Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com
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There are lots of reason why a business fails – but one is particularly insidious. Failure that results from not being held accountable for your actions and their results is an unnecessary call to a futile end.
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Recently, I was recently invited by three different investors to ‘take a look’ at companies that they had invested in. The pattern that I found was so strikingly similar that I set to thinking about what I was finding. I began to think about the roots of the pattern. The more I thought about it, the more I found myself staring at one of the principal reasons that only one in ten start-up companies make it to their fifth anniversary.
In order to take you along on my journey of understanding, I’ll boil these three experiences down to one fictionalized version. So let me introduce you to John Long – CEO of Dip Stick LLC.
John is in his early thirties and has launched a series of failed companies. Some of them were bootstrapped but the current one was investor backed. John’s major assets seems to be the ability to dream dreams that do not come true and then sell those dreams to his ‘team members’ – and, if he is lucky, to an investor. He is marginally charismatic – good at making positive initial impressions – a salesman of ideas – but not much of a salesman for the services of his company. John describes himself as a ‘generalist’ and tends to talk with mild disdain about the technical-types that he has to induce onto his team.
After doing a bit of background research on the company, I scheduled an initial meeting with John. Here is how it went:
The Lethargic CEO: My first interview is always with the CEO. I want to take the measure of the ‘team leader’ – find out what kind of person they are and what kind of leadership they are providing. I start with questions focused on how they spend their days. So, my first question was, “John, tell me about what you are working on right now?”
The key to the question is the length of the answer and the granularity of the response. CEOs that are ‘phoning it in’ tend to give very brief responses couched in general terms. Engaged and productive ones tend to provide a very detailed description of the tasks on their plate along with a direct connection to the results desired. The devil, as they say, is always in the details – or lack thereof.
John’s response took all of half a minute. I immediately got the feeling that he was not engaged in the process of building a business – more in the mode of being a ‘founder’ and hoping that a very few things would come through to make the business a success. Out of frustration, I asked John how he spent his days. “Look”, I said, “there are sixty or so hours in an entrepreneur’s week”. (Based on my past experience, I was being conservative) “How did you spend last week?” The response was illuminating. His description of the prior week’s activities was so paltry that I suggested that “he could have accomplished all that in an afternoon.” As you might image, my suggestion did not go down very well.
The key here is a sense of accountability. The right kind of CEO feels an overarching need to make things happen and spends a lot of time and energy trying to figure out what it will take – and then accomplishing them. Accountability means that ‘it is up to me to make it happen – anyway that I can’. The drive of a successful entrepreneur is always focused that way. The successful leader always lives in the real world – and that real world is a cold and unforgiving place. If you are going to win, you have to be better at making good things happen than your competition – and better than any other member of your team. John seemed to be living in Never-Never-Land – where never is heard a discouraging word, and the sky is sunny all day.
Living Off the Good Guys and Paying Off the Bad Guys: One of the early tests of any entrepreneur is the formation of the initial team. John had been good at gathering the ‘easy and low hanging fruit’ but that ‘easy way out’ had caused problems as the business began to encounter the inevitable growth pressures that any business faces. The ‘sales people’ were ineffective at selling, the marketing people were pure overhead and the team ended up wasting a lot of time on efforts that had little chance of yielding revenues. The dollars that were flooding out the door were yielding little but an increasing flood of red ink. John’s ability to judge and productively manage people was sorely lacking.
John’s history in building and leading a productive team was spotty at best. All of his initial team members were either gone or in ‘retirement’. A couple of them, after taking overly-generous salaries and producing little or nothing but overhead expenses, had either left the business or been asked to leave. It was the nature of those departures that caught my attention. All of them had received ‘separation payments’. The clear intimation was that they had been paid off to keep them from causing the company any problems after their departure. In the end, scarce financial resources were twice wasted on unproductive team members – once during their tenure and again in funding their departure.
249 Responses to “Lack of Accountability – The Core of Failure”
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Joe C Burke wrote:
One way, which I have directly experienced as a founder, is from the “pedal-to-the-metal” syndrome. Now that they’ve invested, they want you to sell, sell, sell only, driving revenue (and the value of their investment) up as fast as possible, no slowing for anything else. For an early stage firm that is still working to get the perfect fit between your product/service and the customers’ needs (which requires some time for investigation, changes to p/s, adjustments to marketing/selling) then your work will be out of sync with the investor’s demands. The financial projections you made WILL be surprised by market reality (you can bet on it), but an early investor who is intolerant of such adjustments will warp the picture and everyone’s reaction to it.
