The Theory of the Third Co-Founder
Why Your Lead Investor Is So Important
At Deciens, we focus exclusively on leading investments with the companies we work with. And who the lead investor is may be one of the most important questions a seed or pre-seed stage company will ever have to answer – as that investor can (and should) play a key role in helping to shape a startup’s long-term success.
I had the pleasure of speaking to early-stage founders this spring at TechCrunch Early Stage. Here are just a few of the questions they asked me – as well as my advice to them.
“What makes a good lead investor?”
A good lead seed investor is like the wind beneath your startup’s wings, lifting you higher and higher. When searching for the perfect lead seed investor, look for someone who is not just willing to invest but also shares your passion and vision, and is enthusiastically ready to embark on this exciting adventure alongside you.
Here are some criteria to consider when assessing a lead investor:
The most successful founders have a borderline irrational belief in their company and are unlikely to find someone who matches their level of excitement, with good reason. But a lead seed investor should still be genuinely excited about the company and aligned with its overarching thesis.
A lead seed investor focused on leading funding rounds can be highly valuable. An experienced and knowledgeable lead, particularly in the seed stage, has seen the challenges likely to occur as a company grows and can prove a useful advisor throughout the journey. Their role is paramount and distinct from non-leads and later-stage investors as they will set the investment terms, forming the framework for subsequent rounds. They will be the most engaged investor on your cap table, your go-to for critical discussions, and your key to future fundraising.
Your lead seed investor will be involved with your company for years to come, meaning you’ll be spending a lot of time together. Choosing someone you enjoy being around and with whom you can build a strong personal connection is crucial.
Think of a lead investor as a third co-founder. A smart founder generally avoids bringing on a co-founder with wholly duplicative skills and expertise. Similarly, a good lead investor is most helpful when they possess a complementary skillset.
Picking your lead investor who proffers the highest valuation isn’t the optimal approach. The lead seed investor becomes an integral part of your business operations, making it essential to carefully consider all the other factors in your selection process. An over-inflated valuation, especially in the pre-seed and seed stages, can actually complicate future fundraising efforts. Ultimately, your relationship with the investor and their contributions beyond capital is much more important over the long term.
“Beyond money, expertise, and their network, what are other important points of alignment between founders and lead investors?”
In order for founders and their investors to have the best experience and most beneficial relationship, they ought to be aligned on how they would like to engage.
Founders should ask themselves what they want out of their investors, and their expectations for how their lead investors will show up, and also understand the same from any potential lead investors.
Points of alignment may encompass the following:
Value-add: Are there specific value creation opportunities (e.g., customer introductions) that are expected from the investor?
Ongoing engagement: Will there be regular discussions, or will they be reserved for board meetings or emergencies?
Future fundraises: Will the investor play a key role in helping secure investors for future fundraises, or will that responsibility primarily fall on the company?
Follow-on capital: Will the investor be able to commit further capital in the future? Are they open to bridge financing if key milestones take longer to achieve than anticipated?
There are no “right” answers – what matters most is that expectations are discussed and agreed on upfront, and that both sides are fully bought into how they will collaborate going forward.
“What if I have interest from a potential lead who doesn’t have experience or expertise in my industry?”
A lead investor with shared industry experience or expertise can be helpful. It gives them firsthand knowledge of how things might unfold for a new entrant in the industry.
That said, the lead investor does not need to be an expert in the company vertical, but they do need to understand the vertical and what the company does in significant depth. Without a solid understanding of the company’s goals and basic approach, investors will struggle to understand why the business unfolds the way it does, which can create problems down the road.
Furthermore, the investor should ideally bring a complementary skill set critical to the company’s development and adjacent to the founders' vertical knowledge.
One of Deciens’ portfolio companies is a perfect example:
Deciens’ partners – Vishal Rana (middle left) and Ishan Sachdev (middle right) – with beatBread co-founders, John Haller (far left) and Peter Sinclair (far right).
I led Deciens’ investment in beatBread – a music funding platform enabling artists to access capital without giving up ownership of their music. While we grasped the industry dynamics that created the opportunity and the need for a platform like beatBread, which ignited our excitement about investing, we were certainly not experts about the music industry.
beatBread did not need Deciens to bring music expertise. Peter Sinclair one of the co-founders, is a former music executive. Peter has the world-class, industry-specific expertise required to disrupt the music business. Deciens brought to the table a complementary knowledge base – lending and financial services, which are core to the company – along with additional investors and product knowledge.
