I’ve spent a lot of time lately thinking about how the Australian (in particular) investment market is segmented. This is mostly in response to talking to people who are thinking about raising money, and wanting a better way of easily communicating my perspective and philosophy as it develops.

In the last few years, Australian venture capital (VC) has heated up in addition to the local startup sector growing, and additionally returns from asset classes like property and equities have cooled (a bit!) – not to mention increasing government incentives to invest in startups (e.g. ESIC legislation, ESVCLP structures etc). This has created a perfect storm of (a) more capital flowing into VC funds ($568m in 2016-17), and (b) more startups out looking for money ($347m deployed 2016-17).

So how should a startup pick the right investor?

I’ve tried to be as general as possible here, but my caveat upfront is that this advice is probably most useful for startups in their earlier stages (raising < $5m) as this is where I have both investing and operational experience. Additionally, everyone’s business is different and what I think works may not work for you.

Finally, I’m still in the early stages of my journey as an investor – I’ve invested in 5 or so companies (and advised a lot more) in addition to running my own.

Do you need money? ‘Right amount’

The first question a smart founder should ask is whether they need money in the first place.

Of course, if you don’t need money at all, then everything is very different – being profitable doesn’t preclude investment, but makes it all the more vital to pick a strategic investor. You also have time on your side.

But let’s assume that for whatever reason you can’t bootstrap or otherwise have a cashflow positive business at this stage¹The assumption that fundraising is the path to success is both dangerous and wrong, and a lot of businesses can be ‘bootstrapped’. More on this, though, in a different post altogether..

So you need to raise some money. But how much do you raise?

Under capitalisation is bad

The risk of under capitalisation (not raising ‘enough’ money) is obvious. You will spend more time fundraising (which is bad, see below), and you run the risk of either not having enough capital to grow the business, or of course running out of money (‘runway’) altogether.

The rule of thumb is that you want to have at least 12-18 months of ‘runway’ straight after a raise in the early stages (‘seed’ and maybe series A), with the runway post-raise being longer as the business matures and investment amounts increase.

Over capitalisation is also bad

The risk of over capitalisation (having too much money) is frequently ignored but is just as risky. If you have too much money, you lose ‘the hunger'²All good businesses and founders need to be hungry: they need to want to win. Again, a post for another day., and you become too relaxed, or alternatively splash cash when it’s totally unnecessary or potentially dangerous to do so.

Working out the right amount

Of course, there isn’t some kind of magic formula you put some numbers into and out spits how much you should raise. You need to have a plan for how much capital you will need over the next 12-18 months. Think of it as a budget (P&L ideally) that considers:

• ‘keeping the lights on’ – the basic costs of the business today³Rent, servers, accounting, legals, advertising, paying your staff, paying yourselves (don’t forget this…)
• who you will hire to help the business grow⁴Don’t just arbitrarily project this – will you hire two engineers and one salesperson? What will the mix be?
• any major opex investments ⁵Like software subscription costs – implementing Salesforce isn’t cheap or capex investments ⁶If you’re building hardware, are you going to need new machines over this period?
• the costs associated with growth based on a reasonable target⁷e.g. to grow at 10% month-on-month, I need to have X new customers. At our current CAC (customer acquisition cost), this will cost $y., and
• how much revenue you expect to (conservatively) bring in to offset costs⁸This ought to be non-zero but depending on your business model it may be.

Is now the right time to raise? ‘Right time’

You are either raising money or not raising money. Never do both at once.

One important maxim in startups is that you are either raising money or not raising money. If you are ‘maybe raising money’ you have lost focus and wasting your (and investors’) time.

Of course, while you’re raising you still have to keep the business operating – it doesn’t just shut down while you talk to investors – but the founding team loses a ton of focus throughout the process of meetings, due diligence and closing the deal.

You might have a ‘dream investor’ ask for a meeting soon after you have raised money and you have 12-18 months runway in your bank account. Be weary of saying yes to a meeting – a mature/serious investor will understand if you tell them that you aren’t raising money right now, but you will keep them updated or their details on file for when you next are. Or take the meeting under that proviso – it’s a coffee talking about a potential future raise, not you ‘reopening’ your current round.

Who is right for you now? ‘Right stage’

The first question a smart founder should ask is who is right for them now. You need an investor that matches the type of stage that your business is now, and who can shepherd you through to the next stage⁹The next stage might be profitability or another investment round – either outcome should be treated equally!.

