Important Questions Investors Ask and How Startups Can Answer

30th June 2023

Author
James Merryweather
Investment Strategist, Robot Mascot

James has almost a decade of experience as an investment analyst at leading UK VC firms and family offices. Having been on the other side of the table – assessing Pre-Seed, Seed and Series A deals – he now uses this insight to craft winning forecasts and investment proposals for our clients.

Once you’ve perfected your fundraising assets (your pitch deck, financial projections, and business plan) it’s time to start approaching investors. An important thing to remember here is that they all have different levels of experience and different motivations as to the returns you must have the potential to provide them with.

In this article, we’re laying out a series of common investor questions for a typical Seed round of investment. We’ll cover what they want to know and the kinds of things to think about in your response to maximise their confidence in you. This will give you the insights you need to prepare for, and nail, your Seed round.

Jump to the following sections:

What early-stage investors are looking for

An experienced early-stage investor is most likely going to be focusing on the ability and potential of the founding team and the first few hires you may have already made, if any. They’ll be trying to assess how much ‘grit’, commitment, and expertise you might have, as well as your ability to think on your feet and be agile to changes in the market and bumps in the road (which you’ll inevitably face).

As well as this, they’ll be questioning the size of the market you’re operating in – often for two reasons:

  1. Because the larger it is the more likely it can support a huge return for them
  2. A large market will allow you to pivot the business one way or the other if you need to and still be successful

It’s also worth noting that not all investors are the same, and we should avoid lumping them into one homogenous group. An angel investor who might have had a modest business exit of their own and now wants to support a handful of emerging entrepreneurs has an entirely different attitude towards returns when compared to a Venture Capital (VC) investor.

Of course, they both want to maximise the money they make, but the angel might be making a small number of ‘hobby’ investments, whereas the VC will be making 15-25 ‘strategic bets’ to form a portfolio – with the knowledge that only one or two of them will return meaningful cash and allow them to go and tell their own investors how great they are so they can raise another fund and do it all again.

This means the questions you get during an investment round can vary enormously, and sometimes it’s hard to tell quite what the investor is getting at or trying to understand when they ask the questions they do.

Investor questions about scalability and efficiency

A typical VC investor will be making 15-25 ‘strategic bets’ out of a pot of cash they themselves have raised from their own investors. In doing so, they have promised those investors significant returns as a result of trusting their judgement.

The VC investor know that most start-ups fail, so the ones that don’t fail, need to ‘not fail’ enormously well. The need to deliver astonishing returns.

Therefore, they won’t be interested in companies trying to return 4-5x their cash because those returns don’t cover the many losses they’ll make. You need to have at least the potential to deliver well above 10x their money, and ‘winners’ in a VC portfolio can generate 100x or higher.

It’s because of this, that they’re very interested in scalability.

The questions you get from a scalability focused investor might include:

  • What is your business model and how do you make money?
  • How do you plan to scale the business?
  • What is your cost structure and how do you manage your overheads?
  • What is your sales process and how ‘people-heavy’ is it?
  • How does you cash cycle work?

For any investor, the fewer the barriers to exponential growth there are the better. You want to give the investor confidence that your gross margins (revenue after costs of product) are strong enough to support your overheads and eventually generate a lot of cash, and you want to give them confidence that your sales process can be made quite repetitive or even self-service, such that you don’t need to keep adding extra salespeople to keep making sales.

It’s great if you can also give investors’ confidence that clients can onboard themselves, so your sales and onboarding process runs like clockwork.

In terms of cash, investors like repeatable, predictable cash income streams and direct costs being paid to suppliers on credit. It’s difficult to demonstrate scalability if you must spend a lot of cash to make or acquire your product which then sits in a warehouse before it might get sold a few months later.

Key summary

you need to demonstrate that there are few impediments to growing your business very quickly. It’s OK to make losses at the beginning when you turn on marketing spend or build a team or product, but if, for example, you needed to spend millions on a new power plant every time you step up revenue, that wouldn’t make for a quick growth plan.

