The Value of Forming Long-Term Partnerships with Investors at the Earliest Stages
When we invest at the pre-seed or seed stage at REMUS, it is with the intention of both creating a long-term partnership and investing in the following rounds — all in the spirit of ‘building not betting.’ This strategy creates many benefits for founders at the early stages, and when executed correctly, it can mitigate many potential risks.
Preventing Negative Signaling
One potential risk of having an investor that invests across stages participate at the pre-seed or seed is that there is a negative signaling effect if the fund chooses not to follow on for subsequent rounds. The effect arises when new investors look at the upcoming round and question why an insider investor isn’t deploying more capital into the company, whether by declining to exercise their pro rata or choosing not to lead the next round. This is why a fund that sprays and prays at the pre-seed and seed stages can be detrimental to a founder’s ability to fundraise in the future.
This negative signaling effect is of course removed if the fund does invest in subsequent rounds. The chance of this happening increases if the fund takes a highly concentrated approach at the pre-seed and seed stages, takes the time to build the conviction required to want to form a long-term partnership, and focuses on company-building, not betting.
This is what we do at REMUS. If we write a pre-seed or seed check and do not make subsequent investments, we view that as a failure on our part and not a part of our overall portfolio strategy. We spend meaningful time upfront to ensure alignment with founders, and we continue to strengthen that alignment after we invest, as we have strong incentives to see each company succeed.
Preventing Cap Table Consolidation
There is a second potential risk of having the same lead investor across multiple rounds: reduced cap table diversity. A varied base of investors with significant ownership is beneficial to founders, who will have multiple sources of capital as well as more partners to help with company-building. For early stage investors that invest across rounds, leading the Series A is usually the goal to achieve a high amount of ownership and to secure a board seat.
At REMUS, we may lead both the Seed round and the Series A, but we won’t lead any subsequent rounds in the same company. We’re able to gain significant ownership in a company and invest significant amounts of capital and time through this approach while allowing for cap table diversity as a company scales.
There are many additional benefits for founders who form long-term partnerships with investors early on in their entrepreneurial journeys, and we have seen that the benefits far outweigh the potential risks when executed correctly.
Working with Investors Before Fully Committing
First, founders are able to spend significant time getting to know their investors and, more importantly, actually working with them before allocating a big spot on their cap table. A lead investor is, after all, a person with whom founders can carry a relationship that can last a decade or more. Founders want to be certain this is the right long-term business partner, and this is even more relevant for first-time entrepreneurs.
Helping with Company-Building from Day One
Second, pre-seed or seed investors tend to have larger, less concentrated portfolios and thus are forced to spend less time with each portfolio company. Investors who are forming long-term partnerships with founders at the early stages are in the process of company-building, and they’re also investing their time — which is significantly more valuable than just capital. By taking a company-building approach, investors can add value to founders by making customer introductions, helping with hiring, developing board strategy, and making intros to future investors.
Avoiding Emergency Situations
Third, having an investor on the cap table with deep pockets early in a company’s life can potentially provide emergency insider capital. This is especially relevant when the company is going through tumultuous times or there’s a difficult macroeconomic climate that may make raising outsider capital challenging. The former occurs when a company hasn’t achieved the requisite traction or product development milestones, but the existing inside investors have strong conviction in the founders and business. The latter scenario is what founders feared at the start of COVID, and what usually occurs after the end of a bubble.
Investors who focus exclusively on the pre-seed or seed stages bring their own value to founders and complement others on the cap table with longer-term ambitions. Ultimately, though, what matters most is not the size of the fund joining your cap table and the resulting dynamics, but rather the fund’s track record in being consistent partners to its portfolio companies in good times and bad. The character, experience, and knowledge of the investors at a fund will have the greater impact on the company.