by mike smerklo
What I have learned about how investors and entrepreneurs think differently from each other – and how both can use these differences to achieve better outcomes.
“This is a very good security. I think we can make a decent upside while still being protected on the downside, assuming the business continues to operate at current levels”
– Private equity partner
“We want to build an amazing company – we have spent the last five years of our lives getting to this point – and now with just a bit more money, we can continue to make our customers ecstatic with our solution”
– CEO of a rapidly growing business
I had just finished two very, very different phone calls, back to back on the same day and I was feeling a bit confused. Why?
The two calls had been on the exact same topic – a proposed equity capital raise for a high growth, exciting company – and the corresponding terms for the investment.
I was considering both an investment in the company and a board seat and found myself somewhere between the investor and the entrepreneur in my mindset. Wow, I thought, these are two really different ways to look at the same opportunity.
As the private equity partner (a well-accomplished and successful investor) spoke about the investment, he kept using the word security. We spoke in detail about terms, preference levels, potential ROI levels and other attributes of the investment. What was really interesting, though, was that he didn’t once refer to the company by name or the entrepreneurs – rather he spoke repeatedly of the “security.”
I had this odd thought (as usual) that it reminded me of how a serial killer might refuse to use the name of his victim to avoid any personal feelings. It’s worth noting that I have never thought much about serial killers, and I expect that my thought was largely a result of the Stephen King novel that I was reading at the time – but the resemblance did spook me just a bit nonetheless….
And then I spoke with the entrepreneurs leading the company, and the terminology used and the focus of the call was almost the exact opposite. We didn’t speak at all of the terms of potential returns– rather we spoke of customers, market opportunity, vision and how the money could be used to further differentiate the company from its competitors.
For guys like me – who have been in their shoes – this is the good stuff, and I know so well just how much these things matter for scaling a business.
But then another thought struck my mind: while these are the things that really good entrepreneurs need to obsess about, really good investors need to obsess about the capital and the terms associated with it.
Investors are from Mars, Entrepreneurs are from Venus
It would be easy for me to make the careless comment about private equity investors “not getting it” because “they have never operated a business before,” but that would be inaccurate at best – flat-out wrong at worst.
It isn’t that they don’t “get it.” It’s that they “get something else.” And there’s no right or better answer here.
In fact, the beauty for an entrepreneur is to understand this mindset and find a way to allow that understanding to help her build an even better business.
That’s what it is all about: using every advantage you can get to build an amazing business, right?
The biggest thing to understand here is that investors only influence a few things, and these all come together in one specific event: the capital raise. You have to understand that the price paid at the time of the investment is by far the biggest determinant in an investor success or failure. For the entrepreneur, this is just one step along the journey.
So investors have to focus on a few key questions and make a point-in-time decision (yes or no), and the outcome of this decision won’t really be known for several years. This is a tough job; most of them are wrong more than they’re right – and they know it. As such, they have to go through several key questions that might be fluid or common knowledge to the entrepreneur.
The decision process goes something like this:
1)Is the market for the company large enough to support one or more big companies?
2)If the answer to #1 is yes, is the company in question positioned to win in the marketplace? And is this leadership position sustainable?
3)If the answer to #2 is yes, then the question becomes about the entrepreneur and the team around her. Are they good? Are they ethical? Are they self-aware?
4)Of course financial performance and market penetration now come into play, and the investor will want to see what progress you have made AND how this progress compares to what you expected it to be (i.e., your plan).
5)Finally, if all this looks good, the framework moves to valuation, terms, and how both relate to previous investment levels.
My point here isn’t to summarize the investment decision process in five easy steps. Rather, it’s to highlight just how different an investor thinks AND what determines his or her success or failure. In short, investors have to make a “point estimate” that will be written in cement the moment the wire transfer is consummated.
Entrepreneurs, on the other hand, are in a fluid environment where the factors to consider are changing on a daily (sometimes hourly) basis. As such, they can’t really spend too much time on “point estimates.”
Instead, their brains must be focused on a wide range of constantly changing data points and alternatives. And this fundamental difference can make the process of working with investors painful, confusing and frustrating.
But doesn’t have to be – in fact it shouldn’t be. By understanding and utilizing the inherent differences in perspectives, a powerful combination can come forward where the investor helps you and acts as your partner.
For a Hole-in-One, Run a Great Play
For a bit more color on this, a sports analogy might be helpful. In some regards, the difference between being an entrepreneur and an investor is a bit like the difference between hitting a golf ball and being a quarterback in a football game. It’s pretty obvious that Tiger Woods has one kind of job and Peyton Manning has another one.
The investor is like Tiger about to hit a drive off the tee. He considers a bunch of variables (distance, wind, club selection, etc.), and then makes a single action (the swing) in a bit of a vacuum. Tiger then watches the ball take flight – the result, of course, already locked in – and has time to contemplate the outcome during the walk down the fairway.
The entrepreneur, then, is like Peyton Manning as the quarterback of a football team. Peyton calls a play based on what he knows at the time, he snaps a football and all hell breaks loose. Peyton is forced to make multiple decisions based on the unfurling of a huge number of events around him. The play ends. Peyton then huddles back with his team, and quickly calls another play. This is like every day in the life of a high growth company.
The problem with this analogy is that it makes the golf seem easy and the football game seems hard. And that is simply unfair. They’re both really, really hard, but the setup, mindset and approach are very different. And like the difference between investing and operating, it’s impossible to claim that one is easier than the other.
And that isn’t the point anyway. The real consideration is that both the investor and the entrepreneur have to think about their responsibility, capabilities and skill sets in a very different way.
The more an entrepreneur can understand this – and learn from it – the better the partnership will be with your investor group. Likewise, investors need to understand just how different their world is from operating a high growth business in order to provide real insight and help to the entrepreneur.