Monday 3 July 2023

Pitching in the shoes of the investor

This article originally appeared on the Matū website.

One of the biggest challenges for founders is the pitch – going to investors and asking for money. A lot of pitching resources tell you what you should present to investors – the pain point, the potential solution, why it will work commercially, the team that will deliver the solution, and how more money would help the team do that faster. 

But most guides don’t tell you what the investor is thinking about, what’s on their mind as they’re (hopefully) listening to you. If a founder can understand the context of the investor, then that should inform how the pitch is presented, and could increase the likelihood of developing a connection and relationship with investors.

So what is the investor thinking about when they take a pitch? Every investor is a bit different, but based on my 5+ years in the industry, here are some of the pressures they might not tell you about:

  • I see a lot of pitches and I don’t have a lot of time. A professional investor (i.e. fund managers rather than angel investors) will see a couple hundred pitches a year depending on where they work. I will probably aim to invest in 3-5 companies a year. Some investors are looking for quick declines so they can move on to the next one. What are the reasons to say no, but in a nice way?
  • I have limited funds to deploy. Every investor only has so much money they can invest, but the constraints you might read about in Silicon Valley are 10x tighter in New Zealand. There is less room for error, less appetite for gambling – so every pick has to be a good one. Does this opportunity meet our highly selective thresholds? Can I deploy enough into this investment round to get a meaningful stake without compromising portfolio diversification? Do we actually have enough money to make this investment and potentially make follow-on investments?
  • We have an investment mandate for a reason. Generally it comes down to what a fund has promised their investors the limits on investment will be. But many of the rules are there to mitigate failure risk as well, such as funds not allowing a single company or companies at a certain stage to be more than a certain percentage of their portfolio. More and more investors are caring about the impact and ethical implications of their investments too, but still expecting market-level financial returns. Does this opportunity fit the values and investment mandate of our fund?
  • Things can go very bad if I lose other people’s money. While some professional investors are using their own funds (or have significant holdings in their funds), most fund managers are investing on behalf of others. So what are the key risks of failure here and am I confident that they can be mitigated enough? Even if there is no financial consequence to the individual investor for making a bad choice, the fear of being judged poorly can be very powerful. Fund managers also have to pitch to investors to get capital for their funds, so they also have to meet milestones and deliver on what they promised. Will I be embarrassed (or fired) because others might say I took an unacceptable level of risk on this investment?
  • I have to convince an investment committee (or before that, my boss in the firm). Even if I really like an opportunity, most funds don’t let one person make investment decisions by themselves. We have teams because we all have blind spots, and if we work together we make higher quality decisions. The consequence is that I have to take what the founder is telling me and synthesise that into a narrative in my own head about why this is good for the fund. Some funds get the founders to present to the investment committee, but at the end of the day the internal champion/lead on the deal has to stand up and defend any recommendation to invest to the rest of their team – do I think I can do that here?
  • I know other investors in the ecosystem have already seen this opportunity. Humans are social animals and word of mouth is an important contributor to our thinking processes. Maybe the other investors are wrong or we see something that they don’t. But if lots of others have said no (or yes) then we should try to understand why to reduce the likelihood that we’re making an obvious mistake.
  • There’s more and more competition in the investment ecosystem, and other people in the fund (or our investors) might be mad if I pass on what turns out to be a good investment. While the current market conditions suggest that terms are leaning towards investor-friendly rather than founder-friendly, there are always going to be some opportunities that are just obviously very good. Multiple investors will want to be leading that investment round. What can I do to create an unfair advantage to win the deal? That might be moving faster to get an offer / term sheet to the company, or looking for ways to build more of a personal connection with the founders, or promising high-value connections. This is generally done in good faith but sometimes it doesn’t work out.
  • Do I like these founders? There is a lot to be said about getting good or bad vibes during a pitch, and sometimes you just have a personality clash. A fund that is very conservative and serious may not like “hype hype” founders who focus on style over substance, while confidence and charisma may be seen as strengths by funds more closely inspired by Silicon Valley. But if an investment is made, someone in the fund is going to have to engage with the founders on a regular basis in a long-term relationship, and it would help if we got along. We often refer to this as “alignment”. It only takes a few minutes (or seconds) for an investor to get a sense of whether they will like someone or not – human brains naturally look to identify in-groups and out-groups.

This is all in addition to what investors are supposed to think about of course, like “is the market big enough” and “what does the cap table look like”. But it’s helpful to remember that investors are humans too, you aren’t pitching to a robot or an immovable process. While investors may be following mental models of what makes a good investment, they face pressures that influence their thinking (consciously or subconsciously) too, and if you can recognise that you can better understand what is in your control and what is not. You can deliver the same pitch to the same investor on two different days, and get a very different response just because the investor is having a good or bad day. That’s not your fault as a founder.

So what can you (as a founder) do about this? 

  • Do your research on the investors you’re pitching to – check what their past investments have been, see if they have any writing that gives you a sense of their value set and ideology. 
  • Don’t assume that all investors think the same – be prepared to tweak your “standard” pitch deck to emphasise things that might appeal to a particular investor. 
  • Overcome the information asymmetry that inherently disadvantages you relative to the investor – they see hundreds of pitches, you only give one – talk to other founders about their experiences and which investors they value and rate. 
  • Give yourself as many shots on goal as possible – pitch to lots of investors even though it’s more work, and even if someone says no, ask if you can keep in touch and maybe present again when you’ve made more progress. 
  • Build social capital with investors – an investment is not just a transaction, it is a relationship that ideally goes on for many years, including before investment.

And, if you want a second (or third, or fourth) opinion, here’s what a bunch of other local investors and ecosystem supporters have to say about pitching and investment processes:

Thank you to colleagues Kiri Lenagh-Glue, Maria-Jose Alvarez (WNT Ventures), and Mitali Purohit (Nuance Connected Capital) for reviewing this article and providing feedback.

Monday 26 June 2023

Don’t judge a cap table by the Companies Office

This article originally appeared on the Matū website.

As an investor in the science and deep tech space, I hear a lot of hand-wringing on cap(italisation) tables. The official record of who owns what portion of a company, these tables can make the difference between an investor genuinely engaging with a company and tossing it aside with an offhand comment of “the cap table is screwed”. Investors are often looking for reasons to quickly say no, and the cap table is a common place to find problems.

There are lots of reasons for why a cap table might be deemed “uninvestable” – here’s Wellington-based angel investor Dave Moskovitz on “messy” cap tables, with a really good framework for understanding the challenges: As Dave writes: “Most early stage investors prefer a “clean” cap table, where the founders haven’t given away too much too soon, have retained a lion’s share of control, have steadily built value over time, have attracted a small number of smart, respected, aligned deep-pocket investors all wrapped up in a tidy package.”

But the message to add here is that investors shouldn’t judge cap tables too quickly. There is often more story and narrative behind the scenes that can significantly change perceptions, especially in deep tech. As an example, here’s a hypothetical cap table after one round of investment, loosely based on some real scenarios we’ve seen over the years:

ShareholderShareholdingEquity %
Founder A250,00019.6%
Founder B250,00019.6%
University Nominee500,00039.2%
University TTO75,0005.9%
Lead Investor150,00011.8%
Passive Investor50,0003.9%

If an investor saw this on the Companies Office, they might conclude that the two founders only have 39.2% equity between them – way too low after the seed round for the founders to be considered “sufficiently incentivised” to turn the company into a billion dollar proposition. The investor might criticise the university for holding 45.1% post-money (by adding the University Nominee and University TTO holdings together), as it could be implied that they “took” 53.5% of the equity at company incorporation before investment. But that could be a very wrong conclusion – what are some of the things hidden behind this cap table?

