OR, THE WORST WAY TO SELL STOCK IN YOUR COMPANY.
In 1969, Mel Brooks won the Oscar for best screen play for his irreverent and outrageously funny movie The Producers. An unscrupulous producer and his mild mannered accountant team up to profit from raising more money than they need to produce a play on Broadway. For their scheme to work they need only to produce a total flop of a play that will leave the investors expecting no return. Then, they can keep the extra they raised for the play.
The producer targets little old ladies, selling them each a fixed percentage in the profits of the play. When they open their musical - Springtime for Hitler (the "mother load" of sure flops) - the initial audience reaction is horror and disgust, raising the expectation of a quick profit from a total flop and early closing. But something unexpected happens and the play becomes a great success, dooming the producer and his accountant to financial ruin.
So, what's the reason for the producer's impending doom? After all, a successful play should generate plenty of profits to share with investors.
The answer is in their fundraising process. The producer sold percentage interests in his play instead of selling fixed units of ownership. Expecting a flop, he sold percentage interests adding up to more than 100% meaning for every dollar of profit they would owe more than a dollar to their investors.
For the entrepreneur, selling percentage interests instead of ownership units can be just as dangerous. The effects are more subtle - unless, of course, you sell more than 100% of the company - but can be very damaging to a company's prospects.
The process makes it harder to raise more money. This is because it protects the percentage investor from dilution in future rounds at the expense of other shareholders, which usually includes management and the founders. This means, literally that the company has less ownership to sell in later rounds. It also means future investors will be disproportionately diluted in rounds after they invest. This is not something most thoughtful investors will agree to. It also makes it harder for management to retain enough ownership interest to motivate themselves or attract needed talent.
This can put an expanding company with growing cash needs in a crunch. The company's success, like the producer's play, can spell the doom of the venture. Not because the company has to pay out more than it makes to investors but because the ability to raise needed investment to fund growth is impaired by a capital structure modeled on The Producers.
The cure is to sell the investor who wants to by X% a number of ownership interests that equal X% of the company at the time of the sale. But when the sale is a percentage of the company that won't change when more ownership is sold, the company has mortgaged its future to raise current cash.
Remember, Mel Brooks is not your venture investor and selling percentage interests in isn't a good idea even if Will Farrel and Uma Thurman are promoting your product. Sell units of ownership instead of percentages.
Image and video clip from promotional photos for the movie The Producers.
THE SCIENCE OF HEALTH ENGAGEMENT and behavior design is confirming some common sense notions that have application to successful business development. Check out the work of Stanford's health design professor Kyra Bobinet, MD, MPH who specializes in the field. In a recent (and short article) in Experience Life magazine, (January/February 2016,)
Dr. Bobinet advises that "setting ambitious behavior-change goals often backfires, diminishing our chances for success in the future." To understand why "setting outcome specific goals may not be the best way to approach making important changes in our lives," Dr. Bobinet discusses how two high performing individuals approached the task of losing weight in a weight-loss study she conducted.
The first individual set specific, measurable, achievable, realistic and time-bound goals and promptly set about counting calories, excluding junk food and exercising. She succeeded but later gained it all back.
The second participant and self-proclaimed sugar addict adopted a more process oriented approach. First, he moved the vending machine that provided the doughnuts and other high calorie snacks he craved to the other side of his building. He set goals and created a spreadsheet to figure out how wean himself off sugar. He succeeded and kept the weight off.
Dr. Bobinet explains that an area of the brain called the habenula records our failures. When we fail it inhibits our motivation to try again by suppressing dopamine-releasing neurons. When we measure our goals in terms of success or failure, this suppression can keep us stuck on square one.
Another physiological function that can also inhibit success of outcome-oriented goals is something called implicit memory. When your have harsh goals, like getting up at 5 a.m. to jog, implicit memory of the discomfort of those goals can encourage you to stop the unpleasant behavior. This is what likely kept our first participant from keeping off the weight.
So, what does this say about business building? We know setting ambitious goals is a touchstone to success in an entrepreneurial company. And failure is a staple in any new business as it charts a new path to a new development or offering.
Dr. Bobinet's research suggests you can improve your odds of success by keeping our focus on your process for achieving your goals. When you get stuck try other approaches and enjoy the problem solving process as you proceed.
And, from one who has witness many entrepreneurial successes and failures, remember that failure to some extent is inevitable. Remember that it is part of the process and be flexible and creative in your approach.
Many venture investors can give your story after story of the company team that failed because of their single minded focus on one approach and stories, too, of the many teams they backed who changed course dramatically and succeeded because their process included an intense attention to market and competitive changes.
As Dr. Bobinet would say, there is more power in the process than in the specific goal and greater chance of sustained success when your focus is on process.
Note: The article referred to is in the January/February issue of Experience Life Magazine. Dr. Bobinet is also author of Well Designed Life: 10 Lessons in Brain Science & Design Thinking for a Mindful, Healthy, & Purposeful Life. Image by Hywards courtesy of freedigitalphotos.net.
KNOWING SOMETHING ABOUT VENTURE venture capital fund managers can help you plan your venture fundraising campaign. It can also help you negotiate and work more constructively with investors in your business.