Investor questions about performance

The absolute greatest indication an investor can ever get when they’re considering an investment is concrete evidence from your customers that they’re willing to buy – especially if you can show customer loyalty and an increase in customer spend over time or across renewal dates.

If your revenue is getting predictable and you’re growing it nicely, that shows investors you’re onto a winner.

The questions might get from investors exploring performance are:

  • What are your last few months of revenue?
  • How much traction have you gained to date?
  • What’s your customer lifetime value and cost of acquisition?
  • Can I see your financial projections?
  • How do you plan to measure success?

In all these areas it’s best to show a nice growth curve over the last few months or quarters, and ideally be able to continue that during the investor diligence process.

Investors will also be judging how much revenue you’re making relative to how much funding you’ve had or when you started the company.

If you only have a handful of customers but launched 5 years ago, investors will take that as an indication that you won’t be the outlying ‘winner’ in their portfolio, because you’ve already proven you’re not growing that fast.

For questions around lifetime value and acquisition costs, if you’re very early stage you won’t have a huge amount of data on this, but investors want some kind of estimate or evidence that you’ve done some rational thinking on how much marketing spend it costs you to get someone to buy your product for the first time, how much spend it costs to keep them interested, and how much gross profit you will make from that individual over time. If you have a plan to make every £1 of marketing spend result in more than £3 of gross profit or contribution, then the investor will have confidence.

Key summary

The best signal an investor can get (by far) is from your customers, which will be demonstrated by your revenue or customer acquisition figures. Investors want to find companies who are making money, growing how much money they’re making quickly, and are making what seems like the right amount of money compared to how long they’ve been running the company.

Investor questions about operations

Investors will want to understand how the business operates day-to-day and judge how efficient and effective they think that set up is, including the internal competence of the team vs its reliance on outsourced agencies for things like marketing or product development.

Clearly, a software business will be expected to have an in-house development team and some senior developers or CTO, but an app which requires tech development but is a consumer business might get away with outsourcing development for much longer in favour of hiring in-house marketers.

Therefore, the questions investors might ask you around operations might include:

  • What is the problem your business is solving?
  • What risks do you see down the road?
  • Why are you confident in your pricing strategy?
  • What are your potential sources of revenue and how have you validated them?
  • What are your plans on product development?
  • How will you handle regulatory changes, cybersecurity issues or other general setbacks?
  • How will you optimise customer success?

All these questions are to do with how you plan to run, or are already running, the business. There should be some kind of business plan to demonstrate your strategic plans in the different areas of the company. This will include of course include HR requirements. They’ll want to see how you plan to build a fully functioning team, but with the acknowledgement that, in the early years, senior staff at least will have to cut across many business functions and spin a lot of plates.

Key summary

Investors want to understand how the company operates under the bonnet and ensure there is sensible business structure beyond the founder(s) they’ve been speaking to during the fundraising process.

Investor questions about the team

The number one and number two things for early-stage investors, as mentioned above, are quality of team and size of market (namely its ability to support financial returns).

Questions will include:

  • Who is in your senior team and what experience do you all have that will help your company?
  • What have you learned from other failures if you’ve founded companies before?
  • Who are your advisors and mentors?
  • What is your hiring plan and how do you think about hiring?

‘Quality of team’ is a subjective concept, and each investor will be looking for slightly different things. Overall, it’s important to stress that all members of the team are domain experts in some way and have relevant experience in your industry or something close.

Investors get less excited by seeing logos of big corporates in your fundraising materials compared to a few sensible notes on what you’ve all done in the past and why that’s useful to this new venture (i.e how the business is going to be more likely to succeed as a result of your past experience).

A lot can go wrong or change in a start-up and the investor will be judging how likely this team is to a) be successful or b) survive pivoting to something slightly different.

Investors also want to see that you know how to hire and incentivise top talent to join your team, so think carefully about how you describe your hiring plan. Investors are more excited about investing in top talent than building out a big team on low salaries.

