How to vet your investors – and why you must
Investors are used to bombarding potential investees with questions – but the nitty-gritty details of investors are fair game too, and social entrepreneurs should feel empowered to push for answers. Alex Evangelides, investment director at FINCA Ventures, has six questions to include in your checklist.
In the arena of impact investing and social entrepreneurship, the most successful investor-investee relationships function like a partnership of equals, not unlike a marriage. Too often, however, a perceived power imbalance disrupts this dynamic: Investors write the cheques, so they’re in control. It’s not surprising that many entrepreneurs become intimidated in this context. The reality is that the relationship is (read: must be) a two-way street.
At FINCA Ventures, I work day in and day out with early-stage social entrepreneurs, leading all aspects of the investment process, from pipeline development, to due diligence, to portfolio support. As an investor, I spend my days peppering potential investees with loads of questions. However, it’s worthwhile to pull back the veil that cloaks investors in our space and give entrepreneurs some practical tips so that they are empowered to conduct the same due diligence on their potential investors.
Dispelling the myth of the one-way street
The unspoken power imbalance in the world of venture capital implies that investees need investors more than the other way around. This is not the case. What would investors like us do without promising entrepreneurs to back?
The unspoken power imbalance implies that investees need investors more than the other way around. This is not the case
As early-stage enterprises look for startup capital, the pitch process can feel one-sided. Investors expect impressive pitch decks, financial models, data rooms and direct access to customers and stakeholders across the value chain. Entrepreneurs do not get nearly the same volume of information or line of sight.
Yet, questions about the nitty-gritty details of investors are fair game and entrepreneurs should feel empowered to push for answers. Even the brightest founders can set themselves up for failure by not asking the right (or any) questions. Investors who shroud their investment process in unnecessary mystery compound this power dynamic and do a disservice to the impact investing landscape.
Six questions that social entrepreneurs should ask their potential investors
So, what questions should entrepreneurs ask of their potential investors? To begin, work backward from the ideal investor. Consider the most desired “value-adds” and the hard “nos.” Here’s a list of questions that every social entrepreneur should use to vet a prospective investor:
1. What is your investment time horizon?
One major stumbling block is misaligned timelines (or no timelines) between investors and investees. Answers to this question reveal when the investor expects their capital to be returned and, consequently, when they will be pushing company management to provide them with an exit (for example, a sale). If the investor is looking to exit in three to five years and the entrepreneur finds this unrealistic, well, that conversation is best had upfront.
2. What does your investment process look like?
Most entrepreneurs ask us just a few questions, if any at all. But if an entrepreneur is going to ask us one question, it’s this – and it’s a great place to start! (To make it easy, we post our investment process online and encourage other investors to be equally transparent.) This may include, “What kind of documents will you want to see? Who will you want to speak with? What are the key milestones along the way? How long does the process typically take?” If the entrepreneur is in a cash crunch and the investor frequently spends six months to a year churning through the investment process, then the company may be better off prioritising other investment leads.
3. What has been your experience investing in companies like mine?
An investor’s résumé is just as important as the entrepreneur’s but often much less accessible. Entrepreneurs must find out if the investor is venturing into a new industry, geography or deal size with the investment at hand. It’s important to understand what the investor can bring to the table in terms of expertise and connections. Entrepreneurs should ask to speak with other entrepreneurs in the potential investor’s portfolio. (I am surprised we don’t get asked this more often.) Fellow entrepreneurs are the best bet for getting an honest scoop on what it’s like to work with the investor.
Entrepreneurs should ask to speak with other entrepreneurs in the investor’s portfolio. I'm surprised we don’t get asked this more often
4. How do you balance impact and returns?
Some investors believe that there is an inherent trade-off between social impact and financial returns; others do not think that any sacrifice is needed. Entrepreneurs should find out where their investors stand. Are they looking for commercial (e.g. market rate) returns? What are their expectations regarding social impact and how will they measure it? Knowing where investors stand on these dimensions gives entrepreneurs a good indication of what they will be pushed to achieve.
5. What role do you expect to play post-investment?
Investors can be very hands-on or hands-off after writing a cheque. Both approaches have merit, but the entrepreneur must know what s/he is signing up for prior to taking on investor capital. Set clear expectations so that both parties are on the same page. This opens the door to dialogue with fund managers and investors and will shape the parameters for the partnership early on.
6. What is the structure of your capital and what is the source of your funding?
This final question is perhaps the most intimidating for entrepreneurs to ask, but it’s crucial. Capital structure and fund sources may be incredibly revealing and doing the hard work to make sure you understand this clearly is worth the time. If an investor says they are impact-first yet their capital flows from commercial sources, you may want to dig deeper. Look for inconsistencies like this.
If a fund or investor is in the midst of its own fundraising, then their interest in the deal may be tethered to their ability to close capital, which is more often than not a protracted process with frequent delays. Entrepreneurs should feel empowered to ask about the size of the fund, where they are in the fund cycle and how much capital has been deployed to date to ensure they do not get caught in this trap.
Entrepreneurs should be saying no to investors more often. At the same time, investor transparency is a vital part of the discussion
Of course, for early-stage enterprises, we understand that capital is capital and choosiness is a luxury. Our team genuinely hopes that power continues to shift toward the new wave of entrepreneurs who enter the fray armed with this guidance. To put it bluntly, entrepreneurs should be saying no to investors more often. At the same time, investor transparency is a vital part of the discussion. Being forthright about the investment process, publishing more information publicly about your portfolio and mandate, and engaging with the questions suggested here will help drive more “equity” in the social enterprise ecosystem.
- Alex Evangelides is investment director for FINCA Ventures, an impact investing initiative by global microfinance pioneer, FINCA International.
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