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Speak the Language of Investors When Raising Capital for Your Startup

Recently I talked with a friend of mine, who is a financial adviser for big insurance company, but has specific interest in entrepreneurship, and we discussed the variety of backgrounds most of the entrepreneurs come from. Then he, surprisingly for me, said: “Well, nobody wants to get business lessons and advice from an engineer or developer.” This statement hit me as a thunder. Was it possible that many people, who even have experience in the sphere and close contact with many entrepreneurs, to still be that prejudice? Or maybe he was right?

But this got me thinking about the way investors look at the entrepreneurs and what do they see as a potential in them. Skills, talent, ideas, personality traits… This is all important, but the true thing that investors want from a startup is to make money, to gain profit. Don’t get me wrong, not all investors are people who chase only their own interest, but the facts are facts: the more successful you are the bigger revenue they make.

We often give advice to entrepreneurs, who don’t have tech skills, that they need to try to learn at least the basics of, let’s say, coding and software development in order to communicate effectively with the rest of their team. But, on the other hand, people who don’t have business experience must gain at least the minimum business and financial knowledge in order to speak the language of investors. The terminology might be confusing, might be difficult, but it is really worth it to be prepared to understand what the investors are talking about.

Many entrepreneurs don’t know how to protect their startups while talking to the investors, because they lack the right vocabulary. When we talk about investments, there is specific jargon and many important investment terms that are essential for the future of the company. It doesn’t matter what is your background, what is your business and who you are pitching in front of, there are some very important terms that you need to be familiar with before you talk with the investors. Be ready to speak their language in order to avoid misunderstanding and to evade making wrong decisions.

Know the difference between venture capitalists and angel investors. Both have their specific strategies and preferences but their main goal is to provide capital to the companies of their interest in order to make profit. Even though many startup owners think that there is no big difference, the truth is that there is and you must know it in order to make the right moves when approaching the investors depending on the stage of your startup. Angel investors are individuals who are investing their personal funds and are willing to invest in high-risk early stage companies. Angel investors often prefer to have specific part in the decision making processes and want to have active role in the company. Venture capitalist are individuals who work for venture capital firms that rarely have interest in early stage companies and they tend to come into the picture after the business concept has been proven and the business is promising high return of investment.

Know what term sheet is. Even though the term sheet is not deal binding agreement, it still shapes the content of the legal documentation. Entrepreneurs must carefully pay attention to the content of the term sheet in order to avoid future legal, let’s say, surprises. In the term sheets sometimes there are included unexpected binding clauses such as terms that forbid you to reach to other investors while you are still considering the offer that you have already received. It is very uncomfortable situation which can make your startup stick in one place for a long period of time.

When the investors hand you the term sheet, be careful and pay attention to details. It is important to have your attorney take a look at it. When you receive the term sheet from your investors, you will probably need some time, preferably weeks, to think and analyze the terms of investment. This can be possible, especially if the investors see good potential of the company. Remember, the investors are not doing you a favor by investing in your company. They have their goals and if they are willing to invest in your company, they expect revenue.

Know what pre-money and post-money valuation is. This might seem very complicated but it is not that hard to understand the difference. Valuation is the value of a company, fundamentally, the worth of the company. Pre-money valuation determines the value of the company before the investment and the post-money valuation determines the value of the company after the investment. Basically, the post-money valuation equals the pre-money valuation plus the new funding that you will receive. Why this is important, you may wonder? Because it determines the equity you will give to the investors after you receive the funding.

To summarize, it is important to pay attention to details when you talk with investors. All these legal details can unexpectedly harm the future of your company. Many entrepreneurs often ask themselves, “Are investors angels or devils?” Basically it depends on you and how prepared you are to face them.

─ February 16, 2015