Implementation before all else?
Posted by Dr. Earl R. Smith II in Questions, tags: adviser, advisory board, angel investor, board of directors, CEO, chairman, coaching, consulting, director, dr earl r smith, dr earl r smith ii, earl r smith ii, earl smith, Executive Coaching, federal circle, federal contracting, funding, Governance, government contractor, investing, investment, investor, Leadership, leadership assessment, leadership coaching, leadership development, leadership styles, management assessment, managing partner, Personal Growth, the federal circle, turnaround, Turnaround Management, Venture CapitalDr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com
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I recently posted a discussion focused on the use of investment proceeds. The response was amazing. Lots of extensive and well thought out responses. I wanted to expand that discussion a bit by asking about what I consider to be the most important characteristic that a founding team can have – the ability to implement effectively and consistently. The first article in my ‘What does Investment Grade mean” focuses on this important issue. http://www.dr-smith.info/the-money-chase-what-does-investment-grade-mean-part-1/ . I would be very interested in your comments about the importance of implementation, how you develop the tendency and how founders can build teams that implement successfully.
© Dr. Earl R. Smith II
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Related Articles:
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The Money Chase: What Does Investment Grade Mean? Part 2
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The Money Chase: What Does Investment Grade Mean? Part 3
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The Money Chase: What Does Investment Grade Mean? Part 4
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The Money Chase: What Does Investment Grade Mean? Part 5
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The Money Chase: What Does Investment Grade Mean? Part 6
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The Money Chase: What Does Investment Grade Mean? Part 7
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Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.
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Abhijit Deshpande wrote:
Doc.
Bingo. Hit the nail right at the forehead. Not much comments on the points – Your experience speaks in those. My couple of cents.
You briefly touched an nice aspect “don’t call us, we’ll call you”…
In my last 18 years, I have seen lots of entrepreneurs who do NOT understand this statement or fail to recognize this. I won’t blame them because if they don’t believe in being ‘investment grade’ then nobody will.
What I feel is, there are no mentoring sessions or discussions on how to understand these signals before loosing entire steam.
One more point which I feel does impact is the ability to verbalize the concept. I have seen people having really nice ideas which had a lot potential to be in ‘investment grade’ but were not able to express / communicate / verbalize the same in front of prospective clients / investors / media, causing delayed realization of value.
Thanks for a wonderful series.
Mark Montgomery wrote:
Scott– the issue of martyrs is indeed a problem in entrepreneurism. When so much of society feeds off of the work of the engine that enough fuel and air isn’t sufficient for combustion, then indeed we experience market failure like that of the U.S. today, which of course costs everyone but government and monopolies it seems– at least in the near term — eventually even they pay a severe price.
I am a very experienced investor, having called some of the best in history — perhaps the best track record as an analyst in venturing in terms of dollars earliest in — although I didn’t benefit from most of it, I can tell you with out any doubt that most investors are sheep and fools. Of course at the early stages very little information is available, so fools are in good company, but the broader message is most important.
Personally I could care less what other investors seek as what I seek has proven far more valuable than the best in the world. — MM
Scott Gu wrote:
If you notice some people did set up traps and ambush you as a victim before, you had better sit down and do nothing.
If you heard people encouraged you, an entrepreneur having already exhausted resources, to do it further without investing on you, it is really a fishy thing.
If investors are serious about it, just invest on it. If they think these entrepreneurs are not good targets for investment, then don’t encourage them. Please don’t let things like housing bubbles to happen again and again. Don’t encourage and stimulate people who don’t have the ability to afford it.
Art Worster wrote:
Thanks, Steve. I will add an example. Typically the folks assigned to the project by senior leadership are either not authorized to commit decisions for the organization or are not courageous enough to do so. One of the disciplines that I implement is that once a decision point is identified on the critical path, the only people who can fail to meet that date are people who have financial decision authority to commit the amount of funds that will result from the delay. Since a week’s delay in a major implementation is often in the $500K/wk category or higher, this allows me to drive to the project plans since few people have this authority. My point here is that the implementation project is directly tied to the financial organization and senior leadership. It is not sufficient by itself, but the example is of one way to align the IT implementation team with the business realities. Incidentally, that project ended on time and on budget (~$30M).