David Withee wrote:
Isn’t life actually pretty simple? And isn’t it amazing that having lots of money and lots of education and lots of experience . . . doesn’t mean you aren’t still going to make unwise decisions? Doesn’t matter whether it is an angel investor or corporate decision-makers higher up the food chain than you; understand each other’s motives, goals and expectations. Communicate; it is their money after all. Agree on metrics; goals aren’t really goals if you don’t have a measuring stick with which to measure progress.
Catherine Thanks for the post. One caution before I respond to your question. Start-up companies generally have little free cash, pay poorly when it comes to salaries and are high-risks for long-term employment. If you are still interested, I would read the local business news regularly. Most findings are announced that way. I would also track local funding through the internet. Third, I would develop relationships with local investors to let them know you are interested. Dr. Smith
Marcos Piccini wrote:
Dr. Smith,
In Brazil, where venture investments has just been born, the most common mistake I’ve been watching is that most investors have the US/Europe mind set, meaning that they are exclusivelly looking for tech-base start ups. However this is not what Brazil has to offer as venture opportunities. As a result almost nobody is making money, and, rather than creating good foundations for growing this industry and attracting good professionals and entrepreneurs to replicate any model/case, the effect that is happening is the oposite.
Catherine Perry wrote:
Dr. Smith,
This is all very interesting – good stuff . . .I am looking for employment opportunities within company’s funded by VC’s and Angel Investors. I believe I have transferable skills that could be applied to enable a new company to get off to a better start. Exactly how does one go about to identify the recently funded start-up companies that are seeking new employers. I am assuming the new companies want to start with experienced staff that can work independently.
Catherine Perry.
dr-smith.infodr-smith.infoBert, Thanks for the comment. I have seen this syndrome flower on both sides of the table.
I have written two articles on the subject – see Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ . The Shadow CEO is a particular example. The difficulty in reaching and maintaining a balance between investors and founders is made difficult because they have different agendas and expectations. Their expectations are that the CEO will move them towards and through a liquidity event that will return their investment with a fat profit. At which time, they will be more than happy to part company with the CEO and wish him well. Balance is very important in these situations and seldom achieved for any length of time.
Dr. Smith
Bert Shlensky wrote:
The biggest issue I have had is that investors have their own perspective (i don’t mean just financial ) and fail to understand and communicate about the metrics of a busienss . This is particularly true with the internet where terms like conversions, 3 day cash from no receivables, CPC, google , social marketing etc. can be like a foreign language . They are also sometimes embarrassed to admit what they don’t understand . Weekly or monthly reports and/or meetings can help if everyone is prepared and formats are established .
John, The great comment. One of the key areas of focus is the culture that dominates the relationship between the investors and the entrepreneurs. Leadership comes out of a productive and supportive relationship in which each side plays an appropriate role. Dr. Smith
John Crockett wrote:
In the world of commercial composting, I am wondering whether it was the investors that killed some composting businesses. IF there has ever been a place where “The Triple Bottom Line” is the ONLY way to succeed, commercial composting is it. Cutting Cost, on eliminating foul odors, and protecting ground water, the environment reportedly resulted in one facility in New Jersey having its permit revoked, and also fined $3 million.
The point is, that trying to maximize ROI by cutting costs on some vitally important areas, is cutting their throat.
Definitely businesses have to do Due Diligence on investors. I believe that excessive pressure to maximize ROI without being socially and envirnmental responsible is endangering the survival of the human race. I believe we need a lot more socially and environmentally responsible leadership.
David J Dunworth wrote:
I agree with my esteemed collegue, Mr. Phillipson. To further the point, investors should be limited in their scope through the PPM or Share Offering Documents. Limiting the involvement of investors, and strengthening the position of the management side of the arrangement makes for better relationships from the onset, rather than to fight your way back to keep control of your own company.
Investors need to be interviewed through the due diligence process. Have they ever invested in High Risk, High Return investments? Have they ever lost money in such investments? Are they willing to possibly lose all of their investment should things not prove out? There are more questions, but you get the point. This sets the groundwork for the future relationship.
joleneanderson.comJolene Anderson wrote:
Having worked with the investment community as a consultant, broker and principal has been an interesting journey over the last 20 years. Before selecting an Angel Investor, due diligence is in order. Ask for referrals from past clients, success stories or the reverse; do background checks or at least due diligence on the principals; check with the Corporate filings in the State or whichever state they have filed in; watch for clues, behavior issues, red flags before you give away your proprietary business information.
