Archive for February, 2012
I cannot tell you how many times I have seen executive summaries of business plans in which the entrepreneur seeks $5,000,000 to build the business.
First, few startups can use that much money today with all of the virtual services available and increasingly inexpensive methods of development, prototyping and marketing. Second, almost no professional investor will consider putting that much into a startup until there is proof of market demand, product viability or some other mitigation of failure.
Third (if you’re keeping score), it is not wise to dilute the founder’s ownership greatly in the first round of financing. The investors want a motivated entrepreneur, and it is certainly more difficult to motivate a twenty percent owner than a sixty percent owner.
Fourth, there is the matter of control. Entrepreneurs have a vision for what and how to create and build a great business. Giving control over that vision to others early on often dilutes the vision and is a disincentive to the entrepreneur.
[Email readers, continue here...] Professional investors love to see companies where the first round of financing came from the entrepreneur, showing “skin in the game” and more motivation to succeed because of money invested as well as time and creativity.
There are so many resources for early money to validate an idea, turn it into a product and increase the value of the company before professional investors come into the picture.
Starting with credit card debt or a personal loan and working through money from friends or family, or simply consulting to earn money for investment, entrepreneurs should consider early resources for capital to produce a prototype, do market research or start to build a team. Once there is progress in any of these critical areas, raising professional investment is easier and the likelihood of a higher valuation makes for retention of more equity during the first important professional round.
I love this statement from John Tukey, coiner of the word ‘bit’ to describe a single switch of digital micro-data. Tukey was a statistician, one you would expect to describe events in terms reeking with precision.
Instead, Tukey implored us to think in terms of relevancy, cause and comparisons to known events. And all this ethereal talk makes me think of how we investors and entrepreneurs are often led to search for instances in which our plan can be wrong, based upon a past measure. Or how one fact in an argument can be disproved, making the entire argument in error in the minds of some.
Yet, if we do bet upon the jockey with more weight in our decisions to invest than upon the horse (or business plan), then our goal is to be approximately right and not to discount the plan for failure of one element which can be proved precisely wrong.
I made an investment in 2000 in a company that a decade later returned 110 times our investment at its IPO on the NYSE. I invested in the jockey even though I liked the plan. And that plan changed several times during the early years, molded into one that worked unbelievably well, enough to create an entire debit card industry which the company dominates today. It would have been easy for early investors to find reasons not to invest based upon any number of facts upon which the original plan was based, many of which could be proved exactly wrong in the minds of fellow would-be investors.
Early stage investing is more risky than later stage when we can look back, know and measure prior successes. But the bet is more often upon the jockey and that s/he will be approximately right by maneuvering the plan with the management team, rather than executing a plan that was flawed as originally written, and in retrospect exactly wrong.
Early stage investors have been arguing over this for years. Do they bet on the entrepreneur (jockey) or the business idea and plan (the horse)? This is serious stuff. If you are looking for money, this question will certainly come up in one form or another when you approach professional or organized angel or VC investors.
My answer always varies as I examine each deal, sometimes deferring and passing on an investment because of an uneasy feeling about the entrepreneur, even if the business plan seems able to capture the market. Speaking for others, I see VC investors jumping into deals knowing that soon they will push to replace the entrepreneur with a professional, experienced manager that the VC has vetted and trusts.
I have bet on the entrepreneurial jockey a number of times and been blind-sided by after-investment behavior that completely reversed my opinion about an entrepreneur’s ability to manage growth to breakeven. Other times, the entrepreneur went on to assemble a great team and execute the plan as it inevitably changed again and again.
[Email readers, continue here...] Although this debate will continue for ages, I tend to fall on the side of betting on the jockey, simply because it has been a rare business plan that did not change again and again seeking a successful model in the marketplace. And great management is able to morph a company to adopt without destroying the culture of the company in the process.
