There has been a lot of talk about how early-stage valuations have risen dramatically over the past few years. Financially, this is probably good for founders and bad for investors. But a side effect of this frothy market is that financings are occurring much faster. It is very common for investors to get introduced to founders with the proviso that a term sheet will be signed in the next few days. As a result, founders and investors are spending very little time getting to know each other before entering into long-term business contracts.
This is bad news for everyone. Most significantly, founders often give up significant control to people they won’t get along with or even might end up hating. Having bad investors might not matter if the company executes flawlessly and the financing market stays frothy. But most companies have difficult episodes, and the financing market will eventually return to normal. Sadly, founders with bad investors will likely face punishing down rounds, key employees being indiscriminately fired, and elaborate financial shenanigans engineered to dilute founders and seed investors.
“It’s only when the tide goes out that you know who’s been swimming naked.” Warren Buffet likes to say this about investors, but it applies to founders as well. Taking on a new major investor should be treated with the same gravitas as taking on a new cofounder. You can’t do it in less time than it takes to really get to know someone, which is usually weeks or months. Quick financings might seem attractive but are actually fraught with risks.