There are some valuable angel investors who have been critical to the successful funding of ventures but the reverse is also true. There are also predatory investors who may hardly be described as “angels”.
Attending venture workshops presented at local universities and asking for information from other officers of start up companies is a great place to start. Knowledge is power.
Finally, before signing a document giving away an interest in the company, listen to your “gut”. If it feels wrong it probably is..
Jolene Anderson
Coldwell Banker Bain Commercial
Serial Entrepeneur and Business Consultant
http://www.joleneanderson.com
dr-smith.infodr-smith.infodr-smith.infodr-smith.info
Jose, Thanks for the comment. I have written two articles on the subject – see Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ . The Shadow CEO is a particular example. The difficulty in reaching and maintaining a balance between investors and founders is made difficult because they have different agendas and expectations. Their expectations are that the CEO will move them towards and through a liquidity event that will return their investment with a fat profit. At which time, they will be more than happy to part company with the CEO and wish him well. Dr. Smith
José Marques wrote:
The kind of investors that simply want the return of the money invested, without interfiering in the management of the company, are usualy not bad for business.
In my experience, the big problem cames from investors that are convinced to know everything, and by the fact of having their money on the company, believe to have the right to take all kind of decisions. That can only be avoided by a firm definition of what can or can’t be their intervention.
Susan Gauff wrote;
Investors and CEOs have fundamentally different objectives. The latter wants to build a growing, sound, valuable company. The former wants to get maximum return on their investment as soon as possible. Clearly this is a conflict. We work with groups of CEOs to facilitate sharing ideas and solving problems. Dealing with Boards of Directors (usually made up of investors) is one of the most frequently discussed topics
Gail Wallace wrote:
Enjoyed them very much including the weary smiles. These sorts of investors are one of the reasons that I am slowly building a database for my clients of heavily researched investment banks, VC firms, and investment groups along with their focus industries to try to help my clients avoid the bad and the ugly.
dr-smith.infodr-smith.infodr-smith.infodr-smith.info
Gail, You and I seemed to have traveled some of the same roads. You might enjoy a couple of article that I wrote: Angel Investors to Avoid – http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly – http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ . Take a read and see if they don’t bring a weary smile or two. Dr. Smith
Gail Wallace wrote:
I have seen that happen several times and it isn’t pretty.
However, on the other hand I have seen what should have been savvy investors ruin a company because they understood nothing about what it did and just assumed it would continue to be profitable. Just ask Chrysler.
The other way investors can ruin a company is to try to run every single facet of it and usually without the knowledge and background to do it successfully. They have what they think is an “always successful” business model to which they want every company to conform. That can destroy initiative, creativity, and the very factors that might have made the company unique and force in the marketplace.
Barry Borden wrote:
Dr Smith – nice summary for a CEO… and likely apt guidelines on key governance personnel. If you can’t measure it….
Hgu, thanks for the comment. Your last question is pivotal and often unanswered by entrepreneurs. The key is revenue. Dr. Smith
dr-smith.infodr-smith.infodr-smith.infodr-smith.info
Eric, Your comments are right on point. I have written a couple of articles about angel investors to avoid – see: Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ and Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ . Most investors focus on industries that they have some experience in. As I indicate in the articles, the problems arise because of non-industry specific tendencies of the investors combined with an unsophisticated approach to the process of getting funded on the part of the entrepreneurs. In The Money Chase: Oil and Water: I focus on the difficulty of productively combining these two perspectives. Dr. Smith
Myron Alexander wrote:
All of your insights and advice are extremely helpful. I like many other entrepreneurs head a start-up. What would you suggest be some of the key questions and signs to look for in an Angel investment Group? I am very actively seeking angels interested in biomedical/assistive technology ventures with a good track record of success. How might one investigate an angels investors track record?
