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Signals
The role of "who else has invested" in angel diligence
Assumptions
“I graduated from Texas A&M University.”
From this information alone, we can make a few statistically reliable assumptions.
This person probably says “Howdy.”
This person probably gives a thumbs up and says “gig ‘em” when they see another Aggie.
This person probably has a giant gold ring on their right hand.
Why are these safe assumptions?
Because those are things graduates of this institution are widely known for.
Do investors make similar assumptions based on who has already invested in a startup?
Yes.
The Observer Express
Don’t have time to read the entire post right now? No worries, here are the main points:
“How have you financed the venture so far?” is a great question to ask.
Investors care about who else has invested in a startup because the demographic of those investors says something about that company. They naturally assume certain features based on who has invested in a company.
It’s important to consider both the segment and unique characteristics of each previous investor.
There are always exceptions, so it is unwise to base a decision exclusively on who else has invested.
“How Have you Financed the Venture so Far?”
This is one of my favorite diligence questions to ask and has become a staple in my founder interview toolbox.
Why?
Because it naturally sets the stage to address several other related questions:
How much have you and the founding team invested?
How much have you raised from outside partners, and what form did that investment take?
Who else has invested?
The answer to each of these questions is important to consider before making a decision.
Today, we’ll focus on that third one: Who else has invested?
Special Opportunity for Readers of the Diligent Observer
Interested in plugging into the Texas angel investing scene? Join the Aggie Angel Network’s Texas Startup Showcase on March 22 from 10 am - 12 pm CT and consider 4 exciting Texas-based angel investment opportunities. Membership is normally required ($1,750 per year), but this special event is available at no charge.
Sorry Uncle Joe
Why do investors care about who else has invested in a startup?
Because the demographic of those investors says something about that company.
For example, which of the following startups would you invest in, all else being equal?
Startup 1: Raised $100K via SAFE note from Uncle Joe and Aunt Sally.
Startup 2: Raised $100K via SAFE note from Sequoia Capital.
My bet is you’re going with #2.
Why is that?
Signals
Just like we assume a graduate of Texas A&M will have certain identifiable features (language, mannerisms, physical markers, etc), so too do we assume certain features based on who has invested in a company.
If I see Sequoia Capital as an investor, I immediately assume that a certain level of institutional rigor and relationship building were involved in that firm’s decision to invest. I assume certain “markers” were present that qualified this company to ultimately receive Sequoia’s money. Plus, I assume Sequoia’s team is going to be meaningfully involved in supporting the company’s growth over time.
In contrast, while its certainly a good thing that the founder was able to raise from Uncle Joe and Aunt Sally, the assumption I make is that this investment decision was primarily based on personal trust and relationship, not a deep understanding of the business. I also assume they’re unlikely to provide anything more than moral support for the entrepreneur.
See the difference?
What Should I Look for When Considering Investor Demographics?
When analyzing a cap table or interviewing an entrepreneur to understand who else has invested, there are two basic categories to consider (excluding considerations related to the amount invested):
Segment: The role this investor plays in the ecosystem. From this, we can imply generic information about diligence rigor, risk tolerance, and deal structure.
Unique Characteristics: The unique features that set each investor apart from others in the same or similar segment.
Segment
Here are 7 common investor segments to pay attention to. These are listed in order from most to least risk tolerance, and I’ve also listed and visualized some “general” assumptions regarding levels of diligence rigor, risk tolerance, and deal structure.
Founders: No diligence, highest risk, little/no structure. Heavily vision-driven.
Advisors: Little/no diligence, high risk, minimal structure. Driven by vision and desire to give back.
Friends and Family: Little/no diligence, high risk, minimal structure. Driven by vision, personal trust, and desire to support the friend or family member.
Angel Investors: Light/Moderate diligence, moderate/high risk, minimal/moderate structure. Driven by potential returns, desire to give back, and opportunity to contribute expertise.
Venture Capital Firms: Moderate diligence, moderate/high risk, moderate structure. Driven by potential returns & opportunity to contribute expertise.
Banks or Other Lenders: High diligence, low risk, high structure.
Characteristics
Here are a few investor characteristics to pay attention to:
Thesis: What are the specific investment criteria that a given individual or entity relies upon?
Process: What is the process by which this investor makes a decision? Is it known to be particularly rigorous, or particularly lax relative to others in that segment?
People: Who are the people behind the decision? Do they have particular expertise, connections, or information that may have influenced their decision?
Brand Recognition: Are they well-known?
Familiarity: do you know them?
Exceptions
Not every Aggie wears an Aggie Ring or says “Howdy.”
In the same way, just because someone else that I trust has invested does not, in and of itself, suggest I should too. Conversely, just because someone I disagree with or who has different characteristics from me has invested, doesn’t mean I should automatically pass.
That’s where the rest of due diligence comes into play.
Final Thoughts
Considering the signals sent by an entrepreneur’s previous investors is an important component of diligence, though it’s not the only one and should never be blindly relied upon.
Next time a deal comes across your desk, take a moment to consider the segment and unique characteristics of the company’s existing investors.
What do you think?
How important is it to you to understand who else has already invested in a deal?
Weekly Observations: 3 Lessons Learned
“Changing the blade” is a great investment.🚜🌱This week I gave my lawnmower some TLC. I replaced the blade, greased the wheels, changed the air filter, and generally cleaned it up. I couldn’t believe how much of a difference it made. Mowing was easier/faster (felt like 20% ish faster) and the grass looks noticeably better. Takeaway? Spending resources to keep your tools sharp and running smoothly is a great investment. This applies to business skills, teams, and organizations just as much as it does to my yard.
Consistency pays off.📖As you may recall, last year I wrote about a different segment of Angel Ops nearly every week for about 6 months. This weekend, I repurposed much of that content to finalize the first draft manuscript for the Angel Ops e-book, which we’ll be releasing in the coming weeks. It was deeply rewarding to see the thought and time I poured into those weekly articles compiled into a single, high-quality resource with over 25,000 words. Want to be notified as soon as it goes live? Complete this 1 question survey.
Focus on the problem.😵A few weeks ago I wrote about the importance of understanding the problem. This week, I was punched in the face by my failure to follow my own advice - I overengineered a solution that I never even got a chance to present because, upon further discussion with real live customers, it became evident that I was solving the wrong problem. Oof.
Weekly Links: 3 Things I Found Interesting
Thanks for reading, have a great week.
-Andrew
Special Opportunity for Readers of the Diligent Observer
Interested in plugging into the Texas angel investing scene? Join the Aggie Angel Network’s Texas Startup Showcase on March 22 from 10 am - 12 pm CT and consider 4 exciting Texas-based angel investment opportunities. Membership is normally required ($1,750 per year), but this special event is available at no charge.
If you enjoyed this post, please share it with a friend, colleague, or anyone else who may benefit.
P.S. - I recently finished creating The Angel Network Toolkit: 90 Resources for Cultivating a Thriving Community of Pre-Series B Investors, and I’m sharing it with anyone who refers a friend.
How did I do this week?
About Me
I cultivate flourishing.
I'm also the CEO of PitchFact, where our mission is to cultivate flourishing specifically through efficient and collaborative early-stage diligence. I'm a proud husband, grateful father, and honest friend. My love languages include brisket, bourbon, and espresso.