Last week, I was catching up with an entrepreneur who is in the middle of a fundraising process. He has received a couple of verbal offers and a few outlines of potential term sheets. One of the obvious differences between the investors he’s been talking to are how the investors operate. Generally, I like to think of it in two broad categories.
The first category includes investors who focus on the upside, what could be, and how big the opportunity is. In the first bucket of investors, it’s easy to hear in their commentary and see in their term sheets that the terms are very clean and simple. The idea is that we’re in it together, and if it goes great, everybody wins; if it doesn’t work out as expected, then that’s just how the cookie crumbles. Typically, the most famous investors in venture, the ones that have had the biggest wins, operate in this manner.
The second set of investors focuses on achieving some minimum threshold return with significant downside protection. In the second bucket, the focus is more on generating 3-5x their money in 3-5 years with solid downside protection. Downside protection is typically revealed in term sheets through things like participating preferred preferences, cumulative dividends, minimum returns, and funding tranches based on milestones. There’s nothing wrong with these other than they have to be accounted for when thinking through the different scenarios of potential outcomes of the business as well as the type of financial sponsor desired.
The key is that there are two major categories of investors, whereby one is focused on unlimited upside, and the other is focused on a minimum return combined with downside protection. When fundraising, entrepreneurs should understand the two categories of investors and think through the pros and cons of being upside-focused or minimum return-focused.
Entrepreneur
via https://www.aiupnow.com
David Cummings, Khareem Sudlow