Jim, One of the best sources of referrals is the successful CEOs who have met and mastered the challenge. Outsourcing can be a very cost-effective way of arranging for financial controls and oversight. I would suggest that start-ups are more often in need of a good controller than a CFO. Boutique accounting firms, particularly the ones that specialize in early-stage companies, can usually provide that . Dr. Smith
neosystemscorp.comneosystemscorp.com
Jesse, Thanks for the comment. I agree that a part-time controller for a start-up (as opposed to a CFO) is a good idea. Tatum is probably not a good example of this service as their minimum size requirements – both in terms of the engagement and the company – would preclude most start-ups. Many investors have well-developed relationships with local accounting firms who provide such outsourced services. This approach has duel benefits. First, the question of financial controls and record keeping is covered and second the accountant provides additional and much needed adult supervision to the company. As a company grows, the need for an expanded financial and accounting staff can also be met by outsourcing. A company like Neosystems – http://www.neosystemscorp.com – can provide that. But, in the end, a company needs to begin building internal capabilities as early on as possible. Dr. Smith
Jesse Millares wrote:
I agree with David about having a CFO or part-time CFO. The CFO is a crucial member of the executive team if the startup has not done so already. Tatum LLC is a good company of former CFOs for hire at a reasonable cost as many of them are looking for the next company that they want to help advance to the next level and possibly join in as full time CFO in the futue. Having good legal counsel is also imperative as the executive team can sometimes act impulsively without thought of any legal ramifications.
David Kirkup wrote:
I know it’s a little self-serving, but adding a part-time CFO to the mix makes a lot of sense. Chances are no one is focused on financial visibility, key metrics or internal process. These all help with transparency and in building value. The part-time CFO is an independent advisor who has a detailed knowledge of the business model and objectives, and can design systems to keep things on track.
Jon Shore wrote:
Some best practices I would suggest are:
1. Invite the executive team of a portfolio company to a quarterly meeting. Either at a restaurant or at the office.
2. Request a quarterly update which is as detailed as possible.
3. Stay in touch with a point person on the executive team. Keep asking, “What can I do to help?”
4. Really follow through on helping when asked.
5. Take some time to go through your network list. Think about people in your network that might be good contacts for your portfolio company and make the introductions if appropriate.
Jon, Thanks for the comment. I think that your point about investors and their attention span is very important. How would you correct the problems you outline? Are there best practices that investors could put in place? Dr. Smith
Joe A. Mancini wrote:
All very astute comments on this thread. Glad I found you Dr E. Entrepreneurs need to be realistic upfront about expectations/milestones – and provide solid due diligence info (even if some of it is not specifically requested by the less-savvy) BEFORE investment, and provide regular ongoing progress info. The brown stuff usually hits the fan when the original Bplan becomes an obvious joke. Sometimes it is only the less savvy angels (incl. industry inexperienced) who will have the guts to put cash in to riskier ventures – so lets not frighten them away, they should be nurtured. Have to educate them/treat them well – give them a “good experience” – so they do it again and again. Very easy to write off a non-tech-minded investor in a high-tech company – I used to do it myself in my younger days – but they are still often business savvy and should be treated well. I have been pleasantly surprised by these guys more than a few times.
Mohan Dharmarajan wrote:
Hi Michael
Seriousness or lack of seriousness : There are several ways to test this with individuals or companies before you contract. Both : S and No.S shows up prima facie or in the first instance.
When you deal with companies and their executives, it is easily possible to identify or see symptoms of the heart failure of these solo entities. They appear sometimes in the first conversation. Watching their attitude and approach to things is exceedingly important.
For example, not answering calls, not responding to emails, doing the opposite of what we request them, refusing to sign off contracts, postponing things, giving excuses not to do certain things : all are warning bells. We should never ignore these natural information that comes to us.
It is impossible for any human being or companies to hide its natural self for long, it shows up here and there, if not every where. Before you drop moneys, into these companies, it is also imperative that we check on their background from their other customers, freinds or bankers and so on. That will be a sure pointer and damn right at that.
Does any one agree ?
Regards
Keith and Michael, I agree with Keith’s assessment of the situation but would suggest that an earlier filter would have obviated the need to consider the second option. After all, it involves leaving the initial investment on the table – or, at least, as much of it as cannot be clawed back. I believe that this type of filter should work both ways. There are investors who evidence the same types of behaviors. It is generally a very bad idea to put off finding how high-maintenance your fiancee is until after the wedding. Dr. Smith
Michael Pullens wrote:
Hello Earl,
Thanks for your first crisp thoughts. I always enjoy your clear thoughts. But just to provide you some exceptional case, this was what happened to me: I once invested in a small start up company, that was already on its route with increasing revenues. The companies’ founder had realised a ‘smart’ and digital way for securing intellectual property. With a group of 4 informals we helped the company out with cash investments and additional competences. We helped out big way with securing growth with new distribution partners and many other things. All the same this founder an our director of the company managed to ruin the company not following up our ideas and already jointly taken decisions. The company remained small and was left with his odd behavious. We couldn’t reach him for long periods of time, while he was living of the pennies (as far as we could estimate) produced. Even the yearly P/L and balanced were not published …The poor man didn’t take the opportunity to have himself and his environment helped. Not fiercely, not friendly, not personally and privately (helping out). There was no way working together or move on together for the better. Even though it could be he was doing this on purpose, I still don’t believe. How to go about these sort of people and investments?