Our team looks for fintech companies that will disrupt industries needing structural or systemic change. We were a perfect complement to a savvy founder with a revolutionary idea who benefitted from our fintech expertise. Different core competencies between the founders and the Deciens team were accretive to the partnership on several dimensions.
“What would you say to a founder who doesn’t have the luxury of multiple term sheets?”
In the best-case scenario, a founder has multiple appealing term sheets on the table. Often though, founders find themselves with several imperfect options or a limited number of term sheets. In these cases, founders should examine the investor they’ll be working with and giving a seat on their board. Does this person share excitement about the company’s mission? Will they be able to contribute to your company’s growth and success?
It’s important to make sure that the terms offered aren’t egregious and won’t be a problem in subsequent rounds. Assuming that’s not the case, the choice of the investor you partner with will matter more over the long term. In addition, having multiple term sheets can give founders some leverage to negotiate improved terms for their preferred partner. Many investors feel it’s important for the founders to feel good about the investment structure as well, and they will be receptive to adjusting terms if there is strong alignment on both sides wanting to work together. That might not result in exactly what the founder wants, and investors do have bright lines, but meeting in the middle is possible.
If there is only one term sheet on the table and it’s not ideal, or the investor proffering it isn’t perfect, a company will likely need to move forward with it, irrespective. However, even in that scenario, there are untapped opportunities waiting to be harnessed. For example, instead of solely focusing on the lead investor, explore the possibility of bringing in other investors who possess the crucial elements necessary for success. Once you lock in your lead, follow-on investors will be more likely to jump on board. Circle back to those folks you would love to have involved and leverage this milestone as a catalyst to bring them onto the cap table.
Most importantly, founders do not want to find themselves having to convince a lead investor of their company’s merits. When there is a term sheet on the table, it’s important to take a step back and evaluate the offer beyond whether the firm is “hot” or the valuation is high, and find someone who is excited about what the company is doing.
“What questions should founders ask about the VC firm?”
Remember that a founder’s relationship with a lead investor is two-way; the founder needs to understand the investor every bit as much as the investor needs to understand the founder. Here are some questions founders should ask any potential VC investor to ensure alignment and a good fit:
What’s the reason behind your firm’s interest in investing? (Does their answer reflect a deep understanding of the company?)
Who at the firm will my company/I be working with?
Where does my company fit into your firm’s universe of portfolio companies?
How many portfolio companies do you have, and how much time do you spend with each?
Is there a different protocol or level of involvement based on each company’s stage?
What factors have contributed to your most successful relationships with other startups in your portfolio?
It can also be helpful to talk to other founders in the firm’s portfolio and ask them about their experiences. Consider asking them:
How does this firm work with the companies in their portfolio?
How engaged is this firm with its founders?
Does this firm provide the platform services you expect?
Is your principal investor someone you can be open and transparent with and trust for good advice and judgment?
“How can I pitch a lead investor?”
Building a startup is a journey that spans years, sometimes even decades. As startups grow, the path ahead becomes longer and more complex. Venture capitalists are looking for those businesses that can be true outliers and, therefore, have a fundamental reason why they should still exist in 10 to 20 years.
During a pitch, savvy investors will look beyond a flashy deck full of buzzwords and focus on three things:
Is this a founding team who can build an outlier?
In the short term, is there a clear understanding of what is required to raise subsequent rounds of financing and a realistic plan to achieve those milestones?
In the long term, can this company be an extremely large and transformative business if things go right?
Founders are, of course, the key driving force behind the startup at the early stages. Different investors have different perspectives on the types of founders they want to work with. At Deciens, we focus on founders who:
Have the tenacity and drive to make it through the extreme ups and downs that are a part of any startup over the long term.
Are mission-driven and building their company because they think it needs to exist in the world.
Have unique advantages and insights (from their background, prior experiences, etc.) that give them an edge in building this company and being the winner in their space.
Possess a clear understanding of how to build something defensible and unique that will allow their company to stand the test of time.
Have the creativity to continue to develop their business well beyond their initial product.
In short, to successfully pitch a lead investor, founders must not only showcase their company's potential and the business proposition behind it, but also exemplify their own potential as a resilient and innovative leader. The most compelling discussions we have with founders are those where we walk out with a clear and strong articulation of the above points.
Like any partnership, the right allies can be grounding, while the wrong ones can become a drag on progress. Be intentional, be brave, and be selective in seeking out a lead seed investor.