Steve Washburn wrote:
Kudos Art. I concur completely. there are WAY too many projects where there is no penalty for failure (late, over budget, poor quality, etc) as long as there is a good excuse or someone to blame.
So why are smart people in so many places missing this obvious need?
I wonder if the resistance is dirven by predudice or the fact that a higher and higher percentage of project teams are disconnected with the business team. This may be simply poor relations between IT and the business, or it can be because key members of the team are contracted and will not share in the success if the business works.
Art Worster wrote:
Let me focus on implementation in the IT industry. Unfortunately, we have continued to perpetuate the divide between IT as a technical function and IT as an enabling business function. As long as this is allowed to exist, implementation will have a completely different goal and organization than it would have if it were to be based upon an ROI case, management commitment and a designed alignment of the business case and the application being implemented. If the goal is completion of the implementation only, then why would anyone expect to achieve the intended business results. If the goal is the delivery of defined and planned business benefits and the rewards programs are defined and executed in support of that program, it is possible to narrow this divide until the CIO position in the company becomes not the IT person who tries to support the business, but the business person who happens to be expert in and responsible for delivering the IT systems to achieve business results. Implementation then becomes business transformation and the IT implementation is only the installation of the tool that is being used to support and institutionalize the changes. This is a transition that many/most companies have not yet achieved, and many have not started.
Barry, My short answer is yes – before a sound plan. Investors like tested assumption supporting business plans. They prefer plans based on the demonstrated ability of the team to monetize the value propositions. They prefer teams that have tried variations of the value proposition and found which works best. Implementation during the development of a business plan is also a time when the team is tested – not as authors of a plan but as a team that has to work together with all the bases covered. CEOs are tested – their ability to organize, manage and contribute tot he team’s success is highlighted. The strength and weakness of each team member is also on show. From an investor’s perspective, funding is not the beginning of a business it is the high potency rocket fuel that can accelerate an already moving company. Dr. Smith
Barry Borden wrote:
Dr Smith – another sound article. Thank you!
Sound implementation, is critical, but favorable results equally require a sound plan. Read that, I’d prefer below average implementation of a great plan over great implementation of a below average plan.
Mark, Thanks fro the comment. My experience is that the drive to generate a customer base and validate the value proposition is the most important that any founder can have. Most of the successful ones believe that, without customers, you are just managing a science project of sorts. Most successful CEOs are very good a developing contacts into contracts – potential customers into real customers. The purpose of my article was to let founders in on the results of many conversations with venture capitalists and angel investors. They prefer to invest with founders who are implementing even before the business plan is finished. They like founders who ask if a meeting with them can be rescheduled because of an important meeting with a customer. Dr. Smith
Mark Schaefer wrote:
I don’t know if this is what you’re getting at, but I’ve toyed around with many business ideas before and found that perhaps the biggest impediment is either developing a system waiting for a customer, or finding a lead customer that would be willing to subsidize the development of a system. Since I’m not a sales guy, finding customers has always been the point at which the pieces didn’t seem like they would come together.
Mark, Thanks for the comment. I am using implementation as it relates to the business plan and generating revenues, building a customer base, controlling costs and generating a profit. Too often investors see teams that have put together good business plans an then have just sat down waiting for the money to show up. Investors prefer team that are building the business whether or not they get funded. Dr. Smith
Mark Montgomery wrote:
Earl, it struck me first as it depends on what meaning you intend for implementation – I could take it several ways, but assume that you are primarily meaning product.
Before operating one of the pioneers in incubation — after bldg several companies including a consulting firm for a decade– several historic mid market turn arounds, several notable start-ups in Seattle, and bruising but excellent ROI in the S&L clean-up.
In tech venturing today sometimes deciding not to implement is more valuable than implementing well– rather under what conditions and with whom. Monopolistic markets and disruptive technologies/product in particular require a deep specialist type of strategy, a very strong network, lots of credibility, and plenty of dry powder. Of course for the few winners, they tend to pay for everything else, so for some it’s worth the risk and investment.
So I guess I would amend to implementing well for the very specific set of conditions at hand, ability to understand and navigate around a very specific set of anchored obstacles, while at the same time bldg appropriate networks for the challenge.
