How Many Investors are Too Many?

Posted on Feb 22, 2011 | 29 comments


This post originally ran on TechCrunch.  Lately I have seen a number of deals announced on TechCrunch in which 5 or more different VCs were participating in the deal.

This always makes me chuckle because in my first company we had 5 investors in our first round and we picked up 5 more before we finally sold the company.

In my second company I had only 1 investor.

When this first ran on TechCrunch I got the greatest comment in the world that I had to repeat here, “VC’s are like martinis: the first is good, the second one great, and the third is a headache.” LOL. I love that. And it’s kind of true.

While there is no right or wrong answer, having seen the extremes I’d like to offer you a framework for considering the right answer for yourselves.

The Perils of Many
I understand the appeal of having many VC firms on your cap table. You may feel as I did in 1999 that the more smart people around the table the more intros you’ll have, the more sage advice you’ll receive and the more impressive you’ll seem to outsiders. Plus, if you need more money it’s far less for each to dip into their respective pockets to fund you.

While all of this is true, it’s also true that nothing so perfect ever comes without a cost. Here’s the problem:

Let’s say you have 5 VCs (plus angels but let’s ignore that for now) and each one owns 5% so you took 25% dilution to get the round done. By definition each of those VCs (unless they are a micro VC – and one who doesn’t mind 5% ownership) will view you as a sort of “option” where they might get to fund the next round if you do well.  Either that or there is something other than a financial motivator involved – NO VC is looking to build a business off of 5% ownership in startups. You simply can’t drive good returns that way.

So why else would they invest if not as an option to re-up in the next round? Maybe they wanted the branding associated with a hot company, maybe they wanted to work with the other investors around the table or maybe they thought it was a cheap way to get educated on your market – it’s always easier to learn an industry when you’re on the inside.

These are all dumb reason to invest – of course. But it happens.

So let’s consider a bad (but likely) scenario where either you don’t hit your targets, the market sours or competition is kicking your butt making it hard to fund raise. Most companies hit a bump in the road at some point. None of those 5 investors is sufficiently motivated to help you in tough times.

Firstly, they haven’t really signaled that it’s “their deal” in the way that leading a deal does. They can plausibly tell others, “yeah, we were a really small shareholder there – we had nothing really to do with the problems.”

Secondly, in tough times they’re also thinking about all of their other investments. Let’s say each of those 5 partners has at least 7 other investments each. In tough times I promise you their time & energy will be allocated more heavily toward deals where they have more money invested and/or where they have a larger ownership position to protect.

Sure, if you become Zynga everyone of those 5 investors will be helping you. In fact, it will probably show up on their Twitter bio & on their website. But how many of you are likely to become the next Zynga (and without hitting a few bumps in the road first).

Now let’s consider the upside situation where you happen to be in a super hot space. Now you have 5 investors of which at least a few will be vying to take a larger stake in your next round. By definition you can’t have 3 investors each wanting to increase from 5% to 20% ownership or you’re fawked anyways. So it will be an internal fight over allocations. This is not to mention the fight you’ll see if you want to bring in a new investor to lead the next round to set an objective price.

“Many” has benefits but it also has drawbacks. If you plan to do it I highly recommend that most of the VCs be smaller funds and ones who are generally not looking to invest much more after your first round of capital.  There are firms with this stated objective – seek them out if you want to load the VC roster on your deal.

Note that I am talking specifically about 5 VCs splitting one round. It might be that over a period of 5 years you’ve done three rounds of investment and ended up with 4 VCs. That’s a different story. Each VC came on with different information, at a different price and with a different risk appetite. Hopefully each lead or co-lead their round so there is more harmony in the configuration.

The Pitfall of One
It is very common for funding rounds to have just one VC doing the investment. This is largely true because most VCs have a 20% minimum threshold in order to invest so bringing in multiple VCs can be very expensive in terms of dilution. So obviously before agreeing to work with this VC you better make sure you know them really well. And I always encourage entrepreneurs to do reference checking. Here’s my guide to how to do that.

There is an obvious pitfall to working with just one VC – if you fall out of love you’re screwed. There are reasons why VCs sometimes don’t support deals once they’ve invested.

  • The most common case is that the partner who did the deal left the firm. You are then a “stranded” portfolio company. You know the drill – the new guy says he’ll support you, but it was never really his deal. If you have any hair on you he can always distance himself and deny any involvement.
  • You might have a VC who is at the end of their fund and doesn’t have deep enough pockets to fund you if you hit bumps in the road
  • The VC might have lost confidence in you. You might just have differences of opinion on the direction / strategy of the company or how to handle situations in difficult times.
  • I have personally seen some VCs who decide not to support certain industries they once had backed. I know that a lot of VCs had roadkill in the Internet Video 1.0 world and many pared back investments.

Whatever the reason, when you’re stranded and you have one investor the only way out is to find new outside investors. And this is doubly hard when your existing investor isn’t supportive. The standard line the new investor wants to hear from your previous VC is, “we’re behind this company 100%. We’re willing to do our full pro-rata & might even like to do a bit extra.” If your VC had stranded you, you won’t hear this – believe me.

Still, most deals involve one VC – just to be clear.

The Squeeze of the “Two Handed Deal”
The most tempting thing to do in a financing is to find two investors to split a deal. In my mind that’s the perfect scenario. You get all the benefits of the “many” deal without the drawbacks. If you can pull it off, I love the “two-handed” deal. If you’re doing well but need a little more gas to prove yourself, it’s so much easier for VCs to split an inside round. It’s both a smaller check and it’s external validation that somebody else was willing to fund.

The biggest problem in two is the “squeeze.” All VCs want to own between 25-33% of your company. That’s the number they feel comfortable owning in exchange for their time & resources over what will likely be a 7-10 year endeavor (if you’re successful). They internally almost all have their secret minimum threshold, which is 20%. There – the secret is out.

So in order to get a two-handed deal you need to dilute by 40% which is an awful lot at the start of your company. When you consider that they’ll also want a 15-20% option pool in the company you’re talking about founders owning as little as 40% after just one round. That wouldn’t be bad if you had just one founder, but if you have 4  you’re already at 10% each and you have 7-10 years more work left (not to mention 3 more funding rounds!).

There are a bunch of VCs out there who don’t cling to the old “20% or the highway” mentality on every single deal and I suggest you seek them out. They are the ones who will often partner better with other VCs. There are ones I’ve worked with like True Ventures, First Round Capital, Greycroft, Rincon Ventures …. just to name a few. And of course most of the micro VCs (fka super angels) also don’t hold to this minimum bar.

The easiest configurations to push for are either

  • One lead VC who takes 20-25% and one smaller VC who takes 7.5-15%
  • Two leads who take 15-17% each.

Rules of the Road

1. Always Have a Lead
No matter which option you choose always have a lead. If you want the “many” deal then give half the round to one VC and let the other 4 split the second 50%. No lead = no one on the hook in tough times = no one to corral other investors to take action = nobody with enough skin in the game to give a damn. Always, always have a lead. Not just to get through tough times, but for conflict resolution in general.

2. Make Sure You’re Stage Appropriate
If you select a lead VC make sure they’re stage appropriate. If you’re raising $2 million on an A round and it’s a $1 billion fund make sure they have a track record of backing and being active with early stage deals. If you’re raising a $10 million B round and a $100 million fund ponies up $8 million you better have a firm grasp of how much of their fund is allocated, how much they have reserved for you and how they plan to support you in tough times.

3. Make Sure They Have Enough Gas in the Tank
In any scenario it’s a good idea to understand where the VC is at in their fund. You can’t ask this kind of stuff on the first date, but ultimately you politely want to get out of them: when their fund was raised, how much capital did they raise, how much is allocated, when they’re raising their next fund and what their “reserve” strategy is. Best if you get much of this from due diligence of calling other portfolio companies and then use this information to confirm with the VC.

