As a private equity investor for seven years, and now as CEO of equity crowdfunding platform CircleUp, I hear the term “value-add investor” thrown around as often as those in Washington have uttered “debt ceiling” the last few weeks. But value-add investor can mean different things and is really in the eye of the entrepreneur. If, for example, you as an entrepreneur want silent capital, “an investor that will make introductions to prospective customers” will not fit your definition of value-add—even if other entrepreneurs dream of this type of investor.
Let’s look at what makes up a value-add investor, and what doesn’t.
1. Value-add investors don’t get in your way.
A criticism entrepreneurs often level against private equity firms is that they require burdensome reporting requirements and weekly calls with 24-year-old associates. I’ve been on calls where the associate asks our CEO routine questions that add no value to the CEO’s world—it's cringe-worthy. While using data to make better business decisions is invaluable, having a regularly scheduled Friday call to report the week’s events to a junior employee who then can report those events to the entire team on Monday is a waste of time and is counterproductive.
It’s absolutely critical that before you accept an investor’s capital, you understand exactly what their expected level of involvement and reporting expectations are. [As a side note, in every fundraising round, whether on CircleUp or elsewhere, you should determine that through the Investors Rights Agreement.] You can glean this information through reference checks with entrepreneurs that the investor has previously backed—both for investments that have gone well and those that have not. You will quickly learn if your potential partner is a wannabe-CEO in disguise or a true value-add investor.
2. You mean something to them ... but not everything.
An entrepreneur recently told me how excited he was that his $5 million snack company attracted investment interest from a private equity fund with billions of dollars under management. While that can certainly be humbling, entrepreneurs need to be wary in this situation because if a fund’s investment in your company is 1% of their total fund size, chances are you will get little attention from the fund’s principals.
A good rule of thumb when talking with a private equity firm: Take their current fund size and divide by 15. The result is likely close to their average deal size. If you are more than 20% below that number, simply ask “how many deals in your existing fund have you done in our size range.”
If things go south with your brand, a too-large fund will have no problem letting you fail. In a sense, you are just the cost of doing business. Contrast this scenario with one in which you represent 20% of a private equity fund’s capital. This other extreme can present its own problems. Your investor may insist on more hands-on involvement than you would want. In short, it is important to understand how much the investor’s livelihood depends on your success. You want them to have something to lose, but not everything.
3. Have they been there before?
If you are a $2 million snack brand and your near-term goal is to be a $10 million snack brand, an investor whose experience lies with helping $100 million brands get to the next level won’t be as relevant. At the same time, if you are a product development guru but the word “marketing” sends chills down your spine, you probably don’t want another product development guru as an investor—you want someone that complements your strengths by addressing your weaknesses.
There is a broader concept that ties these three points together: Sophisticated investors tend to be the best investor partners. Successful investors attract successful entrepreneurs and renew the cycle.
Crowdfunding is no different. Entrepreneurs should look to equity crowdfunding platforms like CircleUp that attract not only successful entrepreneurs, but angels, and others knowledgeable in consumer products or other relevant spaces. Look to those who have demonstrated a history of success in the home market in which you wish to reside.
Don’t look to the successful painter to sculpt. Look to the successful sculptor.