Honest Advice for First-Time Startup Investors From a Long-Time Investor

Please resist the urge to get cute with your deal terms

Roy Bahat


Photo: Emmanuel Wong/Getty Images

Dear first-time angel investor,

It’s wonderful you’re considering an investment in a startup! As a VC who might invest after you, I’d like to share thoughts that may help — especially if you’re in a newer startup market where there are fewer experienced angel investors to offer guidance.

You’ve succeeded in other walks of life, so you might read this and think, “Who is he to tell me what to do?” I’ll make my best case — feel free to ignore me!

1. Embrace the downside

Fact: You will probably lose your money in this company. In almost every case, no amount of “structuring” or “risk mitigation” can protect you. The mythical profitable business that still needs your money and can also grow to enormous size is… rare. This startup you’re considering investing in probably isn’t it.

Naive angels worry about salvaging money from their losing investments — that is, “fixing the dogs.” It’s a fool’s errand (though supporting a founder emotionally during tough times is important). Experienced angels worry about keeping the upside by investing at a reasonable valuation so the winners actually make up for the losers.

2. Diversify

We only know one way to reduce your risk: take many bets. You probably need to invest in ~10 companies before you feel like you are getting a handle on things, and ~20 before you have good odds of earning a return.

3. Resist the urge to get cute with the deal terms

Yes, a shopping mall might thrive because an investor inserted a thoughtful covenant with the lender. Investments with known business models and predictable markets are just different than startups, which are defined by their search for a lasting business model.

Specifically avoid guaranteed returns (other than protecting your capital with the standard 1x liquidation preference), milestone-based valuations (complicated and perverse incentives!), extra control provisions (like a veto right on a sale when you are investing $10,000), options on the next round (other than the standard pro-rata), pre-negotiated sales before everyone gets liquid.

Quirky terms rarely survive, anyway. Later investors force their removal as a condition of investment. Sometimes, these terms even kill a startup because the cap table is too hairy for a good investor to wrestle with it. In startups, even more so than in life generally, simplicity wins, complexity kills, and the road to dissolution is paved with good intentions.

If you want a “deal” (that is, especially good terms), just be transparent and argue that you deserve it. Offer a lower valuation or valuation cap. If another investor will invest at a $3 million valuation and you will only invest at $2 million, tell the founder why you are worth more dilution.

4. Pay a market price (and avoid overpaying)

Know the market price for startups at different stages. Experienced angels know that by overpricing the initial valuation they actually may hurt the company — by hindering future fundraising. Down rounds can ruin businesses.

5. Control your urge to be in control

Startups with less investor control seem to outperform those with more. Startup investments run on trust. If you trust the founder, there are few areas where you’ll need special terms in the documents. If you don’t trust the founders, no special terms can save you.

6. Use standard startup documents

There are many standard forms you can use — like Series Seed if you want equity, or SAFEs if you want something else. These are tried and tested, and the only successful modifications we see come from experienced startup investors. Our fund even published the documents we use—including an explanation of the major terms.

If you are using convertible notes, find an experienced startup investor that has a standard note document without any unusual terms and copy their note.

7. Get the startup an experienced startup lawyer

Yes, you have your trusted firm with which you’ve done dozens of deals, and they have “startup” experience because they’ve incorporated new companies and negotiated private investments. And you trust your sister-in-law with your will and real estate. But startups are different. If you were arrested on a DUI, would you call your brother the tax lawyer to represent you? Use an expert — it matters.

The company’s lawyer must also be independent. We’ve seen cases where an angel thinks they’re doing a company a favor by setting them up with the investor’s lawyer. “We’re all friendly.” Good startups develop the habit of taking their own counsel.

8. Be fast and light

Know if you are willing to be the first investor, or if you want safety in numbers, and be clear about which you are willing to do. You can create damaging ambiguity hanging around the hoop.

Match your diligence to the size of your check and the stage of the business. Asking a day-zero company for five-year financials is a waste of their time and will provide no real information for you. Most experienced angels decide on investments of up to $100,000 in a meeting or two at most (though they often do substantial work calling references or validating assumptions with customers, etc.).

If you do too much diligence, you’ll end up with lemons. Good companies eventually have options. If you spend six months kicking the tires for a $10,000 investment, the startups who wait around for your company-proctology are more likely to be duds.

After you invest, asking the founder to report to you too frequently will only tax your own chances of success — “you can’t grow the pig by weighing it every day.” Imagine if every investor who had less than 5% of a business wanted a weekly update in person. (And, founders, if you want investors to be ready to help you and to stay off your back, then it’s on you to provide them regular updates — monthly is the default though quarterly is fine as long as you include real data about the important metrics.)

9. If you want the founder to respect your experience, you need to respect the limits to how widely your experience applies

Copy editing the founder’s website as a condition of making an investment is… probably a bad idea.

Maybe some of your experience bootstrapping a small manufacturing company in the early 1980s is relevant to an A.I. company in 2018 — most is probably stale. Business experience gets old like milk, not aged like wine. Explaining to employees that you’re going to miss payroll: relevant. Pontificating on which apps you think twentysomethings want: less so.

10. Your time is valuable, too

Think like a medic on the battlefield: triage. Spending half your week on the company that’s not going anywhere is a bad use of your time. Ironically, helping portfolio companies is time-efficient if you control your instincts — founders are the busiest professionals alive! The five minutes you spend crafting one email for your best company to get an intro to one big customer — that’s the stuff that matters.

I’ve seen the movie of startup investing more than 100 times and I believe these principles are in your best interest. The best-performing startups tend to have angels who are experienced and easy. In fact, those angels (especially those who founded startups themselves) are often the most valuable investors on the cap table (even more than, capitalism forbid, us “professional” VCs).

If you want to see and get into the best startups, recognize that this deal probably isn’t it — and your reputation with founders will shape how many deals you see and win in the future.

So treat the founders right, and we’ll all do better together.

A seed VC

If this post sparked more questions for you, try this chatbot some friends made (on my work, and Bloomberg Beta and #thisisnotadvice content).



Roy Bahat

Head of Bloomberg Beta, investing in the best startups creating the future of work. Alignment: Neutral good