Obvious to some, not others perhaps, so worth repeating. .02- MM
Yogesh wrote:
Dear Dr. Earl R. Smith II
I gone through your article on dr-smith.info and found lots of answers i was searching as an entrepreneurs.
Thank you very much
Walter Breidenstein wrote:
You wrote:
“Early-stage investors fund mainly on emotion – they believe in the idea or the team.”
This I agree with entirely. This is a serious problem with the early-stage investor as they effectively understand the value of the technology or company beyond emotion as you rightly say, and load up the front end of the deal with such ugly terms that few will come in the second or third round. I think the issues with your “middle-market” companies seeking funding will be effected by the terms of their early investors.
Change the mentality of the early investors, and you will find money later on.
Walter, Thanks for the comment. I hear that a lot from my entrepreneur friends and am guilty of the same in earlier times. Waiting for other people to change is like waiting to die – or like the proverbial ‘old man yelling at clouds’. The better way forward is to develop a more sophisticated understanding of how investors think and an ability to ‘walk in their shoes’ when putting together your pitch. That was my purpose in writing the series of articles. The better an entrepreneur’s understanding of the investor perspective, the better the chances that he will get funded. That is because he will understand concepts like ‘investment grade’ as legitimate investor concerns. Too many CEOs only see their company only from the entrepreneurial perspective and most of them fail or under-perform when it comes to funding. Dr. Smith
Jose Kumar wrote:
Walter: Thanks for your insight and I would certainly agree with many of your comments.
Dr. Smith: Many thanks for your article, it is always a pleasure to read them. The article does give a very effective way of understanding the grading terms that investors group their prospects on.
Could you give your views on niche projects in growing markets and would any investors approach these projects differently? Considering that the market conditions could grow a good business tremendously, would this change the grading mechanism considerably depending on the market type? i.e. Are the grading policies the same in the US vs. for example China or Russia?
Walter Breidenstein wrote:
Dr. Smith, I agree generally to most of what you said. I’ve been an investor most of my life in many businesses, technologies and real estate. My experience on both sides of the transaction have given me a broader approach to value that is founded in facts about a deal rather than emotion. This does not mean, by any stretch, that I don’t appreciate the value of investor money, but I think the world has sort of been turned upside down in the past generation or three. What at one time was an investment into the company, based upon solid fundamentals, has turned into loading up legal agreements for one side of the table, and making it near impossible for the company to grow.
This is why I have and will continue to refuse any money from VC’s since their model is broken in my view, and when they use other people’s money they will not change until their investors get fed-up with the inferior returns for the risks.
Private equity in the middle market is the obvious smart money, and I see their terms becoming equally complex which will cause growth to be slowed. It is like the company who lives and breaths for quarterly reports and does nothing to offend the “market” with their earnings reports…even to the point of fraud. Which is all too common in the markets today.
Entrepreneurs need to wise up, and stay away from these money sources, and go after either long-term institutional investors (cutting out the VC guys) or look for money from China, MENA or other more reasonable investors who understand the value of long-term relationships, and are not so arrogant. I know it is a bit harsh, but people need to walk away from New York and Silicon Valley money and go outside the country for the smart money if they want reasonable terms, and to get ride of the early investors who make their lives and companies miserable to grow. I might end up deleting this message if I get hammered too hard on the forum!
