As a CEO, when you raise follow-on funding you often must decide what do with your angel investors. Many CEOs decide not to keep their initial commitment to their angels, falsely assuming it is both the only, and the accepted, option. Such CEOs don’t consider the very real and significant consequences of this decision.
Today, we explain why CEOs, as the ultimate decision-making authorities, believe they don’t have a choice in how they handle their initial angel investors. We also shed light on what that means for the business, the business community and the investor community.
Why you think it’ll be necessary, and why it isn’t
Almost certainly, some potential investors in the next round will think the angel investors have ‘too many’ shares, using excuses like ‘they contributed money in the past, which is now used up’, and ‘they likely won’t contribute substantially in the future’.
A number will put pressure on the CEO to ‘clean up the cap table’, or ‘remove dead weight’, and will often suggest, e.g., buying out the earlier investors for the money they put in plus interest/a modest return, often putting pressure on you to use threats of ‘the company will fail otherwise’.
No later investor can force you to do anything against your will, no matter how much pressure you feel. As the CEO, you have control, and which kind of CEO you will be is up to you.
The Angel Capital Casino
The decision to ‘clean up’ or remove your angel investors has a devastating impact on the entrepreneurial ecosystem.
One of the reasons many entrepreneurs find it so hard to find angel investors is because of the way previous entrepreneurs have treated those same angels. If new angel investors don’t get paid out on their winnings, and just get their money back, they stop investing. That makes it hard to find repeat investors.
Imagine going to a casino like that: where they take your money every time you lose, but refuse to pay out when you win. ‘Your number just came up on the roulette wheel? I’m sorry, we just return your initial stake with interest, sir, even though we promised something else at the start. That’s just how things work in the Angel Capital Casino.’
Such a casino would have to rely on being able to continually find a new crop of suckers, because there would be no repeat bettors. It would also be very empty. Welcome to today’s angel capital market, where funding is hard to find for new entrepreneurs and start-ups, because countless angel investors have been burned by previous CEOs.
Saying yes attracts bad investors
If you stay with your angels, you WILL lose some investors as a result: around a third of them, in our experience. That is a GOOD thing.
If an investor feels that loyalty doesn’t matter and commitments can be broken, how long do you think it will take them to turn on you? Is that really the type of investor you want?
It destroys the relationship with the angel
It is important to remember that angels bear very high risks when investing in a company and often provide funding when a start-up has no other options. It is natural for them to expect a degree of loyalty and trust in return. ‘Cleaning’ them ‘off the cap table’ the moment things get better leaves a sour taste in their mouth, and destroys that trust, both in you, and in all future entrepreneurs.
It can damage your personal fundraising prospects in the medium to long-term
As the investor community is tight-knit, and investors value the opinions of other investors, word of your actions will likely get around. The other investors might think that you and your company aren’t worth investing in, because you both literally and figuratively won’t pay back that investment. You likely won’t notice this now: you often will when you start your next business.
So, what do you do?
Many CEOs buckle under the pressure, often finding a way to rationalize doing so.
Yet, no matter how much people tell you that ‘this is the way things work’, it IS possible to hang tough and say ‘those angels believed in me when nobody else would, and I will stand by them now’ (i.e. ‘you dance with the one that brung ya’).
One of the biggest factors that investors try to evaluate is the character of the entrepreneur. Your character, and reputation, get defined by your actions. Choosing whether you stand by your angels is a character defining moment for you, which will help establish your reputation for life.
And all of these decisions together impact whether the funding ecosystem you operate in is healthy and growing, or a barren wasteland. Which do you want to contribute to building?