4. Make Sure They Play Nicely in the Sandbox
I often see VCs getting sharp elbows out at the time of a fund raising. They start muscling for ownership percentages and start angling to kick out certain investors or angels. I find this behavior strange but now a bit predictable.

I usually counsel entrepreneurs with the following advice, “if your VC can’t play nicely on the way in when they love you the most and are on their best behavior, imagine how they’re going to be in difficult times or when the final pie is getting split!”

Seriously, man. Assholes in good times are insufferable in bad times. If you experience this behavior run. Didn’t you get enough of this crap in high school to want to revisit it again?

5. Always Pitch Outsiders for Follow Ons
I have staked my strategy as a VC as being both stage agnostic and willing to follow great deals by leading another round and increasing my percentage ownership. So it seems strange advice for me to recommend that you pitch outside investors first for follow on investments.

Here’s why – even for a VC you really like and who you might like to lead your next round. You know the old saying, “great fences make great neighbors?” My corollary for VC is “pitch outsiders and you’ll have great insiders.” It just keeps us a bit honest. I think if your inside VC wants to lead a round and is giving you a “fair” price it’s reasonable to not “over shop” the deal and try to drive the highest price possible. Get a fair price from outsiders or at least market test the interest level.

6. Always Make Room for Value-Added Angels
Finally, I believe in making round for value-added angels on every round and in every deal. Yes, I include many micro VCs in this category. If there are 4-5 investors who each want to kick in $50-75k – why would I want to turn away smart people from working with the company? These aren’t people who are going to compete for increasing prorata in the future. They aren’t people who are going to demand minimum ownership %’s.

They’re all dopeness, no wackness (presuming they are great angels and not PITAs).

If your new prospective VC is opposed to a great angel or a small investment from Founder Collective, Felicis Ventures, SV Angel or similar – please re-read number 4 above.

  • http://tonepedia.com/blog Danny Strelitz

    Great post if you have the options to choose. most first timers don't :)

  • http://arnoldwaldstein.com awaldstein

    Straight smart advice.

    Might be interesting to segue this into a post on boards for early stage startups.

  • petegrif

    True. But the most pointed advice above “Assholes in good times are insufferable in bad times.” still holds true unless you want a miserable life. Be careful what you ask for.

  • sweller

    Great post, great advice. Very helpful.

  • http://bothsidesofthetable.com msuster

    That's true. But as first-timers go through the process I say it's important to have a framework.

    I raised money the first time in Europe. I decided it was a good idea to spread the capital base across countries to maximize relationships. So I had investors in Ireland, the UK, France, Germany & Switzerland.

    It was a good idea …. in theory. In practice I would have concentrated on having just 2 large investors.

  • http://bothsidesofthetable.com msuster

    Sure. I've written several times about startup boards & advisors. Any particular angle that you think might be useful?

  • http://twitter.com/Sirachm Sirach Mendes

    Great article Mark, very helpful on understanding the joint VC rounds.

  • http://naamanetworks.com/ David Bloom

    On the ABC show Shark Tank last season, one of the “sharks” was negotiating with a founder. The founder started quibbling over a few percent. The shark pulled out saying “things end the way they begin”. Best advice I ever got from reality TV.

  • Homer119

    Also you must remember that zero is not enough.

  • http://bothsidesofthetable.com msuster

    “things end the way they begin” – I like that quote.

    Usually, things actually end worse than they begin, though! Or as I like to say, “if they act this way while they're courting you imagine what they'll be like at the 7-year itch.”

  • http://www.victusspiritus.com/ Mark Essel

    Cap at two VCs, welcome a handful of sharp Angels, and shop out follow on rounds to keep existing investors honest. Good stuff Mark.

  • http://arnoldwaldstein.com awaldstein

    i'll read what you've written first Mark. Must have missed them first time around.

  • sbmiller5

    I've read here and elsewhere what makes a good board meeting – how about, what makes a good board packet?

  • sbmiller5

    Mark, If you can, can you explain why you participated in Seamless Receipts $1.5M round alongside of DFJ Gotham, Polaris, Tekton Ventures, Social Leverage and other angels.