dr-smith.infodr-smith.infodr-smith.infodr-smith.infodr-smith.infodr-smith.info
Walter: Thanks for a clear and useful comment. I also have seen the effects of ‘lawyering up’. But many investors realize that an accommodation of perspectives is the way to profit for them. I discussed the difficulties in two articles titled Oil & Water: http://www.dr-smith.info/the-money-chase-oil-and-water/ and The Money Chase: Breaking the Truce: http://www.dr-smith.info/the-money-chase-breaking-the-truce/. There is no question that establishing a well balanced and productive relationship between an entrepreneur and investor is hard. It is and ever shall be. Entrepreneurs need to become more discriminating in their selection of investors and more professional in their approach to seeking funding. I agree totally that entrepreneurs should seek out those sources of funding that are more accommodating but I also have seen that strategy lead to institutional investors who are more litigious and less experienced than some VCs. The basic truth is that it is a complicated dance that requires a sophisticated approach and is best undertaken with the help of an experienced guide. Dr. Smith
Jose, Some decades back I could say that there were significant and persistent geographical differences in the approaches of investors. But in this globalized world the differences, if they exist at all, are often fleeting. The internet and search engines like Goggle are the great levelers. Professional standards in the more advanced economies quickly spread to emerging markets. This is driven by the fundamental nature of investment. Investors provide funds and expect a significant return for taking the risk. the risks in emerging markets may be significantly higher than in established ones – so investors quickly become more sensitive to risk. Most experienced investors have been through at least one and sometimes many bubble bursts. They know that hype does not make for profit and that over-hype is an invitation to loss. Investors also know the value of government regulations and a reliable legal systems. They feel more exposed when these are not available. This also could push investors to be more cautious. Most emerging markets are fueled initially by the ‘fools that rush in’. Most of them loose all or most of their funds. The second and third waves are more cautious – and more professional. Dr. Smith
Jesse Millares wrote:
I read your article and wholeheartedly agree. Every entrepreneur should read the insights you provided. The classic start-up tries to acquire all the capital they need for all the phases to profitability rather than creating milestones for each capital raise. As you say, they end up chasing money rather than raising enough so that he can focus on building the company by reaching milestones to the next phase. The next investor will always ask the same question “what have you done with the money so far”? With milestones achieved, he’s leveraged himself to confidently answer the question and negotiate better terms with that next investor. With that the entrepreneur increases his odds through each phase to being the 10% that brings his dreams to fruition and retain creative control.
Jesse, Thanks for the comment. Every entrepreneur should learn the lessons you outline before entering the Money Chase. Even the first investors ask the questions you outline – ‘what have you done so far?” To object to them or not have good answers is to misunderstand the process completely. Dr. Smith
Kishore Jethanandani wrote:
All interesting comments. From the experience I have had so far, the good investors are rigorous and supportive while the bad investors are way to skeptical and demanding and stingy with their money. I really don’t see a point in going to an investor who expects a working product and a revenue earning project before they will invest. They should be able to tell ahead of time whether they have an effective team to deliver a viable business.
Walter Breidenstein wrote:
Dr. Smith, you wrote:
“I agree totally that entrepreneurs should seek out those sources of funding that are more accommodating but I also have seen that strategy lead to institutional investors who are more litigious and less experienced than some VCs.”
Litigation from institutional investors, or any investors, is the end result of an investment gone bad. As you know, it is very rare that a happy investor is ever going to sue the entrepreneur and the company. I think that litigation most commonly brought by institutions is because they have a business and investment model not to loose money, and be happy. The VC model is not likely to sue the entrepreneur because their mind set is different, and they expect to loose money on a vast majority of investments…hoping to score it big with a couple. Have you ever seen a resume of a VC which highlights all their great successes and brand names? I once asked one if he has a list of the deals he could provide of those investments that tanked with him given away someone else’s money, and the smile and silence said volumes.
Private equity and institutional investors are not out there looking for the big score, but rather using a much more balanced approach to nurturing the entrepreneur and growth if there is an active role, and carefully watching their investments if there is a passive one.
One point on litigation. I would encourage entrepreneurs and investors to use the services of mediation rather than arbitration when things go sour…since managing lawyers for both sides of a dispute can be difficult. Once I was working with a well respected American working in China that had been there most of his life, and he helped develop the mediation rules for the American Chamber of Commerce in Beijing. He told me that most internal disputes (where during his years nobody wanted to go to court in China) could be often easily resolved with third-party, neutral mediation, and not attorney driven arbitration. His examples were very consistent with my own experience working all over the world. The principle of mediation is sound, and I think many times there is no need for litigation except in the very minority of cases. Again, our society has been turned upside down with litigation as well, but that is another topic all together.
Walter Breidenstein wrote:
Kishore, you wrote:
“I really don’t see a point in going to an investor who expects a working product and a revenue earning project before they will invest.”
I think your point is consistent with Dr. Smith who also makes this distinction in his original topic post:
“Early-stage investors fund mainly on emotion – they believe in the idea or the team. But, as a company grows, investors more and more look at it as a going business.”