Don’t go barking up a tree of a massive fund who typically invests in the millions of dollars unless you are looking to raise that kind of capital, or unless they often invest earlier as a ‘holder’ for a future round¹⁰We’re seeing more and more of this in Australia as competition increases for the best Australian startups and as VCs need to get money out the door – the bigger funds will invest in early stage companies at seed to ‘reserve’ a spot in their series A down the track. Whether this is good or bad is a different thing of course, but you need to be aware of how and why you are approaching them..

Here’s an overview of the kinds of funds/people you might approach. Note though that there is a lot of flexibility and crossover, particularly the later 2 stages – the best way to understand each group is to talk to them, look at past deals, and read what they say about themselves.

Stage	Idea/traction	Initial scale/growth	Expansion
Raise 'type'	Seed	Series A/B11A series B on the smaller side!	Series B/C+
Your startup valuation	$1-3m	$5-25m	$25m+
Your startup team size	1-3	5-30	30-200+
Total round size12This is the total amount you're raising – not how much these investors might individually put in. Usually, even at later investment stages, you will have a group of investors who share the risk, albeit with one 'leading' the round.	$100-500k	$1-8m	$5m+
Fund size	$20k - $20m13Yes, this varies a lot, as some VC funds ($10-20m) might specialise in seed investing, while obviously individual angels are unlikely to have that much capital at their discretion.	$50-200m	$100-500m
Examples	Angel investors Syndicates Early stage VC funds FFFs14"Friends, family and fools"	Blackbird Ventures Rampersand Family offices (Airtree Ventures)	Airtree Ventures15However they do play in other stages quite extensively Blue Sky Venture Capital Accel Andressen Horowitz

What do you need help with (if anything)? ‘Right alignment’

Now is when we get into the nitty gritty. Broadly, founders have three choices when looking at the alignment between them and their investors.

1. Smart money: adds value and takes an active role in the business.
2. Just money: doesn’t really add value, but it’s money. Cares about the business but not actively involved (at this time, or ever).
3. Destructive money: tries to add value but fails and takes an active role in the business.

A typical startup raise will involve some of (1) and some of (2), but the key is obviously to avoid the destructive money at all costs. But let’s look at each category individually.

Smart money

Smart money helps you with your business, at the stage you are currently at through to the next stage.

The second part of that sentence is vitally important, because in the same way your business has different capital requirements across its lifespan, it also has different advice and perspective requirements.

Smart money may be from an angel/individual or it may be from a fund. But it will come from someone who can add value in one or more ways. For example, they might help you:

• create your go-to-market strategy (sales/marketing/internal systems)
• understand core technology challenges
• hire new employees
• meet new investors
• meet prospective customers
• have some accountability to a ‘board of advisors’ (or actual board of directors)
• create and structure teams and organisational hierarchy appropriate to your business’ stage
• find businesses you can acquire or merge with to grow
• get an acquisition offer, or
• complete an IPO.

Every business is different, and every investor is different. But as someone raising money, you need to understand what you want in addition to just cash.

If you don’t want anything in addition to the money, don’t raise from people who like to be active and/or who think that they are ‘smart money’ in your round. You’ll end up doing battle with them on many fronts, and nobody will be happy.

If you want something in addition to the money, be clear about what it is. Of course, everyone would say that ‘meet new investors’ is important while you’re raising for a round, and you should always ask people you meet with for introductions to relevant investors for that round that they might know. But this is more about meeting investors for the next round/stage – are they connected to the right people for an IPO or series C for example?

If your startup has certain critical success factors ¹⁶Critical success factors are the things that are absolutely necessary for you to succeed. It might be actually creating the product/service, marketing it, entering a new vertical, building an enterprise sales team or anything else – but know what it is!, make sure you find investors with the right alignment.

Don’t mistake the amount someone invests in their potential value as an investor. This is particularly the case early on – just because one person has invested (say) $10k and another $100k doesn’t make the $100k person’s thoughts any more valuable¹⁷They may or may not agree with this sentiment however!.

Keep in mind though that some investors may ‘follow on’ their money (or at least expect to), while others won’t. A good example is the VCs playing in an early stage – they are absolutely planning to follow their money through, which has implications when you go to the next round.

