Investor Dilemmas

Most startups kick off with limited financial capital and somewhere along are the way are faced with the need to seek investor’s capital to move the business forward. Each type of investors will present its own set of dilemmas. Founders need to reconcile these benefits and challenges with their startup’s needs and reach out to those investors better suited to fulfill the startup’s needs.

Once the founders’ capital has been exhausted or deemed not sufficient, the most easily accessible source of capital is from family and friends. While this source of capital often comes with little to no restrictions, it is likely not enough and will severely damage close personal relationships if the startup fails or doesn’t perform as expected. Noam Wasserman explains how “friends-and-family investors introduce a more emotional element to the business as it moves forward, regardless of whether that heighted emotion is beneficial or detrimental to the founder and the startup” (Wasserman, 2012, p.262). Personal relationships associated with this form of capital might blur an entrepreneur’s objectivity and force them to continue to pursue an idea that otherwise would have been cut short. This particular case would occur since the startup’s failure would be costly and damage an entrepreneur’s professional and personal network and support systems.

The next level of investors available to entrepreneurs are angel investors. While more difficult to access, angel investors are able to provide significantly more financial capital and business experience at the expense of some equity and a higher level of oversight. Angel investors are financially driven and personally involved in ventures. A recent study from Baylor University found that given angel investor’s experience and venture involvement, they tend to be sensitive to conflict with entrepreneurs leading to exiting the venture (Collewaert, 2011). These findings would be in line with Wasserman’s acknowledgment of added oversight and an added level of management difficulty. However, angel investors provide valuable resources including possible introductions to venture capitalist.

Venture capitalists are the most complex type of investors. They are extremely resourceful and also the most difficult to attract. Reputable venture capitalists bring human, social and financial capital, along with significant recognition by mere association. However, all of these benefits come at a significant price in terms of equity and control of the business (by means of control of the board of directors). According to Wasserman’s data analysis, startups that decide to involve venture capitalists usually see close to 50% of their equity going to them by the second round of financing. Since venture capitalists are long-term investors, they play a significant role in human resources practices and many other aspects of the organization. Venture capitalists yield significant power to take control of the board and effectively take control of decision making in the organization. As Wasserman points out, by taking control of the board “[venture capitalists] not only evaluate the CEO’s performance but also decide how the CEO should be compensated and whether or not he or she should be replaced (Wasserman, 2012, p.284). All of these newly introduced dilemmas create a much different environment for a business. While venture capitalists can provide the means for massive growth, entrepreneurs need to evaluate all costs associated with this type of investment.

Each startup as different investor needs at different stages of their growth process. Therefore, investors need to carefully analyze their current needs along with their expectation for the startup, before pursuing a specific source of capital funding. Careful planning goes a long way in helping entrepreneurs decide what approach works best for their specific startup. Entrepreneurs should not be afraid of these tradeoffs, but rather encouraged to seek out those that best fit their needs.

References

Collewaert, V. (2011). Angel investors’ and entrepreneurs’ intentions to exit their ventures: A conflict perspective. Entrepreneurship Theory and Practice Journal. 36 (4), 753-779. doi: 10.1111/j.1540-6520.2011.00456.x

Wasserman, N. (2012). The founder’s dilemmas: Anticipating and avoiding the pitfalls that can sink a startup. Princeton, New Jersey. Princeton University Press.