Getting funded. Understand the language of the investor
My previous blog discussed the classic challenges of contemporary entrepreneurs by listing six general barriers that cover the majority of entrepreneurial human resources difficulties. If you ask an entrepreneur how to overcome any one or all of those challenges, he will likely say investment funding.
In comparison to entrepreneurs, investors live in a very different world. To provide the appropriate context for this discussion we seek your indulgence while we belabor the obvious and list four fundamental differences between entrepreneurs running companies, and the investors who might consider investing in those companies. Here are a few of the most obvious differences between entrepreneurs and investors:
Investors have sufficient amounts of discretionary money… Entrepreneurs have insufficient money to accomplish their business objectives (by definition). Investors actually expect to lose money on a significant number of their investments… Entrepreneurs expect to make money with their business, and certainly do expect to provide a healthy ROI to the Investor.
Investors are interested in and therefore participate with several (often many) different companies simultaneously… Entrepreneurs are focused on one company – their own.
Investors pursue a fundamentally different core purpose – which is typically NOT to fulfill the mission of any of the individual companies in which they invest.
In considering the above fundamental differences in the business lives of entrepreneurs versus investors, we might boil this discussion down to a core difference. It would be a fair comment to suggest the individual commercial mindset of a typical investor is substantially different than that of the typical entrepreneur.
For example consider their respective (a) levels of business experience, (b) understanding of capital leverage in the marketplace, (c) emotional predisposition toward the mission of any given business, and certainly their perspective, (d) track records at making money in the open market.
Why is this a big deal? If the topic is money, there could not be a more clear delineation of a buyer/seller role. It’s the classic situation sometimes referred to in business as “The Golden Rule – the guy with the gold makes the rules.”
These substantially differing mindsets – the entrepreneurs contrasted with the investors – are typically at the heart of the problems and challenges faced by the investor in the entrepreneurial game.
Here again, a complicated and often intensely involved relationship develops between the investor and the entrepreneur who is asking for the cash.
For our purposes in this discussion we will highlight a few areas to illustrate the interpersonal dynamics of this problem space. Some of the more significant challenges to the community of investors are:
1) Difficulty in remaining current with the most promising areas of opportunity – In their respective areas of interest, investors report having increasing difficulties in keeping abreast of areas of highest promise. Especially in industries such as high tech, healthcare, communications or for that matter any technology driven market sector, the volume of data and rate of evolving business models create a potentially overwhelming task for the individual investor to maintain current awareness.
2) Many new opportunities presented to the investor on a regular basis – By their own choice investors would like to be exposed to a relatively large number of investment opportunities on a regular basis. This creates exceptionally limited time windows available to make an investment feasibility judgment.
3) Entrepreneurs’ understanding of the investment cycle – With few exceptions the typical entrepreneur enters the investment seeking process with an inadequate understanding of the investor’s perspective and the types of information required for an expedient funding solicitation process. In fact there is very often a misunderstanding by the entrepreneur of the investor solicitation process in general.
4) Failures or subpar ROI’s at a very high percentage – Ask an Angel Investor about the expected typical won/lost ratio on overall investments and you will likely get something like… “To be successful I must maintain an average that for every 10 investments, one will be a big winner, two or three will break even, and the rest will lose money to varying degrees.”
One investor is quoted as saying,
"People are embarrassed to talk about their failures, but the truth is that if you don't have a lot of failures, then you're just not doing it right, because that means that you're not investing in risky ventures… I believe failure is an option for entrepreneurs and if you don't believe that, then you can bang your head against the wall trying to make it work."
We feel this helps sum up the heart of the problem faced by investors – they often feel that exceptionally high risk is simply part of the game of entrepreneurial investment.
Investor’s strategic approach
In response to the challenges described in my previous blog, the serious investor has developed a remarkably adaptive strategic approach having two core parts.
The first and most obvious part of the investor strategy is to evaluate the potential of the business idea being presented by the entrepreneurial team asking for money. The investor will only invest in a company believed to hold the highest potential for a positive return, with the lowest apparent risk.
