Lesson 2: Why do People Invest

Why Do People Invest?

People invest in start-up companies for different reasons. It may surprise you to learn that the reason is not always the projected returns. Investing decisions take on more emotional, psychological, and values-based dimensions in the early stages of a company, while company financial performance (numbers) plays a bigger role in later stages.

While investors want to make a positive return on their investment, other factors come into play when an investor decides whether to invest in a particular start-up. By being more aware of the spectrum of reasons, you will be better equipped to prepare yourself to appeal to different investors with different motivations.

In general, five factors influence how an investor decides to close on a particular deal / start-up / entrepreneur in the early stages of a new business. You might call these “intangibles,” as they can be very subjective.

Quality of the Leadership Team

• Does the leadership team inspire trust and hope in the investor? Does the investor believe in the CEO and the quality of his/her team? Does the investor believe in the vision of the founder?

• Ideas can come and go, but the quality of the CEO and the leadership team is enduring. Investors want to know that the leader of the company has a track record of accomplishment and knows how to grow a company – i.e., to go from $0 to $10 million to $100 million to $500 million. The charisma or intelligence of the CEO can inspire investors to trust in the strategy because a highly intelligent leader crafted it.

Practicality

• Is the idea of the start-up grounded in common sense? Is it understandable to the average person? Is the company addressing a problem that is practical and affects many people?

• Some investors choose to invest in a company simply because they can understand the purpose of the company, as opposed to looking at a company that is so technical that the investors cannot make out what the company does. It is easier to go with a company that is understandable than one that may have a better product, a better business model or a better total addressable market size.

Values

• Does the start-up put the same value on the things important to the investor? Do they share similar values?

• Some investors want to know that they are investing in a company that has a similar worldview or similar values as they do. It makes the investor feel closer to the company, making a difference in the world. For example, the values of the company may reflect a commitment to doing business ethically, in an environmentally friendly way, and connecting disconnected people.

Industry of Interest

• Has the investor invested in other companies in the same industry? Does the investor have insights about the industry? Is there a certain comfort level with the industry because of the market dynamics or historical record?

• Certain investors can provide industry connections or offer industry-specific advice. Some investors like to invest only in tech companies that serve the financial industry. Other investors like more innovative industries or will go out on a limb with a cutting-edge product. Certain investors like the growth rates in a certain industry. Some investors only like consumer markets, while others prefer business-to-business (B2B). It could be simply a “comfort zone.” You can do research on where your target investors have invested in the past.

Investing in the Future

• Is the investor motivated by funding the future of innovation for something significant?  Is the investor interested in having bragging rights of getting in on the ground floor of a bold vision that reimagines the future?

• Some investors are willing to take the higher risk to invest in unproven start-ups because they see the opportunity to provide funding for a better future. Their imaginations get caught up in the investing. As part of a diversification strategy, it can also be a small percentage of their overall investment portfolio. But the wilder and bolder the idea, the better for the 5% that an investor, for example, will invest as part of their $10 million overall investment portfolio. The investor feels pride in funding an effort to reshape the future.

Moving from Intangibles to Tangibles

As a start-up progresses and more investors consider investing, expectations go up across a broader swath of investors to see financial numbers backing up the big vision.

If an investor comes into a potential deal with a company that is in a later stage, he/she would want to see the financial performance over the previous quarters to make sure that the company is managing resources wisely and is gaining traction in the market. They may still consider one or more of the above-mentioned factors that are used in early-stage start-ups, but the numbers clearly increase in importance.

Also, investments in later-stage start-ups can involve more groups of people making more impersonal decisions, as opposed to individual investors who are making personal decisions based on their gut or emotional connection to an idea or team or possibility.

Specifically, institutional investors, such as limited partners of VCs (pension funds and other big pools) or family investment offices, become more prominent and want more predictable returns. They also more closely evaluate the opportunity cost of investing in your company vs. investing in another company. It’s less about investing in or funding a marvellous future, and more about making sure their money will work for them in your start-up ecosystem.

Know What Triggers Investors

It’s smart to know the triggers of your target investors – in what stage of start-ups do they like to invest? How much risk do they tolerate? What are their expectations?

You should be able to tell a story about your start-up that appeals to both early-stage, go-out-on-a-limb-with-intangibles investors and later-stage, safer-bet, tangible-minded investors. Some investors may be a little bit of both, and you can appeal to both sides in the same investor.