Key summary

The team is probably the primary investment driver for early-stage deals alongside the nature of the market you’re in. You need to explain why you’re the best team to do this and how you’re going to bring top talent along for the journey as you grow.

Investor questions about the funding round

Clearly, investors will need to know the particulars of the fundraise you’re currently working on and will already have a lot of this detail from your deck, business plan or forecast. They will need evidence that you’ve not picked a random figure out of the air as your target raise size, and that your valuation is appropriate.

Questions might include:

  • Why are you raising £X, how have you estimated that is the right figure?
  • What are the key milestones you need to reach before you can raise money again?
  • How are you going to measure success against the funds you’ve raised, what do you need to have done before you’ve achieved your targets with this funding?
  • When do you plan to raise again?
  • How many raises do you think it’ll take to get to profitability?
  • What is your valuation?
  • Why is that your valuation?
  • What is your current burn rate and what do you estimate it’ll be after the round closes. Also, how much revenue is included in that burn rate?
  • Are there any special terms coming into the round?

During the process of refining your pitch deck, business plan and forecast you’ve probably zeroed in quite confidently on why you need the amount of funds you’re asking for. Investors will want an approximate split of how you’re going to spend their money so they can judge if they think that’s sensible.

It’s important you have a very clear plan as to what specific things you need to achieve before the funds run out, as those things will be the enabler for your next round of funding. It’s not good enough to say, “we want to grow the business”, rather, “we want to acquire X subscribers and get into X number of new markets, at which point we aim to have monthly revenue of £X which could support an increase in valuation on this round of 2-3x and enable us to raise money again”.

There needs to be some element of confidence that if we achieve X we know we’ve done well with this money and our valuation will have grown.

As mentioned earlier, some investors are motivated by you making the biggest business you can in the shortest timeframe possible regardless of the risk, whereas others are happy to be involved and help you grow more organically.

So, there will be different attitudes towards profitability from different investors – some will want you to raise as many rounds of funding as you can, as fast as you can, ignoring profit but making a huge business which sells quickly but risks failing fast too.

Others will want you to get to profit quickly and eliminate the risk of a disorderly company failure. Understanding your investors attitude towards risk is crucial in this context.

In terms of valuation, I’ve addressed this at length here, but an investor in an early-stage round is going to be expecting to acquire 15-20% of your company. Anything more and they risk overdiluting your stake as founder, and any less means their investment will dwindle to nothing over many further rounds of funding.

Key summary

You have to have an approximate idea of how you will move the needle on your business within the 12-18 months of runway that you raise. You need to communicate to investors what you believe the company will look like when the funds are starting to run out, as by then you’ll be raising your next round and they want your valuation to have increased by then.

Closing thoughts

You will most likely already have a handle most if not all of these things already (if you don’t then I highly recommend you join this free fundraising strategy session run by Robot Mascot co-founder and best-selling author James Church), but it’s useful to have thought about how you would answer these questions prior to investor meetings so you can be more confident when sitting across from a potential investor.

The most important things to get right, in my view, are how you talk about your team, how you talk about your market, and how much homework you’ve done to understand the motivations of the potential investor.

It’s important to remember that if an investor has taken the time to ask you any of these questions it means they’ve not only responded to whatever the (probably) cold outreach was that got your deck into their inbox, they’ve also bothered to read the deck and engage with you amongst the tens of other decks they’ve probably had that week (or day).

If they’re taking a call with you there is some interest, and the rest of the process is about gradually building their confidence in you. It’s always about getting to that next step in the process or the next investor touchpoint. If you keep getting to the next stage and giving investors confidence in you and your business, the last step is writing you a cheque.

UP NEXT:

A Complete Guide to Angel Investors for Small Businesses and Startups

How to Convince Investors (And Yourself) Of Your Funding Worthiness

Raising Investment: Three Mistakes Investable Entrepreneurs Must Avoid

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    2024-01-24T11:09:04+00:00June 30th, 2023|Categories: Pitching, Advice|

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