The second part of the investor’s strategic approach is equally as important as the first. In fact many investors will argue it is even more important than evaluating the business idea. The investor must also evaluate the people who will run the business.
And, even when the occasional great business idea pops up on the investor’s table, there must be an initial judgment on whether the proposing entrepreneurs can indeed successfully implement the business they are proposing.
These judgments are made in many cases on a rapid fire basis in spite of certain naïvetés the entrepreneurs may possess, such as lack of experience in the context of the basic needs of a good investment evaluation.
Like any complicated business situation, the entrepreneur-investor relationship has been subject to a wide and varied array of metaphors.
Some investors use a horse racing metaphor to capture the essence of their strategy. If the business is represented by the horse, the CEO or executive leadership is the jockey. The metaphor suggests one might have a strong and fast horse, but without a good jockey they will not win the race. In fact, many investors will emphasize their investment is actually “a bet on the jockey” (and not necessarily the horse).
Probably our most favorite metaphor for the potential entrepreneur-investor relationship is that of a marriage. In one sense or another, the entrepreneur is looking for a partner in commercial wedlock. To be consummated, the marriage must be legally sanctioned with contractual agreements during which there is:
an exchange of vows where the business plan becomes the marriage promise;
the symbolic exchange of value where the interchange of money-for-equity becomes the ring of holy matrimony;
a honeymoon period during which the marriage partners are emotionally connected over the grand promise and possibilities for the future; and
the honeymoon is over and the investor and entrepreneur get back to business as usual; with the exception they are now legally bound in a relationship (for which the entrepreneur had no training about what to expect).
You can probably see how this metaphor can be squeezed… ad nauseam.
To put this in a relevant context for the investor, the entrepreneur’s strategy is fairly straightforward. The entrepreneurial enterprise reaches a point in their business growth and maturity where a significantly large cash infusion will provide the necessary impetus to rise to the next level of business.
At this point in the business journey – from the entrepreneur’s standpoint – acquiring the capital investment is a critically important priority. In many cases, there is a relatively short timeline for the entrepreneur business in which the business must radically gear down or close down altogether, if the investment is not received.
With this in mind it is also relevant to add that the entrepreneurial team very often becomes so highly focused on the task of soliciting capital funding that many other important components to the business may take a backseat and with it, an inferior position on the daily To Do List.
Here again, for the entrepreneur it is a bit like the fervor and intensity of hitting the dating scene in search of that ideal spouse [i.e., the investor]. It is an exciting time filled with emotion and energy that drives the search.
Especially when an apparently good investor candidate shows up on the entrepreneur’s social scene, the game often intensifies to a point where other unrelated daily business operations tend to grind down to low gear.
This narrowing of focus by the entrepreneurial team is not necessarily a bad thing, but rather a necessary part of the search. Why? Because the investor’s approach to evaluating each potential deal can be highly demanding in terms of time and resource required of the entrepreneurial team.
One way to summarize the investor-entrepreneur interpersonal dynamic is in terms of a “selling” relationship. The entrepreneur is trying to sell the business concept to the investor, so the entrepreneur is always strongly interested and highly motivated to sell their idea.
The investor interest in any specific entrepreneur – contrary to the entrepreneurial emotional investment – will vary substantially depending on where in the cycle of interest the investor is with a given entrepreneurial opportunity. As the investor interest grows toward a particular entrepreneurial opportunity, so does the level of business intimacy correspondingly grow between that investor and the the entrepreneur’s offering.
But viewed in terms of who holds the power in the selling dynamic – the entrepreneur typically needs the money from the investor, much, much more than the investor needs to invest.
The investor’s strategic approach then, must address the types of challenges expressed in [Section 2.3.2] by efficiently reviewing literally hundreds of potential investment opportunities in order to pull out the small handful of prospects that are worthy of closer inspection.
It is this interplay between the respective mindsets of the investor and the entrepreneur that is at the core of the investor-entrepreneur relationship – and perhaps the origin of their mutual frustration.
