who don’t know what the market is for where you are. They might have a more flexible time horizon than a VC because the money doesn’t come from a fund with a limited lifespan.
On the other hand, they could be the opposite—much more focused on near-term cash distributions than long-term equity appreciation. They might not understand how a pre-revenue startup could be worth anything, let alone be valued at $5mm.
The first thing you need to get straight with a high net worth individual—what is their return expectation? Can they lose this money? How long do they think it will take to make a return if there is one? Do they know how rarely these types of companies succeed?
Closing
Some wealthy people don’t sweat the details. They try to sign simple, market-standard deals, keeping the bells and whistles to a minimum while focusing on just a few critical deal points that are most likely to move the needle on their returns. Other people feel like they got to where they are by scratching and clawing for every last dollar—or retaining lawyers to do that for them.
One of the biggest downsides I’ve experienced when you deal with non-VCs is the addition of non-standard terms to a deal, especially when they use a lawyer who doesn’t typically work on venture deals. Not only will it cost you multiples more than average in legal fees to get this deal done, but you might wind up with some gnarly documents with terms that prevent other investors from wanting to come in.
Before you get into a deal with someone, especially if they’re in a lead position and writing a big check, suggest to them that they retain the kind of counsel who knows what the market is and what’s standard and what isn’t. It will save everyone a lot of cost and time.
Governance
Moreso than a lot of actual VCs, a lot of high-net-worth folks tend to ask for board representation—even in the super early stages of a company where boards tend to be a little less formal.
On one hand, I get this. I’m a big believer that you should act like an adult company from the beginning, reviewing prior performance, setting goals, and creating a forum for discussion and feedback. That’s why I normally ask for a Board Observer seat. This way, you don’t need to worry that I’m trying to vote you out of the CEO role, but we’re both clear that if important conversations are going to be had, I want to be in the room. Plus, we agree that we should have this type of meeting and try to make it productive for all parties.
A lot of these folks underestimate how much help they can be to a company and how much influence they can have by just being in the room. If you’re getting down to contested board votes on important topics before a Series A or B, something’s wrong. Helpful investors should use their sage advice and support of the founder to make them into better, data-driven decision makers to impact a company, instead of relying on their contractually held voting rights.
Role
When I was a lowly Analyst at Union Square Ventures, I had so many ideas for the founders we worked with. I would e-mail Paul and Rony from Indeed regularly with feature ideas and get super frustrated that they implemented zero of them—especially in the face of stiff competition from Simply Hired. What’s Simply Hired, you ask?
Exactly.
Paul and Rony focused on doing one thing and doing it better than anyone else—returning great job search results. Instead of getting hung up on what their better-funded competition was doing, they focused on executing on their near-term goals, then setting new ones, then executing on those, and so on and so on, all the way up to a billion-dollar acquisition with very little dilution taken along the way.
I’ve seen a lot of high net-worth individuals who haven’t been founders themselves, or former CEOs who weren’t around during the formative stages of a company act the way that I did—constantly pinging the company with new ideas, new directions, and trying to make lots of introductions. They’re always pushing a founder to do more when most of the biggest companies started life by just doing one thing well for years. They get frustrated by the pace of things out of the gate and feel like a company’s products should be everywhere yesterday. Meanwhile, a ton of companies fail because they do multiple things not so well because the team is spread too thin. If your early customers aren’t blown away by the experience, you’re never going to become a huge company.
Part of the reason why this happens is that sometimes people aren’t just wealthy in terms of money, they’ve got a wealth of time, too. They may have just exited a business or maybe they’ve just been managing their own money, which isn’t a full-time job for most people. They happen upon you and your company and see not just a place to park their money, but a place to park themselves.
The problem is when, if it wasn’t for the money they wanted to put in, this isn’t a person you would objectively consider the best fit for any particular role within the company. That’s just never a good idea, and it’s not what this investor should want. That would be like buying your favorite baseball team so that you could sign yourself to play third base. You’re going to suck compared to an alternative player and you’ll undoubtedly cost your team wins. Why would you want to do that? I get that you want to play baseball but do that on your own time. This is a business and the goal should be to get the best people at every position, regardless of their position on the cap table.
I would be wary of an investor who tries to insert themselves into the company before watching it operate for a while. It’s one thing when someone comes to you after lots of observation and says, “Hey, it looks like you’re getting stuck here. I think I could free up some of your bandwidth by doing X, Y, and Z for you and here’s why I think I can be successful at it.
It’s other when someone has near zero minutes of observing the company perform and they’re already inserting themselves into the top of the org chart. If you want to be helpful, take the time to observe the company, offer your help for free and without obligation, and earn your way into the org chart through your performance.
I’ve had great relationships with high-net-worth individuals acting as leads or co-leads in early rounds of companies. They not only took the time to understand what the company needed but they respected the experience that I brought to the table as well.
Before you figure out whether the person is going to be helpful or distracting, make sure you’ve papered the arrangement in such a way that the only thing you promise them is an opportunity to invest and your best efforts to make them a return. Everything else should come in time through open communication and patience on both sides.