As you know, VC’s have brought their model and money to compete, in some degree, with private equity. Certainly there is a blend of synergy between them and institutional VC’s have become more common. I guess the theory must be: why turn their money over to VC’s to deliver inadequate returns over 10 years when they can manage it often smarter themselves since it is their own money?
Certainly, from my vantage point, if you are looking for money to grow your company in the middle market, I would encourage entrepreneurs to go to institutional investors or overseas to find the money. It is cheaper, smarter and is not invested based upon emotion to a large degree.
If you are talking early stage money…I have some of my own experiences and theories I’m experimenting with on new technologies, but that is simply because, out of necessity, I will not accept hard money terms from the current investor model which is broken and legally/emotionally one sided.
Walter and Kishore: Early-stage investor attitudes have changed considerably since the bubble burst in the late 90’s. They are more demanding of demonstrated results as a precursor of investing. For the most part this is because they have had bad experiences with ‘promoters’ parading as entrepreneurs. Kishore wrote, “I really don’t see a point in going to an investor who expects a working product and a revenue earning project before they will invest. They should be able to tell ahead of time whether they have an effective team to deliver a viable business.” Although that attitude may make sense from an entrepreneur’s point of view, it is difficult to maintain if the investor’s response is, “I don’t really see a point in investing in a company that does not have a working product and revenue earning project.” The point of the article series is that successful entrepreneurs achieve funding by recognizing the legitimacy of investor standards and expectations rather than arguing against them. Investors have learned that the only reliable way to “tell ahead of time whether they have an effective team to deliver a viable business” is to look for teams that implement and monetize the value propositions reflexively. They have had too many experiences with teams that said “give us the money and we will begin to act like entrepreneurs” only to find out after the money is gone that they can’t. As a result of these experiences, early-stage investors are acting more like later stage ones. They are demanding that a team actually demonstrate that they can produce results prior to investing. I recently chaired a panel which focused on the expectations of investors and entrepreneurs. The discussion that followed the program provided a good example of how wide this chasm can be and how it might be bridged. The investors had little patience with packages which contained a business plan and a request for funding. One investor called them unprofessional – another lazy – a third referred to them as irrelevant noise. Of course, the entrepreneurs who put forth these packages took offense – but there were a number of other entrepreneurs in the room that seemed to be listening. For them, the question became, “OK, then tell us what you are looking for, how you determine value and what your investment criteria really are.” These were the entrepreneurs that the investors really wanted to talk to – entrepreneurs who recognized that investor criteria were closely related to the chances of their business being a success – not irrelevant chatter but real measures of potential success. The result of that program is a planned series of seminars. I have pulled together a panel to approach the core question – how do you improve the investment grade of your company. Panelists will discuss the business, legal and financial considerations and an investment banker will discuss value creation as he sees it. The goal of the seminar will be to provide audience members – CEOs and CXOs – with valuable insight and specific action steps that can help them improve the investment grade of their company and their chances of getting funded. The point of all of this is that the world has changed considerably since the late 90’s. Entrepreneurs who recognize and accommodate those changes are more likely to get funded. Dr. Smith
Walter Breidenstein wrote:
Dr. Smith, you wrote:
“The investors had little patience with packages which contained a business plan and a request for funding. One investor called them unprofessional – another lazy – a third referred to them as irrelevant noise. Of course, the entrepreneurs who put forth these packages took offense – but there were a number of other entrepreneurs in the room that seemed to be listening.”
I could not agree more with the investor position. Where are those investors? They deserve a pat on the back! Why?
Because too many “criteria” for money (both stupid and smart money) has been based upon the business plan and financial valuation. I’ve seen 10 page plans with 10 pages of financials, and 100 page plans with 10 pages of financials. We I want to see as an early stage technology investor is simple:
What are the intangible assets and how do you make money with them with or without the entrepreneur manager, or the scientists behind the technology? How do I cover my downside risk to at least break even if the company folds early, but also how do I give the entrepreneurs/investors/scientists incentive to work with my money? Certainly, if there is not even the limited ability to manage, today you can hire a swat management team to turn around just about anything for the right price…but are the intangible assets able to deliver the future revenues to attract such a team?