Keith Pollan wrote;
Specific detremental interferences from the investors (PEGs) which I have encountered include:
1. Encouraging the President of the Business Group to launch too many
concurrent projects. The initiatial funding did not support all the R&D,
Marketing and Production set-up expenses required to bring all the different
products to the market. The PEG partner sat on the board and encouraged
and approved all the projects recommended by the CEO of the
business unit. The financial forecast for each new product indicated the cost
to launch and forecasted the potential revenue for each product, but not for
all the products to be launched simultaneously.
2. The PEG partner did not provide any discipline to the CEO when the
R&D fell behind target and the product launch dates were missed.
The cash flow of the company could not support all the R&D without
the forecasted revenue on the first products being realized. The attitude of
the CEO was that the projects were approved so the PEG had to fund them.
The financial disciplines which were implemented by the CFO were over
turned by the undisciplined funding approved by the PEG.
3. The CEO launched projects without board approval and the PEG expected
the CFO to control the over spending.
4. The CEO would have private meetings with the PEG which deliberately
kept the CFO in the dark with regard to what was said or agreed to.
5. The PEG wanted to chase the top line revenue in order to take the company
public. The business foundation was not in place to support the delivery
and product quality commitments made to customers.
In hindsite, the CFO & PEG need to be on the same page. The PEG
may be tempted to communicate with the CEO without input from the CFO
which will damage the counter balance of the CEO/CFO relationship and
protect the business from over commitment & overspending of the investor
funding.
Mohan Dharmarajan wrote:
Yes, very true.
We are doing a 5 Mil USD in a residential project in Bangalore. The PE comes with a lot of expertise in construction, real estate, market and several other areas. Its a pleasure to work with them.
However, the developer has his own skills and thought processes. But we faced no problems in the deal at all, since both of them applied their minds to their relevant areas of their expertise and left the rest for the other experts to handle.
Thats just swallowing – just what we can digest. And quit the table on time.
Regards
Mohan, Well said. General statements about the nature of investor/entrepreneur relationships are not useful when it comes to specific situations. Entrepreneurs tend to treat all investors the same – as sources of money. But they all come with much more. The article was intended to highlight some of the excess baggage you may get when you take the funding. Dr. Smith
Mohan Dharmarajan wrote:
Hi Keith,
Thats very right what you said.
However, I think what Dr Smith wants to iterate here is that :
1. Investors have created negative impact on companies that they invest into
2. Investors are shooting their own legs
This must be peeled further into :
- Reasons for the failure : Diagnosis
- What needs to be done to heal : Post and pre investment care
Which means we need to look at both :
- The existing management of the company
- Participation – style and stature – of the investors.
The book about angel investors will center around the above fundamentals.
Dr Smith : Have we understood it right ? Or would you like to elaborate ?
Once we have clarity on this, lets pen issues down and we can pin them out one by one.
Regards
Mohan
Keith Pollan wrote:
In my experience, start-up’s or turnarounds require committed investors.
The initial funding will get the foundation built. If executive management follows their business plan, hits their numbers consistently from quarter-to-quarter and communicates with the investors (PE Firm) on a regular basis, they
should be able to fund the growth with additional investment. Eventually, the business will become self sustaining, but only if the growth is controlled which may be too slow to take full advantage of the market place and really satisfy the investors market share goals or top line growth expectations. Significant growth in short periods of time will consume cash faster than the internal rate of return can fund the infrastructural needs of the of business. This means that you need to maintain a long term relationship with the investors (PE Firm) because your business will depend on continuous funding. The initial selection of the investors is very important. The commitment from both sides needs to be there and will be tested over time.
Mohan Dharmarajan wrote:
Hi Carlos,
It is not that they do not have a sense of urgency and do not have mentors or have no plan of work.
Many working minds in the system do not allow progress that easily.