Similarly, if you want someone to take a more active role, then talk to them about what that might mean. What kind of expectations should be set in terms of how, where and why they will help? Will it be more structured, or ad-hoc¹⁸For example, angel investors who are actively running another company might not be able to sit down with you for a few days, but can definitely give you some quick thoughts about the best advertising strategy for example.? What happens if you disagree¹⁹This should always be ‘founders get the final say’ unless you’re at a later stage and you no longer have full control, in which case it becomes ‘the board gets final say’ regardless of whether the investor is on the board…? A smart, value-adding investor will respect and appreciate having the conversation and clarity here.

Don’t confuse ‘yes investors’ with smart money. Investors who always think things are going well can be very useful (everyone needs encouragement after all), but a good ‘smart money’ investor will challenge you and ask hard questions at the right times. It’s a partnership, and they are there to help you throughout the journey, even when things are going badly²⁰They might help you communicate to other investors when things are going badly for example – ‘just money’ often reacts badly to bad news, and while sugar coating it is a terrible idea, they can help you come up with the plan for how you will respond and you can take the bad news and the plan to the other investors.

For example, I can say that for most of the investments I do, I like to take a fairly active role where I can help and add value. That has certain implications for the kinds of businesses I invest into²¹Something I should write about, but in short my experience is in B2B business models, marketing/ops/sales and SaaS. I also don’t write massive cheques or participate in big multi-million investment rounds – I am just as happy giving a perspective to a later stage company as a ‘coffee contract'²²You pay for the coffee but that’s it, I have no obligation to follow through or spend tons of time with you if I can’t. rather than investing when I will end up with negligible upside if you succeed. I’d rather conserve my capital for other small companies that I can work with to ’10X’ before the next round.

As your startup grows and matures, you can expect the things that ‘smart money’ helps with to change over time. In particular, you’ll have more and more internal knowledge and talent to tap into rather than needing the thoughts of outsiders who don’t always know the full context of the business²³Another post for another day….

Just money

Sometimes it might just be money. These investors usually have a particular key motive for investing, like the belief that you are going to make them a lot of money, wanting to just help you out, or maybe to keep an eye on you so that they can invest more at the next stage.

For example, as more bigger VC firms start investing at earlier stages, they often don’t have the bandwidth to take an active role. That’s totally okay – they will help you out in certain areas if you ask them of course, and expect to be the first port of call when you look to raise your next round.

‘Just money’ doesn’t mean that you should write them off. Keep them updated like all of your investors – and make sure you understand why they are investing so that you can know what they expect.

The more knowledge you have about your investors, the better you can target and tailor your investor relations (e.g. investor updates).

Destructive money

Nothing destroys startups faster than bad advice that you feel obliged to take. Or bad advice that you think is good advice for that matter.

Sometimes investment is simply destructive. Maybe it’s from an angel who was very successful in a different but irrelevant industry, who thinks that they can apply their own experience into your segment. Or maybe it’s from someone with 50 years experience who experienced a company at your stage 20 years ago, when the market was totally different.

Maybe it’s from someone (person/fund) who is used to businesses of a certain size (e.g. $10m+ revenue a year) when your company is not there yet (a $1m yearly revenue company is very different to manage, operate and structure than a $10m one).

Or maybe it’s a fund that needs a fast exit when that isn’t the right thing for the startup right now.

Importantly, destructive money isn’t ‘malicious money’. Most of the time, this group won’t realise that they aren’t providing the right kind of advice (otherwise they wouldn’t). So don’t react like they are intentionally trying to pull your business apart – that will never end well for anyone involved.

Be very careful about destructive money. It can and will either destroy the business, or at a minimum waste a ton of your time.

Setting expectations is important, and there is no more important expectation than when you can ignore advice. The answer is almost always that you can and should only take and use the advice that you think is right²⁴This does get more complicated at the far later stages of a company where boards get involved, but even then the CEO/exec team should have the final say, even if it needs board approval..

Adding it all up: what it means for you

In summary, here are the main questions you need to ask yourself when fundraising and/or choosing the right investors.

• How much money do you need and what is the minimum/target/maximum you want to raise?
• Are you currently raising money or not?
• What stage is your business at?
• Do you want ‘smart money’ or ‘just money’ investors?
• What are your knowledge gaps, and where could someone value-add to your business?
• How do they think they can help, and is that aligned with what you think you need?

Finally, don’t be afraid to ask for a reference in addition to talking with people you know who have worked with them in the past. Do other people they have invested in think they have been value adding? Have they followed through on their promises, like how they will be involved? Are they a ‘good person’ and easy to work with? Do they ask the hard questions?

I haven’t talked about how to find investors, pitch them or understand term sheets. Save that for another day.