The bottom line: The business should be designed not to fail in the first 5 years, and hopefully by then break even, or start making a profit. If it can be done in 3 years without failure and turning a profit, that is even better.
This you don’t find in business plans. Besides one thing I’ve learned is that most investors and entrepreneurs spend little if any time reading anything you give them, and thus it is just usually driven by presupposition to the deal and emotion. It is better to show the holes in the technology/company/concept, plug those holes with experts, customers or carefully designed securities, and then plow forward in a dynamic way being flexible to the challenges. We must remember this is a Newco in a start-up/survival mode, and is not like taking over or acquiring a broken business.
dr-smith.infodr-smith.infodr-smith.info
Walter, Thanks for the comment and for participating in the discussion. Most investors fit the description I gave. I do a lot of work with them and, as a result, have an inside seat. You raised a couple of interesting points. The first, valuation. My position is that the correct valuation for a start-up is the sum of money being invested plus a small amount for the founders. The founders will then have a progressive earn-in ability to accumulate ownership through meeting and exceeding metrics. I wrote about one of the major benefits of this approach in Death of the Hockey Stick: http://www.dr-smith.info/death-of-the-hockey-stick/. When the focus settles on accumulating ownership based upon meeting or exceeding expectations, the tendency to develop unrealistic financial projections disappears. That leads me to the second benefit. Plans based on this formulation are much more likely to anticipate glitches and provide for delays in meeting expectations – therefore the companies are more likely to have the resources to get through the initial years.. Finally, such an approach better serves as a basis for an understanding between investors and founders. Dr. Smith
Walter Breidenstein wrote:
You said, “My position is that the correct valuation for a start-up is the sum of money being invested plus a small amount for the founders.”
I would not be able to agree with this view due to its unwillingness to consider the value of the intangibles that come with the company. Money is not the only driver of value, and my experience in working in almost 40 countries is that money can destroy value and valuation. It is too complex of a discussion for this forum, and look forward to watching your continued posts.
Thank you for the stimulating discussion!
Walter, I think that you might find the approach more useful than initial reactions indicate. It is better to understand first then judge. It is not hard to include ‘intangibles’ in the formulation. I worked a arrangement where the founders ended up owning two-thirds of the company. They monetized, including the intangibles, and blew away the projections. There never was the tension that is so prevalent between investors (who have crafted unrealistic projections in order to retain a large chunk of the company ab initiao) and investors (who normally think they are getting hustled). In that case, the investors actually celebrated the regular reduction of their percentage interest in the company as the value of their holdings went through the roof. The point here is that some approaches to valuation inherently create conflicts between founders and investors while others do not. In the end, the successful entrepreneurs will benefit more from the latter and enjoy a more constructive relationship with investors as a benefit. Dr. Smith
Walter Breidenstein wrote:
Agreed, if you include the intangibles in “plus a small amount for the founders” then I would most likely agree with the structure. There is no doubt valuation is the hurdle for any entrepreneur/investor relationship…even at exit. My view has been to try to avoid the valuation focus pushed by the current marketplace as the primary driver. I spoke last year to a “brand name” VC who asked me in the first 20 minutes what was the perceived valuation of the technology, and when I shared the NPV, First Chicago and VC method post money valuations he was ready to hang up the phone and end the discussions. Please don’t think I discounted your concept of valuation too quickly, but I am happy to see you take into consideration the intangibles in the equation.
You have a lot of valuable insight…thank you!
Kishore Jethanandani wrote:
Dr. Smith said: “OK, then tell us what you are looking for, how you determine value and what your investment criteria really are.”
I think this is pretty reasonable. There is no reason for entrepreneurs to have a problem with this kind of approach.
I will illustrate my issue with an actual case study.
I introduced one entrepreneur to an angel friend of mine. The entrepreneur had developed a medical device for the detection of breast cancer using optics. The device was tested in Russia and the initial results were encouraging. The angel, a Ph.d in life sciences, liked the product. It was clear that the device could be a game changer. The entrepreneur also introduced the angel to folks in a medical group who put in a good word and said they would be willing to try it in their own clinics.
The hitch was some problems the entrepreneur had with an investor in the past. The first round of funding went fine. Then the company needed more money. The investor then started issuing letters in the name of the entrepreneur’s company, without informing him, to raise money from the wealthy even though he was not a licensed broker. Things went awry and the investor proved to be less than professional and the company was charged for violating security laws. The matter was resolved by going into bankruptcy and taking out the investor.
