1. What is your exit strategy?
This is important question. Translated by me: Is your baby and you intend to keep it forever, or can I count on a cash-out event within my fund horizon?” Keep in mind the first prospect means you may be seeking a lifestyle while the second relates to your always seeking a way to make money for the investor base. My usual honest answer is, “I am not in this for a religious experience. We will evaluate all offers and do what is best for all the shareholders. If I have to, I will stay and grow the business until we can get a reasonable offer.”
I actually ask this from companies I consider as potential clients or where I may consider working. For me taking equity has no value if there is no liquidation event; I do not need wall paper in the form of stock certificates.
A second point I wish to make is that you consider developing your personal exit strategy. Many founders have eventually been replaced by investors or the board at some point in the development of the company. You should consider adding language to your employment agreement to cover your parachute; protect your equity and salary for some period post removal from the company. This does not need to be articulated to investors, but you do want to take precautions to protect yourself since you did create the company!
2. Review the timeline and cash needed to the next inflection point. What is the minimum you can get by with to the next step-up in valuation?
The inflection point is thought of as the next step in the valuation increase. This can happen based on a great deal with a partner, positive data from proof-of-concept, a major advancement in development, or other such value creating events.
I actually heard this question posed to a client recently. The fund was trying to determine the least amount of money they could invest to take the company to a significant step-up in valuation. A rework of the financials taking out everything not related to the primary product opportunity generated that minimal number for this company.
3. How much cash have you invested in the company so far?
You have no obligation to make cash investments. Some investors may insist that you co-invest in a round. In fact, some technology areas will not be considered by investors without them thinking you have “skin in the game”. Lucky for me, Biotech (my personal favorite) is currently not one of them!
4. How many months of cash do you have left?
I actually dislike this question and always interpret it in the most negative way. To me, it says “how long before you run out of money so I make a very low offer which you have little choice but to take.” There is nothing but the truth you can offer in reply if you are private. If you are public, you can say see our last Q report which disclosed our financials.
5. What is your company’s pre-money valuation?
I always try to establish a fair value to the company. I also try very hard to not give the answer unless we are approaching the investors with a very specific deal structure for the investment. If you are dealing with a lead investor, they usually go by the “golden rule; I got the gold I set the rules.” Most of the time, the investor tells you what valuation they would invest at for your company. They will also add a lot of other terms. You never have to take the deal offered and can try to negotiate a better one. In the end, it depends on your other options for funding.
6. Will your current investors participate in this round?
It is common that certain investors will chose to invest in subsequent rounds, if they have the resources. The previous investors are getting diluted out in their percent ownership and many will invest in the follow on rounds to maintain the percent ownership. You want to take their temperature in advance so you will know their appetite for investing in follow on rounds. One way this helps is if they are willing to invest 25-50% of the next round, the new investor pool needs only to find the remainder.
7. What other investor groups have you spoken to?
This is another of those questions that I dislike. I always translate this to “who can I call to see if they like you?” You can count on one thing; fund managers will call around to their friends to get their opinions of you and the technology. It is a herd mentality group. If their friends want to invest, the fund manager does not want to be left out. If someone does not like you, the fund manager may not even go to the next steps.
Taffy Williams is the author of: Think Agile: How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon