Dr. Earl R. Smith II
DrSmith@Dr-Smith.com
www.Dr-Smith.com
Very few entrepreneurs take the time to really study their company from the perspective of an investor. Those that do are often initially frustrated by what they see as a heartless and antiseptic assessment of the object of their passion and dedication. But, if they fight through those self-justifying tendencies and come to understand the investors perspective, they can substantially improve their chances of fathoming the process and, perhaps, of getting funded. The investor’s world is quite different from the entrepreneurs in many ways. But there are also similarities.
Similarities
The most notable of these similarities is the fact that investors, much like entrepreneurs, make decisions in anticipation of a future which may or may not actually come to pass. Investors know that projections of future results are not the same as future results. They know that estimates are just that. The best investors use all their skill and judgment to make investments that will have a high probability of generating a very significant return. But, no matter how good they are, none can truly see the future.
Investors, like entrepreneurs, plant a flag every time they commit resources. They decide to put down a marker on this technology, with this team and on these terms. Once they have committed, they do everything within their power to help their investment pay off. In doing so, they are taking significant risks. They expect very significant profits in the form of a high return on investment (ROI). Like entrepreneurs, they are in it for the payoff.
Venture capitalists tend to be industry specific. Much like entrepreneurs, they focus on industries that they know. Many investors pick an industry focus because of personal experience, education or the anticipation that it will provide good opportunities for profit. Most entrepreneurs to do the same.
Both investors and entrepreneurs are focused on building a reputation for success. Investors realize that their ability to raise subsequent funds will depend of the success of their current portfolio companies. The most successful venture capitalists have built a reputation for picking winners. As a result, they have raised a series of funds involving increasingly larger amounts of investment capital. Many entrepreneurs also look beyond their current company. They realize that a reputation for success will make it easier to fund a second or third company. These recidivist or serial entrepreneurs see their career over decades and as involving multiple companies.
Differences
The similarities pale in comparison to the differences. Bringing entrepreneurs and investors together is a lot like mixing oil and water. No matter how vigorously you shake the bottle, the mixture will, in time, separate out. But the fact that mixing these two perspectives is difficult does not mean that it should not be attempted or cannot be done. Both sides make efforts, some successful and others not, to understand where the other is coming from. Investors tend to see a lot more entrepreneurs than entrepreneurs see investors.
From my experience, the short-comings that often make the meeting of minds so difficult come from the founders. They simply do not put in the time and energy to understanding how investors think and what they consider a quality opportunity. The worst offenders are ones who rail against investors as stupid, lacking creativity, manipulative or arrogant. It is not just that this attitude, which you can track with a simple Google search, is insulting. For most investors, it reduces their interest in backing a venture involving such people and attitudes to zero.
My goal is to outline some of the differences between investors and entrepreneurs. My hope is that, by laying out some of these differences, I can help entrepreneurs better understand the vision and objectives of investors. Here are just a few of those differences:
Tomi Price wrote:
I think that the process for seeking funds is so complex that anyone of the people seeking funds can fall into any of these challenges, especially if it is their first time seeking funds. I would suggest that the entrepreneur who reads this, be able to identify which challenge is most recognizable to their actions, and improve from there.
I watch the show, “Shark Tank”, and they show a few examples of some of the challenges you have referenced.
Ali Zartash-Lloyd wrote:
Dear Earl
Hope you had a great Christmas and thank you for an excellent article. As always, it is concise and covers many points that we should all know but it is amazing how often we ignore the basic rules of business at our cost and peril.
Without the doubt the points you have made are valid and are worth remembering when looking for investors for growth or survival. What I would like to add is the need for entrepreneurs to take a critical look at their business and in essence become their own toughest critic. Have a look at my recent article on Business Grooming ( http://www.cognisantassociates.co.uk/articles/Business_Grooming_1.html ) to see how critical this issue is when dealing with investors or just running your business on day-to-day basis. Principal of sound business management is universal across industries and no matter which country we are operating within.
I hope you and your readers find my article a useful resource.
Happy New Year.
Randy Long wrote:
Dr. Smith,
As a newbie to Angel and VC financing I found your article to be very beneficial.
I am a retired banker and work for a national business lender that among other things is involved in Bulk Portfolio Real Estate Foreclosure and Non-Performing Note Brokerage. We locate banks, federal lending agencies, credit unions, credit companies, RMBS and CMBS investors, etc. who need to sell portfolios and match them up with Private Equity Groups, REITs, and Hedge Funds that want to buy. We try to set-up a minimum 25% ROI.
So far we’ve used our capital plus wealthy private investor’s capital for
operating expenses, portfolio deposits, and initial portfolio acquisitions. The
minimum portfolio size is ~ $5MM and the maximum tends to be $150MM.
Our small capital base limits our acquisitions to the smaller portfolios which require higher prices (less ROI) and/or we can only bid on a small percentage of a large portfolio which impairs our ability to obtain larger price discounts which would produce a higher ROI. Typically, we hold most properties &
notes from 60 days to 6 months before we retail them or sell them to one
of the end users mentioned above.
Thus, we need more leverage and investment capital primarily from Private Money Sources. I have located a couple of warehouse lines-of-credit lenders that will extend a $10MM line-of-credit for 13% + 2PTS. which will help us to leverage our acquisitions. Next, we need additional Private Equity Capital of $50MM-$150MM so that we can bid on the larger portfolios and increase the ROI to 30%-40%.
Questions:
1) What suggestions can you make in regard to our business model?
2) What minimum ROI is acceptable for the Private Equity Groups?
3) How do you locate the experienced and equitable Private Equity
Groups? Are there any that you can recommend?
4) What other suggestions can you make?
Please advise.
Randy Long, National Accounts
HomeCoast Capital LLC.
Direct: 770.635.7800
Email: rlong@homecoastcapital.com
Vic Williams wrote:
Cooking a turkey mixes the oil and water into a delicious dinner. The sustained interactive engagement through cooking is a recipe for success. As in the Hudson’s Bay Company – since 1670. The most hazardous thing for a smaller North American company using a bank-investor is that the bank will change its mind and take its money elsewhere.
More interesting might be China. A Western company outsources manufacturing, shipping, and a call center to China. Those all combine investing and entrepreneurial activity in the same injection into China, and all too many companies depend on a contract as a way to manage/regulate the operations.
Jhank Regmi wrote:
Good article.. I would like to appreciate and many thanks to the writer.
Ray, Thanks for the kind words. I am glad that you found the article useful. Dr. Smith
Ray Zoeller wrote:
A great article, with points made succinctly. Excellent advice for those contemplating a possible search for funding. — Ray Zoeller
James Troscinski wrote:
Dr. Smith,
As being involved in three start ups from a management team aspect, I found your article on target.
I must agree that “oil and water” is a great analogy, since many entrepreneurs are very passionate and emotional. They have great difficulty grasping the need for a metered approach.
I also agree that a great management team makes or breaks the relationship. They can usually adapt to investor concerns while maintaining the integrity of the company’s vision.
Vithal Donakonda wrote:
Dear Dr. Earl,
very nice article which concisely addresses the shadows in thought process of investors & entrepreneurs.
Appreciate your sharing it with the group.
Regards
Vithal