Recently, the New York Times published a popular post about the right number of angel investors for startups. The story, titled For Start-Ups, How Many Angels Is Too Many?, offered useful insights into this hot form of seed investing.
While it makes sense that 20+ investors is too many chefs in the kitchen, it’s understandably difficult to say no to money and potential big name angel investors.
When you’re a fledgling startup, can you really afford to turn down opportunities? To answer this question, it’s worth examining the potential danger of having too many angel investors. Here are four reasons you’re better off saying no to some of these so-called opportunities.
1. It’s a logistical nightmare
Imagine having 20 bosses to report to. Everyone wants quarterly updates, monthly meetings, and a chance to offer their two cents about how to run the company. Some will be hands-on, and some will not. Some will introduce you to people in their network, and some may not. Communicating with everyone and managing everyone’s expectation can be especially challenging when you have too many investors.
2. It increases the chances of information leaks
Consider these scenarios: You’re discussing an acquisition with a competitor, or you’re thinking about raising additional capital from a new VC, or you’re launching a new product. Until you’re ready to go prime-time, this information is all confidential and best kept internally. But when there are too many investors involved, sensitive company information almost inevitably leaks out. More importantly, personal opinions may get out and influence your startup’s reputation. If you have 20+ investors, can you really control what they are saying about your team and your company?
3. It can block future investment from other institutional investors
Convertible debt is the most common way angel deals are done. Even though it’s called “convertible debt,” it really acts more like un-priced equity. The terms of convertible debt can be complicated and sometimes have hidden clauses that are unfavorable for entrepreneurs and future equity investors. Debt investors may also be less likely to invest in companies that carry convertible debt, because it can reduce a company’s cash flow at maturity if the convertible debt doesn’t convert into equity.
So if not done correctly, having convertible debt on the books with many small and individual angel investors can prohibit your ability to raise money in the future.
4. Voting rights can complicate important decisions
Depending on where your company is incorporated, voting rights of investors vary. In Washington State, for example, making major decisions in financing rounds requires a majority vote of the common shareholders for each class of financing.
Before those convertible notes convert into equity, more angel investors means that you need more people to agree every time your company needs to make an important financing decision.
So, what should you do when it comes to getting investors?
First don’t treat investor recruitment as a “trophy collection” exercise. Just because you can say your company is backed by some notable angel investors doesn’t mean it gives you the best chance of success. Instead, think of investors as an extension of your team.
What’s their industry knowledge? What level of commitment can they offer? It’s better to have a handful of deep-pocketed angel investors you want to work with than 20+ small angel investors who may or may not bring added value to your company.
For investors, your company may be just a small percentage of their portfolio, but for you, it’s make or break. So think twice and choose wisely!