What if you were the investor and someone walked into your office handing you a business plan executive summary that floored you with its brilliance? And what if that person admitted immediately that he or she had no team and was not the person to take this plan to market? Would you, as an investor, plow money into the plan and help to incubate the idea into a real enterprise? I would not, nor would most all of those I co-invest with. There are millions of great plans that failed over the years for want of a great management team. And I am sure there are many, many average plans that developed into great companies with the help of a great team.
So if you are one of the entrepreneurs without experience or ability to take your great plan to market, admit this early and form a team that investors can trust to do this, personally stepping into a position that fits your core skills, be it marketing, sales, development, or other areas required by a young company.
It would be refreshing as an investor to meet an entrepreneur with a great plan and a pre-formed management team fronted by the strongest possible leader, even if the entrepreneur offers to take a back seat in order to make the vision a grand reality.
From the time we learn to manipulate our parents from the crib to the present day, we learn to negotiate to obtain our wants and needs. As we grow, we negotiate constantly with our parents, then with our peers. As we enter the business world, we negotiate with our bosses and our subordinates. We negotiate with our suppliers, customers, investors, and even our auditors. At home, we certainly negotiate with our spouses or significant others.
If we are constantly negotiating to obtain an advantage or just a win-win attempt at parity, we should make an effort to learn and then practice the art of negotiation (although I prefer to think of it as a science then delivered in its final form as art.)
Because I believe that negotiation is so important to our success in the business and in the social world, I re-read my favorite book on the subject again every couple of years, just to keep myself aware and sharp using the tools and techniques so important to a successful negotiation. The book, You Can Negotiate Anything, by Herb Cohn was first published in 1980 and is available today as the best and easiest to read of all the books on the subject. I implore you to read this book and internalize the three crucial variables, the many styles of negotiation, and the fourteen powers you can call upon or recognize when used by others in a negotiation.
[Email readers, continue here...] Over the years, I have been delegated by a number of entrepreneurs and boards to negotiate critical agreements, sometimes to sell the company or merge it with another. I was selected because I did not have an emotional stake in the outcome as did the entrepreneur, or the continuing relationship with a buyer as would others in management who might remain after the sale. With that freedom, I was able to use the tools of negotiation to achieve a result better than if I worried each moment about disrupting the deal when making each move and countermove. There is a lesson there, one the same Herb Cohn quoted in a later book, in which he entreated his readers to negotiate with care, but “not that much care” as to lose perspective.
I recall one such instance, when delegated to be the lead in negotiating a sale of a company on whose board I sat, I asked the entrepreneur to name his expected price in an ideal sale, which he did immediately as if he’d been thinking of this for some time. Surprising him and the rest of the board, I asked him to go home and not to attend the negotiation session set for that evening at a local hotel, promising to call him immediately with the outcome. I am sure he worried over losing control of his most important business negotiation ever, but he did cede the task to me (and another board member).
Doing my homework ahead of time, using one of Herb Cohn’s principles (please read the book), at the start of the negotiation I placed a paper in front of the negotiator representing the intended buyer, showing how our company would be accretive to their public company valuation, properly valuing our purchase at three times the ideal amount as stated by our entrepreneur-CEO. The buyer looked over the numbers for a few minutes, recognizing the accuracy of my statement from his due diligence and knowledge of his own financials. In a sincere response so transparent as to be an obvious truth, he stated, “Oh, but I only have authority from the Board to offer two-thirds of that” which of course was twice our entrepreneur’s the asking price.
After forty-five minutes of further negotiation, we walked from the room with an agreement to sell the company for cash at twice the asking price. And as the entrepreneur still tells the story, we two board members walk on water for having delivered such great results. In fact, we had done our homework, presented a logical case, and created a win-win by leaving enough value for the buyer to add to its market capitalization as well as doubling our sales price.
Since we negotiate daily for things large and small, wouldn’t it be high on your list to learn to use the tools and be aware of the elements of a great negotiation?