How do you get investors to trust you?

For any investor to invest in a startup, they need to have a lot of trust given the scary statistics on how many startups fail.

You can even divide this trust into two things the investor must believe in: trust in the business opportunity (that the problem you are trying to solve is real, that the market is big enough etc.), and trust in your team (that you have what it takes to deliver on the opportunity).

But there is a big difference between early- and late-stage startups when it comes to how trust is generated. 

If you’re a late stage startup, you have a product, users, paying customers and revenue, and a team that have delivered the above. What this means is you have a lot of historic data, that is both quantitative and qualitative, to support your claims. You are able to provide credible answers to tough questions like: What is the cost of getting a customer? How much are they willing to pay? and How big is the market? Real data beats every scenario analysis there is. If you have customers paying, that is proof – and proof generates trust. Of course, they still have to have trust in you and the team, but it’s relatively easy to convince investors about the business because you have real data.

But what about an early-stage startup? You might have a beta version of the product, maybe you have some users, but you probably don’t have paying customers yet. You’ve hopefully convinced a few people to join you, but it’s likely to be an incomplete team. You have very little performance data; it’s all about the future. You’re saying, ‘I think there’s a big market; I think my customer would pay for this cool product if I made it.’

Early-stage startups should of course explain the business and market opportunity, but it’s really 80 per cent about you and 20 per cent about the business.

If it’s all about trust, how do you get early-stage investors to trust you?

There are two different types of investors: those you already know, and the rest. Perhaps you have an acquaintance, or friends and family, who know you and have the means to invest in you. Great, they know you and therefore trust you (and, if they don’t trust you, perhaps you should look in the mirror). Most startups will have to go beyond their personal network and approach investors they  don’t know at some point. When they do, they will need to build trust. The key point here is that trust is built over time. You’re unlikely to trust a person you have met for half an hour. This explains why you can’t expect to get the money on the same day
you meet a potential investor – there’s no personal trust. Even if they think you’re cool, feel you have what it takes, and you have a great business, the chance you’ll get money the same day or the day after you meet is tiny.

Entrepreneur turned venture capitalist, Mark Suster, from Both Sides of The Table, said, I don’tinvest in a dot, I invest in a line.

Imagine yourself as a dot on a graph with performance on the y versus time on the x. Even if your performance at a given time is good, investors want to see a line so
they can see you at different points in time. Investors look at entrepreneurs they heard about six months ago who had great plans for the future, and when they meet
six months later they may see they’re still not quite there yet but the line is going in the right direction.

As Lars Andersen, General Partner in SEED Capital, explains: The most common mistake startups make in relation to contacting VCs is that they make contact too late. Seriously, it’s about sticking your neck out there. Your product doesn’t have to be perfect. Build a minimum viable product, use it to learn about your customers, and start contacting VCs. We might say that it’s still too early, but that doesn’t mean never. The now successful wine scanner app, Vivino, had a first productthat was absolute crap, but they gave us something to work from.

This creates a paradox for many startups. You should not count on VC money too early since in reality they invest rather late in the process, but you need to begin building relationships with them early on. They need time to get to know you before they invest their money – just make sure you don’t waste too much time
on coffee with VC partners!

 

What does this mean to startups? You have to build relationships with potential investors before you need the money – you shouldn’t wait until you have everything in place. Create relationships now.

Premature scaling at Addwish

What happens when two inexperienced entrepreneurs get millions in Venture Capital funding? Sometimes it ends up with premature scaling and near-death experience, as in the case of Addwish.

Background: Addwish was initially a wish list solution for consumers and online stores that allowed users to manage the registration and purchase of gifts. The company was started by Brian Petersen and Kasper Refskou Jensen as a side project, which both worked on part-time. The two co-founders had managed to sign up a hundred web shops and had a total of 20,000 users who had tried their service. In early 2013 the company received a €1.5 million seed investment from venture capital fund Sunstone. Now the goal became to do an international rollout – very fast.

Kasper Refskou explains:

For the first year we had a goal of one million consumers on the wish list – a 50-fold increase! This meant a fast ramp-up from two part-time employees to 12 full-time employees during Christmas 2013. We also started to spend heavily on marketing, including some heavy Adwords campaigns for user acquisitions in the US. This led to a sharp increase in burn-rates, which rose to €100,000 a month. The initial strategy was to build a critical mass of consumers (who use the wish lists for free), and then monetize on the web-shops.
We just didn’t manage to reach those figures. For the first year we got 100,000 consumers – a huge growth, but only 10% of projections. So since the revenue stream from the web shops was still not in effect, this slower-than-anticipated growth was critical.