    Given the small fund size of everyone but you and Polaris, I could see how you're getting smart people like Howard Lindzon around the table, but it's hard to imagine you're getting a significant stake with that many investors and such a small round.

  • A.G.

    Great post, thank you.
    Thats +1 to my MS-dictionary btw. ;) (PITA)

  • virginstartup

    Good stuff for the first time entrepreneur. Thanks Mark.

  • http://tonepedia.com/blog Danny Strelitz

    when you bag for money you don't really care who is trowing the dime at you…

  • http://tonepedia.com/blog Danny Strelitz

    So you really could focus on building the product without investors getting in your way? lol

  • http://claylo.com/ Clay Loveless

    Mark, thanks for posting this. Very helpful advice as I move down the path with Jexy!

  • http://www.facebook.com/profile.php?id=500150092 Brendan Wright

    That line of thinking reminds me of this quote:

    Tom Cruise in Cocktail: “Everything ends badly, otherwise it wouldn't end.”

    I'd be interested in articles on two board questions:
    1. When do you add members to your board (beyond founders / venture round driven additions)?
    2. Who should you recruit to your board (i.e. what skills / talents / experience) and how?

  • Dave W Baldwin

    Thanks for the post…. I like number 6 personally based on an anchor, then the value added based as much on their experience/expertise.

  • http://twitter.com/amootweets Amoo Venture Capital

    Great article. Very apt too as I am currently advising a client who has the “problem” of having two interested investors. Mark, you stole the words right out of my mouth. Hope you don't mind my quoting you in the client email :-)

  • http://twitter.com/rkillgo Russell Killgo

    Mark, your posts are becoming a highly anticipated occurance for me. We seem to be on the same wave right now. Every step along the way for me on this startup journey has coincided with your current or recent blog posts. I end up researching questions I'm having and then all of a sudden you post the answer the next day. This article about funding is so timely for me right now, it couldn't have been more on target if I had asked you to write it myself. From being a total outsider to trying to get my foot in the door, it's amazing how much I have learned in such a short period of time and I have you to thank for everything I know so far. So when I am interviewed for TechCrunch and I make some stupid comment, I can blame you; right? I'm attending the San Diego Tech Founders Group speech you are giving at the end of March. I'm looking forward to hearing your thoughts in person and hopefully getting to introduce myself in person. As always, thanks again for your time and any comments you make that help me along this journey. — Russell

    Siffter CEO
    RussellSiffter@gmail.com

  • http://www.SalesCrunch.com Sean Black

    Great post Mark!

  • petegrif

    Good luck. Lol

  • http://bit.ly/hDp9Sw Domains' funded NewSpaceAgency

    too many???

    I've not even found ONE for my projects! :(

  • http://www.startupgazette.com StartupGazette.com

    Anecdote: Every single VC showcase which emulates the Dragons Den in LA is a scam bar none. They make money off of the showcasing fee, and the organizers know with 100% certainty that either the funding was preplanned or there is never going to be a “winner”. I would throw DEMO(San Diego), and LAUNCH(Norcal) into that pool as well. Twiistup is pretty bad as far as demos go, but at least Francisco Dao is honest.

    I like the way the SBA works. They back 75% of your bank or credit union loan in case of default, sort of like a school loan. The only problem I have with the SBDC which we work with at Santa Monica college is that as with all government agencies, the salaries are low and the representatives are on the low end, not always giving complete or accurate information. Still going loan rates are WAY lower than what you'll ever get on convertible debt or equity investments. You are allowed to use your enterprise web servers as collateral and the FICO floor is only 660.

  • ara

    I’d be interested in a post for early-stage, first time entrepreneurs whose first goal is to seek angel money: how many angels is a good number, how much dilution to expect, what do angels bring to the table, diff between angel & seed financing, what angels typically expect in return, how big a role do they have in strategic decisions….

  • https://www.google.com/profiles/andrewranwong Andrew Ran Wong

    Mark, Love your writing. Keep them coming!