The few things that I think the system lacks is : team work – that is businessmen work together to make one another sucesful. Unrealstic expectations – of returns on goods and services. Enormous amount of time wasted on negotiations. Indecisiveness or too many decision makers. Well, some of the management thoughts even this day teach how to “kill” your competition ! Now, that does not mean peaceful coexistance.
Given that the number of players are not too many or in markets that are limited, in my opinion, the corection is posible.
To go back to what Dr Smith’s head line – how investors help start ups fail, we should make a consolidated list and make it freely available to all globally. Investors as well as business teams. Whats your opinion ?
Regards
Regards
Keith Pollan wrote:
It is good to hear the word “accountability” in the same sentence as investor.
As a CFO and Corporate Controller my experience is that if you cannot see it (revenue, expenses and changes to the balance sheet) forecasted in detail then you cannot measure it and you cannot compare the actual business results to the expectations. There will not be any accountability without a detailed forecast which identifies each department in the business.
Your article highlights the interview you conducted with the CEO. Your questions were answered quickly with not much detail and that told you a lot.
I would recommend that if the CEO did not have a very detailed forecast (budget) for the business which reconciled with the business plan sitting in front of him that nothing he said could be trusted or accounted for. The first job of the CEO is demonstrate to the investor(s) his plan for moving the business forward. He needs to communicate with a document which specifically lists the customers, products sold, direct margin expectations and lists the expenses down the the number of employees, rates of pay and all compensation of executive management. If the executive management’s compensation is not significantly earned by the achievement of the financial results forecasted in the budget, then they are not intitled to the large comp package. The compensation should be a variable expense paid after the results have been achieved. All revenue and expense should be lined up to the business plan forecast and the variances will tell the investor what went right and what went wrong with the business.
dr-smith.infodr-smith.infoVijay, Thanks for your comment. You have identified a very important tendency with some angel investors. Some, particularly those who have made their money working for larger organizations, consistently misjudge what is either appropriate or needed given the condition and stage of the company they have invested in. There is one local investor who pushes this tendency to its limits. He only invests in weak and inexperienced CEOs. As a result, he ends up acting as the shadow CEO. But that is only one of many corrosive approaches. I have written two articles on the subject – see Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ .
Investors do want to – and have right too – provide effective oversight. It is never a good idea to just give new companies money without that. Management – particularly inexperienced management – often thinks that they should have no bosses or anybody to report to. I always take that as an indication that the team is inexperienced and does not know how things really should work.
The investors that I work with are far less interested in numbers these days and far more focused on the results of implementation. They seldom want to see a company that is all business plan and little customer base. Most of them have fallen for the “we will finish the product and generate lots of customers once you give us the money” pitch. One investor recently told me, “Give me revenue from a class-B team and class-C idea any day. I will always choose them over a class-A business plan.”
In the end, business is not about numbers – that is only the way you keep track – and you need something to keep track of before they have meaning. Business is about the ability of a team to turn potential customers into actual, paying customers. Strangely, this is one the areas where some investors actually increase a start-up’s chances to fail.
Dr. Smith
Andrew, I can sympathize with your situation. There are a lot of scammers and con artists out there. The economy, the loosening social bonds and the clear inability of law enforcement to successfully prosecute them seem to have stimulated a proliferation of them. More than ever, buyer beware is the good rule to follow. Increasingly I see people without much substance trying to make it look like they have substance. They are acting as brokers for assets they have no control over or putting themselves forward as intermediaries but have no portfolio – or trying to make deals that are so tilted in their favor as to be outright robbery. It is truly sad to see this development.
The fact that you had an offer to invest might, in the past, be seen as a positive indication of how the investor community is viewing your start-up. Now, things are far less clear. it sounds to me like they wanted to acquire you and your partner as employees.
Most of the US companies that are developing digital libraries are bootstrapping. They are holding off talking to any investors until they have developed a solid revenue stream. Until you do, the balance of power is in favor of the investors. My advice would be, hang in there, make every dollar count, push the business as far along as you can given the resources you can beg, borrow or steal. Turn every investor away until you can demonstrate a successful business model – then allow conversations on your terms. Investors are starving for investment grade deals. Give them what they want but on your terms. Dr. Smith
Mohan Dharmarajan wrote:
Hi Andrew !
That is bad news. Am sorry to hear that.
