When your goal is to find an investor for a startup or growth company, it's worth dedicating careful attention to finding the right investor. Vesa Lehtinen, a seasoned entrepreneur and business coach at the Startup Factory, also acts as an angel investor for several companies. In this article, he sheds light on the funding criteria of venture capitalists and the typical progression of financing negotiations. Need assistance with financing? Explore our Incubator!
An investor for a startup or growth company can be an angel investor or a venture capitalist
Within the realm of venture capitalists, there are both angel investors and venture capital investors.
"Angel investors invest their own money, whereas VC investors invest funds from other investors," defines Vesa Lehtinen.
Venture capitalists are usually approached when financing is needed, but public funding and debt-based financing are not viable options. However, the involvement of a venture capitalist in a company implies mental preparation for selling the company or part of it in the coming years.
"When a venture capitalist comes on board, the company is stamped with an exit label, and the company needs to start building an exit strategy. The venture capitalist wants a multiple return on their investment, ideally within a 3-5 year timeframe. However, this shared journey often extends to 5-8 years," emphasizes Vesa Lehtinen.
What kind of investors should a growth company approach?
A company seeking venture capital should thoroughly prepare for contacting potential investors. The company needs to first consider the amount of capital needed and where to obtain it. The required amount provides an indication of the type of investors to target.
An angel investor typically invests tens of thousands of euros in a company, while venture capital investments range from hundreds of thousands to millions.
"Venture capitalists are usually not interested in funding rounds below half a million," says Vesa Lehtinen.
"If the company requires several million euros, the angel investor field usually does not work because it would require forming a syndicate of several tens of angel investors," adds Lehtinen. According to him, only a few angel investors are willing to invest over a million in a company.
In addition to angel investors, it is advisable to attract at least one venture capital investor. This investor can act as the lead investor, bringing in other venture capitalists in future funding rounds.
"In smaller funding rounds, there are often 1-3 business angels and perhaps one venture capital investor specializing in early-stage companies," explains Vesa Lehtinen.
A potential investor for a startup or growth company can be found through associations
According to Vesa Lehtinen, the success of funding negotiations largely depends on finding the right investor to present your idea to.
"A company can waste a lot of time if it randomly goes through investors," he points out.
Therefore, the company's team needs to do their homework and strive to contact investors who, based on their criteria and previous investments, could potentially be interested. The selection of a venture capitalist also involves considering their approach and personal chemistry.
"In Finland, angel investors are quite well-organized. For example, FiBAN (Finnish Business Angel Network) is a good channel for finding information about angel investors. It's like a Tinder for the angel investor field. You might find a match there," Lehtinen laughs.
"Another association that startup entrepreneurs should explore is Pääomasijoittajat ry (Finnish Venture Capital Association). This association has more venture capitalists involved. Both of these mentioned associations are entities that companies seeking venture capital should get acquainted with," Lehtinen advises.
Preparing a compelling pitch deck is essential for meeting with investors and addressing their key questions. The presentation should be tailored to match the criteria of each investor.
"Both angel investors and venture capitalists are interested in the innovation of the service or product, potential patentability or existing patents, as well as the team's competence: the team must be capable of commercializing the idea. The team should clearly explain how the idea generates revenue," emphasizes Vesa Lehtinen.
"What is the realistic market potential of the idea, and what are the next steps? How will the product enter the market, how will it be commercialized, and how will the business scale after the initial market openings?" Lehtinen asks.
Investors are also interested in how the funds will be utilized. According to Lehtinen, an investor may propose, for example, dividing the investment into multiple installments. In such cases, the investor wants to see evidence of results from the team before proceeding with the next installment.
This is how financing negotiations with venture capitalists progress
The exact progression varies depending on the investor, but there are certain patterns in the process.
If an investor shows even cautious interest in investing in the company, they may conduct due diligence on the company.
"In practice, the company's financial situation is examined, the realism of budgets and plans evaluated, the team checked, and the level of the company's contractual legal matters verified (Legal DD). If it is a technology company, a separate due diligence is conducted for technology, also considering the protection of intellectual property rights, such as patentability or already filed patents," explains Vesa Lehtinen
If the investment opportunity seems interesting, the investor provides a funding offer, also known as a term sheet, outlining the terms on which the investor will participate in the company.
The terms often include the company's valuation, the amount and price of the investment, the number of shares, as well as the payment schedule and repayment conditions. There may also be a requirement for the company to provide regular reports, which may include a demand for a board seat. The company being invested in evaluates whether the offer is acceptable, particularly in terms of valuation.
"In principle, the company sets its own valuation, but the investor may express an opinion on the valuation in their offer. They may try to negotiate the company's price to obtain a slightly larger share with their invested capital," notes Vesa Lehtinen.
"In the end, it is the company's general meeting that approves the funding offer, unless the general meeting has authorized the board to close the funding round," says Lehtinen.
The investor brings their expertise and network to the startup or growth company
After accepting the funding offer, the ownership information of the company needs to be updated, and the company's strategy and reporting need to be adjusted according to the financing terms.
"The investor may demand special conditions in the shareholder agreement, in which case the agreement is revised. If the investor accepts the existing shareholder agreement, then the investor becomes a party to it through an accession agreement," explains Vesa Lehtinen.
Some investors may want a board seat or an observer role, along with potentially structured written reporting. Reporting is likely to increase with the involvement of a venture capital investor.
"It's generally easier to work with angel investors in the sense that it's easier to discuss terms with them, and the bureaucracy is lighter. VC investors may require fairly structured reporting," says Vesa Lehtinen.
A good investor improves the company's prospects for growth, internationalization, and development, which is why it is worth investing in selecting the right investor.
"The investor brings their own expertise and network to benefit the company. It brings more muscle to drive the company forward," explains Vesa Lehtinen.