Why Investors Invest in Start-Up Companies
“One of the most important things to understand when talking to a potential investor is that they don’t need you. ”
As anyone who has ever pitched an idea can attest to, you know the feelings of anxiety that come with fundraising for pre-seed companies. You’re watching every flick of their eye, every shift of their body, every slight change of facial expression, hoping that there will be something there to calm your nerves and simultaneously let you know that they love your idea as much as you do. You’ve gone as far as you can go on your end and, in order to grow, you need them. You need their help, their expertise, and sometimes most importantly, their money. But what decides who gets the check and who doesn’t? If only there were a way to get inside an investor’s head and understand why they make the choices they do, this would all be that much less nerve-wracking.
In conversing with many investors over the years, they’ve shared with us some insight into their thought processes. One of the most important things to understand when talking to a potential investor is that they don’t need you. They have already built their business and made their money. Investing in your company isn’t really going to change their life. But that doesn’t mean they don’t want to help you. Think about it. You’re a multi-millionaire who’s created something amazing, made more money than you know what to do with off of your business, and have been able to do everything you’ve always dreamed of. It was an incredible ride. But now what? Where do you go from here? I’ll tell you. It’s time to share all the little tidbits of knowledge that they picked up along the way with you, a brand new entrepreneur.
They want someone that will benefit from everything that they took years to learn. They want a cause that they can believe in and get behind. They see a little bit of their former selves in you and that is exciting. They know what it’s like to be in your shoes and they want to guide you on your way. They are looking for a meaningful way to use their wealth to impact the world without having to start over and create a new company.
“They want someone that will benefit from everything that they took years to learn. They want a cause that they can believe in and get behind. ”
But who do they choose? How do you separate the ones who are granted investment from the ones who get the cold shoulder? What will set you apart from the competition? You know you have a great product or a fantastic idea. The investor is clearly interested in it, which is an incredibly important first step. They probably won’t invest if they aren’t passionate about your idea and business. They need to see something that excites them and a purpose that they want to get behind.
Once that is checked off your list, the next thing you need to look at how much money you are trying to get from your investor. If they have a net worth of over several million dollars from a previous exit, you can be assured that the vast majority of it has already been tied up in multiple technical investments that they can watch and calculate their rates of return. As a new start-up business, they can’t calculate you. They won’t truly know if you were a good investment for several years. You are a much riskier venture. But for many investors, once they’ve diversified their portfolio, they are looking for a more personal and meaningful endeavor to get involved in. That’s where you come in.
A typical angel investor will only invest a certain amount of their net worth into high risk, pre-seed deals like yours, (meaning only around 1-3% of their net worth). Typically they will invest around $50k in a single deal and bring in other angel investor friends on deals they feel good about. A $250k investment then will usually be made up of about 5 or 6 angel investors. This also means that the total amount of money they invest is limited. If an angel has decided to invest $500k in startups this year, they will probably make about 10 different investments.
Additionally you will need to help them understand the investment opportunity that your company represents. This can be done by following our article: The best pitch deck format to get your startup funded.
The psychology of a pre-seed angel investor is very interesting and complicated. These guys have almost always earned their wealth through an exit from a company they built themselves, and are typically more interested in purpose over financial returns. While they do want to get a financial return on their investments, the initial attraction to pre-seed investments will be a desire to bring something new into the world. What this means to you is that these rare investors are less likely to need to see traction in order to invest. Someone has to go first and believe in you right? That’s the real strength of the early stage angels.
When pitching in the very early stages of your company for that very first dollar after a friends and family round, listen closely to the questions your potential investors are asking. If they want to see revenue and a lot of traction in the market, you may be talking to the wrong people. However, don’t be discouraged. There are more types of investors that you may realize. Just keep pressing on until you find a true believer that cares as much about the opportunity as you do.
I've heard people say many times: "Well... if I was an investor I'd want to know...." I can tell you that unless you actually are an investor, you really don't know what they want to know. Hopefully this article has shed some light on the way that early stage investors approach funding startups. If you have questions, horror-stories, or comments about your fundraising experiences, leave a comment below.