But on the other hand there are quite a few experienced PEs in the market place who do not even seek a seat on board. They invest, monitor their moneys once a quarter or so and take their returns once the project is closed.
Since they are taking the entire risk of placing the money into our business it is but natural that they have to see whats happening to the bread.
Guess one must look for a professional, well established, institutional PE for lending – be it debt or equity. They should have the expertise and experience in your field of operations and industry. We have to evaluate their value add to the company if they seek a portion of the business or executive berth. One should take references from others whom the PE has invested with and find out what the blocks are upto.
I would sound the horn on them before they step into the office. What do you say ?
Regards
Andrew Turnbull wrote:
I had a recent offer to invest in our new startup from an Australian (Publicly listed) Accounting Practice based on the Gold Coast.
The offer letter and contract was such a releaf as we wanted to expand, we have somthing unique and all we needed to do was market the service….
Cunningly, the offer terms were exquisitely written in a way that they would be investing the total amount of money into our business….then I picked it to pieces…
As well as owning an Accounting / Financial Planning practice, They also owned a Web Hosting Company & a Property Investment / Mortgage Broking Company of which the owner was going to double as the new “Sales Director” for our business. ( He knew nothing of online recruitment)
I only knew this as I have been a Financial Planning Recruiter in the Banking & Finance space for over 15 years! They were not really forthcoming with this info…but I knew already.
The capital offering was $500,000 for 40% ownership + for marketing, expertise and advice.
The problem for me was….
They wanted to appoint their own Sales team…allocating $150,000 to their appointed staff for their expertise.
The were going to force us to rent office space in 2 locations
1) Gold Coast Office = $60,000 pa
2) Melbourne Office = $30,000 pa
They allocated $100,000 for Accounting advice.
They allocated $100,000 for miscellaneous services….
What are we up to now = $440,000
+ They were going pay myself and my business partner $4000 per month each to kick on like we always have.
They were only going to support the project for 4 months and the terms were, we must transfer our hosting to their web hosing business.
To market our business nationally, we were left with $28,000.
They must have thought I came down in the last shower…
I told them to F*&% off….and stop wasting my time…and they were upset with my reaction…. I broke it down for them above and never heard a thing back….
This is an example of how investors try to own your business, whilst taking huge tax deductions in the process. We could have ended up owing them money, have all our IP sitting with their Web Hosting business (never to return) and a lawsuit to regain losses for the rest of the ownership of our company….
Vijay Raithatha wrote:
The answer is perhaps in the term “Angle”; a majority of these investors are self made millionaire entrepreneurs or professionals. Their net disposable income far outstrips what they can spend. They have made the usual investments in material items for their homes, real estate, equities and government supported tax incentivised schemes and then go on to seek new avenues for their cash.
When investing in start ups and mid growth co’s, they expect the same level of feedback they have from quoted stocks (twice annual results, mainly revenue and profit numbers) and not much more (Oh, and they expect dividends). After all some of them are cash cows and prefer not to be bogged down with too many numbers (common misnomer “isn’t that the job of the accountants?”)
Companies want investors’ cash but prefer to be allowed to run their businesses autonomously, and many investors like to think they’re being fair by allowing the company such latitude.
PE/VC’s, on the other hand, will usually seek KPI data from the company’s existing management, and if this not forthcoming or if the management is not capable of extracting such data, the PE/VC will usually install one or more of its own management team and/or make recommendations for new hires. Angel investors should ideally take a leaf out PE/VC’s strategies but where do they start and do they have the time or the knowledge?
dr-smith.infodr-smith.infoEric, Your comments are right on point. I have written a couple of articles about angel investors to avoid – see: Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ and Angel Investors to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/. Most investors focus on industries that they have some experience in. As I indicate in the articles, the problems arise because of non-industry specific tendencies of the investors combined with an unsophisticated approach to the process of getting funded on the part of the entrepreneurs. In The Money Chase: Oil and Water: I focus on the difficulty of productively combining these two perspectives. Dr. Smith
Eric K. Solorio wrote:
It becomes readily apparent that problems can arise when investors get involved in business affairs in which they do NOT have expertise; and also refuse to get involved in business segments where the investors do have expertise. In both situations the investors can “help start-ups to fail”. I imagine each business has unique strengths and weaknesses. The entrepreneur must be honest with himself about his or her weaknesses and savvy enough to seek out the right match of financial and human capital.