But the worst part was that we didn’t recognize until way too late we were heading in the wrong direction. We had lost our objectivity during the rush for the Christmas season peak. Despite so many clear signals of low traction in the consumer market and being unable to achieve the key performance, we didn’t realize we were dying until we were actually dead! We woke up way too late, when we had only just made the initial entry into selling and revenue generation, resulting in the company being on the brink of bankruptcy by January 2015.

I guess this is what happens when two inexperienced entrepreneurs receive too much unrestricted funding. With too little guidance and supervision, we entered into a-way-too-high burn rate resulting in only one option: go big or go bankrupt.

In perfect hindsight, it’s easy to see what went wrong: we started scaling before we had reached a product-market fit. A wish list did not have a viral loop that was fast enough to meet our goals. When you share something on Facebook it triggers the recipients to share it again straight away. But when you share a wish list, the recipient may like the product, but they don’t need to create their own birthday wish list at that exact moment, which is why the sharing and viral metrics take a lot longer. We were blind to this at that time. If we had noticed it in earlier, we could have changed strategy before it was too late.

Unlike most cases of premature scaling, this one ended well. Before going bankrupt, the venture capital fund sold its shares to a local business angel, Niels Henrik Rasmussen, who injected more capital into the company to keep it afloat. Admirably, the VC initiated and supported these changes in order to help the business survive.
With the new owner also came a new and improved turn-around strategy, now focused on building the B2B segment first. The company was able to become early-stage positive within seven months due to a rapidly growing customer base of 400+ e-commerce businesses.

Kasper Refskou elaborates:

Our turnaround made us focus on what we did really well: approaching the business segment (web shops), and making use of the technology that brings them higher conversion rates and larger basket size. If we were to do it all again, we would do it very much like we do today: “identify – test – adjust”.

Perhaps what you think is a goldmine, might not be. It’s essential to test out every initiative, being truly honest with yourself about the results. It may not be a bad idea, but perhaps the audience is not ready for it, the tech is not there yet or the adoption triggers are not present. But get the right people and make sure they see the vision as you do, and you will eventually find a way. Now that we are mainly focusing on the B2B segment, it’s quite funny to see that our wish list, two years after our big launch and missed KPIs, has gotten more air beneath its wings. This time, without any marketing-related initiatives, we can see that the 100,000 users have more than tripled, and that social sharing is slowly becoming our main acquisition channel for wish list users. Now we have also included the wish list data in our intelligent data analysis for even better personalization in our business offering. In some ways you can say that we have gone full circle – just the other way around.

Dilution – Splitting equity in startups

Many entrepreneurs are chasing investors but the real question any entrepreneur should ask yourself is, do you really want the investors’ money?

Why shouldn’t you? Well, first of all because no investor will be giving you the money for the sake of your blue eyes – except your mum and uncle, of course. The rest want something in return – a share of the company. In startup jargon this is called ‘dilution’, when your share of the company is diluted by investors.

The example below illustrates a typical dilution for a company that receives funding from the usual suspects at the different stages of the company. It starts with you getting a co-founder, and having friends, angels and accelerators invest in the company. Next you give shares to the first employee and later employees in the form of an option pool, and then you receive huge investment from a local venture capital fund and later an international venture capital fund.

So is going from 100% of a very small cake to 17% of (hopefully) a large cake worth it? This depends on your specific situation and what you really want to do with your startup. Is it more important for you to be in control of your company, even if it’s a small one, than to grow it into a world-leading company? Then you certainly shouldn’t go this route! But if you have a startup where you need funding to grow, or grow fast enough, VC and other types of investors might be exactly what you need!

You should ask yourself: Do we really need the money? Will the money really make a tremendous difference for our company – or could we achieve what we want without it? And if we need money, do we need it now or could it wait till later?

It’s hard to find entrepreneurs who regret they didn’t take in external investors earlier in the journey, while it’s easy to find entrepreneurs who regret taking in investors too early when (they know with hindsight) they would have been able to bootstrap longer.