Consider the following factors that influence the average venture capital fund manager:
There is more about this topic in Richardson's Growth Company Guide 5.0 but even this partial list provides some insight into your potential venture fund investor and future board member.
A few observations pop out from this partial list. Do your homework and screen the funds you can as best as you can. Do they invest in your market or your stage of investment? Do they have money or are they in fundraising mode?
And, have you prepared a convincing deck and a worthy written plan to back it up? Think about how can you tailor your approach to stand out among the many who apply? Do you know someone who can make and introduction and increase their interest in considering your company?
Image from Roswell, NM. Copyright Clinton Richardson.
RECOMMENDED READ. It is not a recent blog but it addresses a very real phenomena in venture investing that is worth any angel investor's consideration. It's basic stuff, really, but if you want to avoid being the goat after an investment, its worth your consideration.
Check out this blog from YCombinator addressed to start up entrepreneurs. They provide a thoughtful and balanced narrative about the subject, noting several reasons why investment opportunities become hot. They also note the following:
"But frankly the most important reason investors like you more when you've started to raise money is that they're bad at judging startups. Judging startups is hard even for the best investors. The mediocre ones might as well be flipping coins. So when mediocre investors see that lots of other people want to invest in you, they assume there must be a reason. This leads to the phenomenon known in the Valley as the "hot deal," where you have more interest from investors than you can handle.
The best investors aren't influenced much by the opinion of other investors. It would only dilute their own judgment to average it together with other people's. But they are indirectly influenced in the practical sense that interest from other investors imposes a deadline. This is the fourth way in which offers beget offers. If you start to get far along the track toward an offer with one firm, it will sometimes provoke other firms, even good ones, to make up their minds, lest they lose the deal."
Image courtesy of Wikipedia.
Think about it. They fly in looking for prospects. They hover around their candidates. They probe. They question. They challenge.
And then most of the time they fly off.
Most of the time, you are not in their sweet spot. You need more sales or profit. Your team is incomplete. You are a milestone short of where you need to be. Or, your financial reporting is insufficient.
But once in a blue moon they swoop in and stay. They offer money. Lots of money. They have contacts and experience. You celebrate.
But then come the terms and conditions. Their expectations are high. They want a lot of stock and their own special kind of stock. They don't want control but certain important things will require their consent.
And then there are the rights they want. Odd sounding things like preemptive rights, first refusal rights, tag along rights, co-sale rights and anti-dilution rights.
And, they want a seat on your board so they can monitor your progress and ask more questions. Regular financial reports with comparisons and detail will be required.
There interest is genuine. Their presence will be a new constant in your life.
So, what makes them this way?
To protect yourself and benefit from their presence you need to get into their mind. You need to think like a VC. More about that in our next post.
Image copyright Clinton Richardson. Taken at the Roswell, NM, museum.
RECOMMENDED READING. David Hornik of August Capital explains why you want an introduction when you approach a venture firm for investment in a recent VentureBlog posting. He says he has never funded a company he wasn't introduced to and then explains the math of "borrowed credibility" and how it applies to fund raising. Direct and worth a read.
The image is a detail from Raphael's School of Athens in the Vatican.
CONGRATULATIONS TO TAMMY FARLEY AND RIMAS KAPESKAS this week as they both represent Atlanta's entrepreneurial community in the news.
Tammy, President of Rainmaker and a thought leader in the revenue optimization industry, cofounded her business with Bruce Barfield (CEO) and is now being honored as is one of the Hotel Sales and Marketing Association International’s Top 25: Extraordinary Minds in Hospitality Sales, Marketing, Revenue Optimization. Rainmaker was one of the Atlanta Business Chronicle's "100 Fastest Growing Companies 2015 and a regular on the Inc. 5000 list of the Fastest Growing Companies. Click here to read more.
Rimas is Atlanta's leading corporate venture capitalist, heading up UPS's efforts in that area. His thoughts on corporate venturing, innovation and enterprise appear in a recent Wall Street Journal article entitled What Corporate Venture Investors are Talking About.
In talking about how to facilitate venture investment decisions inside large companies, Rimas notes “You can try to create the best, most rational data-based presentation, but ultimately you find that human beings need to make decisions,” Mr. Kapeskas said. “You need to find the right people in the company and take them out in the world. …They need to viscerally see and experience some of this stuff. That’s what changes minds.” Click here to read the WSJ article.
HOLLYWOOD GETS IT RIGHT with the release of Joy starring Jennifer Lawrence. The film has been described as the "wild true story of Joy Mangano and her Italian-American family across four generations centered on the girl who becomes the woman who founds a business dynasty by inventing the Miracle Mop."
For someone who has worked with entrepreneurs for decades, much of the movie rang true. Achieving entrepreneurial success is messy, demanding work that is full of hazards and advice. Consider the following scenes from the movie:
Joy prevails again. By this time, she and her business have the kind of qualified professional advisers her business could have used earlier on.
We write for creative doers who seek inspiration from everywhere. Our readers are students of life, interested in travel, photography and ideas.
Clinton Richardson, has been writing for decades. His critically acclaimed venture strategy books first appeared in 1987 and are now in their 5th edition. His Ancient Selfies is an International Book Awards Finalist and an eLit Award Gold Medal Winner. Ancient history and capturing photographic moments are among his passions. See his photo galleries at TrekPic.com.