dr-smith.infodr-smith.infoSteven, Thanks for your comment. I take your point that my comments don’t fit every situation – however, I have not been successful in finding one that does. Logically you are correct that investors should look to qualified consultants when appropriate. But logic seldom prevails when egos and economics converge. My article is based on what I see investors doing rather than being prescriptive of what they should do. To you comment about angel investors not having the skill – well, overestimation of skills is a major problem. See my articles on Angels to Avoid: http://www.dr-smith.info/angel-investors-to-avoid/ and Angel Investors – The Good, Bad and Very Ugly: http://www.dr-smith.info/angel-investors-%e2%80%93-the-good-bad-and-very-ugly/ . The world we find is very different from the one we would hope to find – but we have to live in the former and work towards the latter. Dr. Smith
dr-smith.infoSimeon, Thanks for the comment. We do agree on the need but probably not on the method for meeting that need. In a recent article – The Money Chase: What Does Investment Grade Mean? Part 3: http://www.dr-smith.info/the-money-chase-what-does-investment-grade-mean-part-3-%E2%80%93-the-team/ I discuss what I see as the proper make-up of a start-up team from an investor’s perspective. The point of the article is that, in order to be considered investment grade, a team has to have all those skill sets on-board and not covered by outsourcing consulting agreements. The one variation to that formula is, in the very early stages, outsourcing financial controls. Many investors have relationships with trusted accountants who regularly supply ‘adult supervision’ to their portfolio companies.
Your point about the oversight responsibilities of the board is a very good one. Many start-ups suffer from a lack of such oversight. Their boards are mere formalities and do not effectively control and guide management. But, like building an A-level team, the challenge is not overmastering. I have know many entrepreneurs who have managed both. Investors prefer to put their money with them and avoid the ones who can’t seem to overcome the difficulties. Dr. Smith
Simeon Hitzel wrote:
Thank you Dr. Smith; however, I think we actually agree. I’m glad to see Angel Investors are already working with a network of “professionals they know and trust” such as yourself. I suppose this was my point.
Just as in the article, you were hired by the angel investor to analyze the management and accountability of the example CEO. One might assume that a great inventor or technician (i.e. Cancer Researcher ) with a great product may not have expertise or focus on management, bills, or staff. An experienced management consultant or advisor such as yourself could help that investor and inventor to unlock that potential opportunity instead of walking away from the deal because the guy won’t leave the lab and keeps churning out ‘ideas’.
Typically, this is the role of the Board of Directors to ensure appropriate management is in place with a fiduciary responsibility to protect equity investors assets and provide guidance to management. A small privately-owned company (and its lending angels) lacks a knowledgable and experienced board to serve this role, and therefore investors are wise to hire outside advisors to protect and grow their investment and develop an opportunity into reality.
Simeon, Your suggestion may sound appropriate but it is a non-starter for three reasons. The first is that start-ups are notoriously short of cash and will always focus the little they have on generating revenue and building the company organically. Investors rightfully expect that the team they invest in will have all the skills necessary to get the company off the ground and on an upward path. If this is not the case, they have invested in the wrong team. The second reason is that most consultants who would consider such an engagement are not worth the money they are asking to be paid. Most of them could not get or keep a job and are reduced to finding consulting gigs to pay the bills. As someone who built six businesses, I never allowed consultants to fill significant roles and seldom even considered outsourcing important responsibilities. The consultants who do have the depth and breadth of experience – meaning they have actually built large companies or successfully turned around complex operations – are generally not interested in working with start-ups. They are engaged with larger companies with far more experienced and professional management and whose checks reliably clear. The third reason is that Angel Investors tend to have their own experience to call on and that of a selected group of professionals that they know and trust. Most Angels have financial, sales and marketing resources that they have decided to go to when needed. The DC area is littered with consulting firms who are seeking exactly the kind of engagements you mentioned. For the most part, they are under employed and spend a lot of time getting paid. Dr. Smith
Simeon Hitzel wrote:
It would seem appropriate and valuable to both parties if Angel Investors developed a network of Angel Management Consultants to continue working with their young start-ups through their growing pains. An effective management consultant can act as customer-devils advocate, validate marketing concepts, and forecast potential obstacles or conflicts.
Some teams I’ve worked with suffered from a lack of sales input, others suffer from excessive revisions without closing the first sale. To be successful, a company should develop a tempo or cycle of market validation and feedback; one which includes true market feedback, but is not paralysed by it. It is also important to retain those early lessons (institutional learning) that sparked the product.