  • There is a Founder C, who wanted to avoid a perceived conflict of interest with a potential grant funder, so their 15% (pre-ESOP) stake is held on their behalf by the University Nominee. Everyone agreed it was a practical solution to manage a potentially perceived but immaterial conflict.
  • The 5.9% held by the University TTO is for a financial capital contribution made from their investment fund, and therefore should be treated the same as any other financial investor, not as baggage from a spin-out.
  • Accounting for the above two points, the pre-investment equity holding from the university is 30.9% (held in the University Nominee only). You can still argue whether this is too high or not, but don’t argue with me because this is a hypothetical scenario. In exchange for this, the TTO has covered the costs of protecting IP (which will be assigned to the company for free when it raises a couple million dollars) and the university is providing a lab lease for free for two years, in addition to grants and operational support pre-investment. All in all, this was a couple hundred thousand dollars worth of value, before any investor was willing to even hear about the project.
  • There is a 15% ESOP pool, which appears in company spreadsheets to calculate fully diluted shareholding but doesn’t appear on the Companies Office. Some of that is allocated to the three founders but it is mostly allocated to other key staff. Staff in the company (including the founders) hold 61.1% of the company fully diluted. The investors are holding 18.3% fully diluted. I’m not saying that this is necessarily a good or bad split, just that it might not be what you expected from the table above.
  • Founder B is close to retirement, and is planning to leave the company in three months. Half of their shares are unvested and will be bought back by the company for $1 in aggregate and then reallocated to the ESOP pool.
  • At this stage, the company has received one tranche of funding out of two scheduled in the subscription documentation. In the next couple of months, if the company achieves its milestones, the current investors will pay a smaller second tranche into the company, bringing them up to 25.2% fully diluted.
  • The passive investor is one that has historically had a poor reputation for being difficult to work with, but there has been a change in management in that fund recently and the new folks are much better to deal with and provide more support to the company – they just haven’t met with most of the ecosystem yet and are slowly rehabilitating their image.
  • From the Companies Office, you can’t see that the investors all hold preference shares, while the founders and university nominee hold ordinary shares. This means that in the event that the shares are liquidated, the preference shareholders will be paid out first to recover their investment before the ordinary shareholders are paid.

Doesn’t this all seem like pretty material information to understanding how to interpret the cap table? The context paints a very different picture of how much equity the key people in the company hold, and how “active” the shareholding is. It seems unfair to me to dismiss an investment opportunity simply because a search on the Companies Office has returned an “uninvestable” cap table. A fully diluted cap table spreadsheet in the data room might reveal a bit more, and hopefully the founders have added some notes to explain things like Founder C’s nominee shareholding. Maybe it’s more fully explained in an Information Memorandum (IM), or we just need to talk to the founders to find out more. Communicating the nuances of a complicated cap table is challenging for founders, but as investors we need to ask the right questions too.

A more comprehensive cap table in the data room might look like this:

ShareholderCurrentAfter Tranche 2
ShareholdingEquity %
(fully diluted)
ShareholdingEquity %
(fully diluted)
– Founder A250,00016.7%250,00015.3%
– Founder B250,00016.7%125,0007.6%
– Founder C
(held by nominee)
– University TTO75,0005.0%112,5006.9%
– Lead Investor150,00010.0%225,00013.7%
– Passive Investor50,0003.3%75,0004.6%

Some investors might be reading these hypothetical numbers and muttering “this is a dumb article, the cap table is still broken”. As Dave Moskovitz writes also: “There is no cap table problem so big that it can’t be solved.” Yes, recaps (recapitalisation) are painful for everyone involved, but sometimes they are necessary and investors should be prepared for them. If a company is otherwise successful – good tech, good commercials, good team, good almost everything – it seems regrettable that a company could fail to raise capital just because of a cap table, something that is constructed by the humans involved in and around the company and in their control. There is enough uncertainty and risk in all the other parts of the business to let internally negotiated finances be the pitfall.

All of this is to say – jumping to conclusions may mean an investor misses out on a good investment opportunity, and ultimately that would be their loss. Don’t be lazy – spend a bit more time to get the full picture so that you can make an informed decision about whether or not the cap table is actually problematic enough to be a showstopper. And for founders, if you know you have a complicated cap table, front foot it in your pitch or IM with potential investors.

Thank you to my colleague Kiri Lenagh-Glue for helping review this article.