Now the angel was not willing to have the entrepreneur to be a part of the management team. He wanted him to be a consultant. The entrepreneur was not willing to accept those terms and his point was that he had solved the problem. When he was later introduced to an attorney-cum-investor by the angel, he suggested to him to forget the angel and to do business with him directly. Needless to say, the matter ended there. The angel also bad mouthed the entrepreneur.
My question is: Was the angel being reasonable? This is not an instance where the entrepreneur had just a business plan to show. Could the management have been structured to retain the founder but put in enough checks to safeguard the investment?
The irony of it was the the angel kept saying that he liked the medical device and inquiring about the entrepreneur. Well, if you have burnt bridges, how do you restore them.
dr-smith.infodr-smith.infodr-smith.info
Kishore, It is hard to respond to your case study without a lot more information. I would need to see the results against projections at the end of the depletion of the first round funding. If there were short-falls or under performance, I would have to determine where and why they occurred. I do this on a regular basis for investors. They are not normally in the blame game – they want to find and fix problems with their portfolio companies. The bridge to the second round is often a time of reorganization. Many times the original team has taken the company as far as they can and need to be replaced. Sometimes it is a matter of replacing one or two team members. Two examples are replacing the controller with a fully experienced vice president of finance and replacing the recruiter with a qualified vice president of human resources. I wrote about this process in Battle at the Cottage Gate: http://www.dr-smith.info/battle-at-the-cottage-gate/
That being said, I am not a fan of doing business with individual angel investors without extensive prior diligence. My preference is to deal with organized angel groups. They are more discriminating and their procedures more thoroughgoing, but they are far more reliable partners. Many entrepreneurs take the easy road of finding a wealthy investor to back their company. Often this decision leads to many of the problems you describe in your comment. But it is important to realize that such combinations are combinations of ‘likes’. Entrepreneurs who are more casual than prudent and investors who are amateurish and predatory make a poor mix and augur more for missed opportunities than success and profits.
A lawyer friend is fond of observing that, if you have the right to do something under the existing agreements, it is by definition reasonable because the parties have agreed that it is possible to do. If your friend entered into an imprudent set of agreements then his definition of what is reasonable needs to be defined by them – even though he wishes that was not the case. In investment situations, the written agreements rule – verbal agreements are not worth the paper they are printed on.
Entrepreneurs should work to better understand the criteria and expectations of professional investors. They should work to clearly understand what ‘investment grade’ means and how they can organize their company to merit a higher grade.
Dr. Smith
Kishore Jethanandani wrote:
“When the focus settles on accumulating ownership based upon meeting or exceeding expectations, the tendency to develop unrealistic financial projections disappears”
I would think that this is the way to go to manage risk. Financial projections are really a shot in the dark. The focus should be really on milestones to be achieved to get there. But this rarely happens.
Kishore, I agree with that formulation. Further, I suggest that performance against projections as milestones should be used to determine the equity ownership of the founders. Once this idea is in place, all parties will focus on projecting the attainable and the founders begin to figure out how to exceed expectations – and, thereby, increase their ownership in the company. Dr. Smith
Kishore Jethanandani wrote:
I think this makes a lot of sense especially given that the value of an early stage project is hard to determine. That said questions are bound to arise when entrepreneurs are bringing tangible value to the table at the outset such as intellectual property. Granted the IP has not yet proved its worth in the marketplace, I don’t see how an entrepreneur is going to agree to zero share at the outset. Similarly, partners would have invested time to build a team, prepare a business plan and have some work done such as engineering designs. If investors are going to insist on something as tangible as revenues, then I guess we might as well go to banks or hedge funds.
Kishore Jethanandani wrote:
Your comments on the case study are illuminating. I am learning a lot. I found it odd that the angel (who is also part of a larger group) was hankering for the technology but he insisted on his way for the management to the extent where he burnt bridges. Also, how do you motivate a founder, who is also the chief scientist, if he is going to be reduced to a scientist’s position. Some people are very rational and will say, “Oh well, as long as I am going to get a rate of return, what the heck”. This guy said, “What makes the angel think he can do better?”. Thereby hangs a tail, no one won. The project is still in limbo…
Kishore, My approach to valuation is out of pattern I will admit but it solves many problems that the old way of doing things cannot avoid. It is centered on two principals. The first is that the process should be collaborative and not adversarial. The old way puts the entrepreneurs in the position of pushing projections in order to retain as much equity as possible. That makes the projections overly adventurous and puts them as odd with the interests of the investors. Such an adversarial relationship is seldom therapeutic. The second is that arriving at the earn-in formulation aligns the interests of both sides. In the initial equity distribution, the founders will get a recognition of the value that they bring to the closing table. The key negotiation is the formula for earning additional equity. From an investor’s point of view, a realistic baseline will allow them to feel secure if the team cannot deliver. If the team makes the milestones, they will be happy with the agreed upon equity earn-in. If the team blows away those projections the investors will see a decreasing percentage interest but an increasing value of their investment – a smaller cut of a bigger pie that is more valuable than a bigger cut of a smaller pie. In order to achieve this arrangement, the approach of both sides needs to be collaborative from the beginning. Investors are generally receptive to the proposition on its face. Entrepreneurs need to come to understand the process and have the confidence that they will out-perform expectations. The resulting partnership will better survive the glitches that inevitably show up along the way. Dr. Smith
MOHAMMED ASLAM wrote:
What is the quickest way to find more about venture capitalists who cater to a certain type of industry?
Do investment houses use services of experts who can help them analyze operations before making an investment?
Mohammed, Thanks for your comment. By far the easiest way to determine the interests of venture capitalists is to visit their website and review their portfolio companies. That will tell you a great deal about the spaces they are interested in. If you do some additional research, you can find out which funds have resources to deploy and which are fully invested. The more you know about a fund before you approach it, the better your chances will be to get funded. Many funds do use experts to analyze potential investments. for the most part, they do not publicize those relationships. They tend to be with people who they have know for a very long time and who have the experience and track record with the managing partners which would justify such trust. Dr. Smith
J Jeyaseelan wrote:
Although I have walked the path of my innovation alone, I can still vouch for the factors that make any venture investment grade. It is of course totally another issue how an entrepreneur could find resources to grow the start up till it becomes an investment proposition.
I am really glad that you have put customers first. Customers not only provide proof of the revenue earning potential of the company but also help perfect the early stage technologies. It is important for technology start ups to work with select customers before they venture in to the wider market space.
Forward momentum is equally important as it signifies technological maturity. Forward planning would remain hazy unless the technological feasibility is not clear. The need for agility and adaptability can never be over emphasized. It is part of the forward momentum. Without it, the new technology may cease to address changed scenarios.
I guess perseverance and continued initiative has to be the hallmark of successful innovators, because fatigue is very common in long term projects particularly when cash flows get disrupted for no fault of the entrepreneurs.
It is good to know very well about what investors would look for in a potential project, because you are your own first and most important investor. If you do not see any of these clearly, then do not waste your your money in the first place and wait for a VC to bail you out
Neil Lewis wrote:
Actions count more than words
The advice you give Dr Smith is spot on. And, I have found that entrepreneurs would do well to apply it to their own businesses too.
The greatest danger for any business is to hire or contract with people who talk a good game but fail to deliver.
The problem with the traditional employment structure is that it works on the basis of pay me first and then I’ll show you what I can do.
Whereas the business wants greater certainty that the person can deliver, the person just wants a regular pay check. Just like the investor and many junior entrepreneurs.
In my view, those entrepreneurs who are saying ‘give me the money and then I’ll make it happen’ are stuck in the traditional employment way of thinking. The chances are that the last thing they did was a job.
Interestingly, the approach of the investor is exactly the same approach that the entrepreneur should take to his or her business implementation. The two are not different.
The insight here is that if this is a surprise to you, then you are not really an entrepreneur. And, if you wish to do something about it, start hiring freelancers or contractors for short and specific projects – that require lots of implementation and a small amount of words. You’ll quickly find out who can deliver and who can not.
So, perhaps investors should take the same approach to entrepreneurs? Give them small projects and see if they can deliver?
Best regards
Neil