How to Avoid 90 Day Wonders
What kind of deal is a 90 Day Wonder. It’s a transaction or an agreement where 90 days after you sign the papers, you wonder why you ever did the deal. And, whichever side of the table you’re on – investor or entrepreneur - take it from me, you don’t want to end up there – with a bucket full of regrets and egg all over your face. Even if Halloween’s just around the corner.
There's a great old poker expression: "If you're in the game for 30 minutes and you don't know who the patsy is - you're the patsy." Needless to say, in any context, but especially when you're negotiating over money for a new business, nobody wants to be the patsy. And you can usually avoid it if you go into the negotiation process understanding even just a little about the needs of both parties; how those will change over time; and just how crazy most entrepreneurs get from time to time as their companies and their circumstances change and grow. Remember: as the Latin saying goes: "finis origine pendent" which means "the end depends on the beginning".
And keep in mind that I get to call entrepreneurs “crazy” because I “are” one. So please don’t be offended. If you’re a VC or other investor and I haven’t previously offended you, it certainly isn’t for any lack of effort on my part. I like to say that “asking an entrepreneur what he thinks about venture capitalists is like asking a dog how he feels about a fire hydrant”. But I digress.
The fact is that, for many investors, each new deal and each new entrepreneur is a distinct set of experiences – so good, some not so much – and it’s an ongoing education for both sides of the equation that can be very instructive and also very painful. Education is expensive, no matter how you get it.
One of the problems, however, from the investor side, is that very often you’ve got young, relatively green guys representing the money and, because they don’t have a great deal of maturity or experience, they tend to fall back on a standard set of approaches, formulae, repeated mantras (that they seem to think are infallible expressions of long-settled wisdom) and other inflexible (and often inapplicable) views of the deal that basically have worked for them (or – at least – that they got away with in the past. And, often for worse, they try to jam every deal into the same cookie-cutter mold and approach.
Part of this is simple inexperience and a larger part is butt-covering where they figure that they can always say – in their defense if the deal structure ends up sucking – that this was the way they were told to do it in the past. Just as they say that no young MBA ever lost his job at a VC firm by saying “no” to a deal; there’s also no place in the partnership (or anywhere else) for a whole lot of innovation, clever new solutions or risk-taking. Shutting up and doing it like it’s always been done is the tried and true course. Gag me.
In any case, here are a number of things that are critical to understand and keep in mind as you start down the road of working with entrepreneurs. The first 3 are pre-deal; the next 4 relate to considerations growing out of the ongoing deal negotiations; and the last section covers some very common comments and a bunch of rationalizations that customarily start to be heard with great frequency when the business is most likely in the toilet or on its way there.
I include these last quotes from both investors and entrepreneurs because they function very well as early warning signs (but sadly not early enough in most cases) that the deal is in real trouble.
Be Careful Not to Starve the Baby
Building new businesses may take less money today than it used to, but it still takes some basic amount of capital. In negotiating an initial deal, unfortunately both sides are perversely incented to starve the business. The entrepreneur wants to conserve his equity (you only give away your equity once) and to avoid early dilution at a low valuation. The investor wants to put as little capital at risk initially as possible although getting in early at a low valuation is an offset to this sentiment. The risk is that the business is undercapitalized from the outset and never has the resources necessary to get a serious start.
Be Broader than the Boy Wonder
It’s the investor, not the entrepreneur, who has to make sure that whatever deal is made adequately provides for the entire management team (key players) and for players to be named at a later date. For the entrepreneur, very often, the business is a mission and a sacred crusade and he or she would basically work for free. But this isn’t usually the case for most of the other senior people - at least not to the same extent – especially if they were lateral and/or later additions rather than co-founders or early members of the team. Because entrepreneurs are so intensely committed themselves, they very often fail to appreciate the differing levels of commitment that exist among the rest of the members of their team and they almost always fail to adequately provide for the rest of their team when they are dealing with the investors. It’s very rarely an issue of selfishness and usually it’s just the fact that they’re so focused that they’re oblivious.
Be Sure to Ask the Hard Questions and Don’t Kid Yourself
Making an investment deal is very often a time-constrained process and, unlike a divorce proceeding where the lawyers on both sides are perfectly happy to bill their time and just wait until the parties calm down and get a little more rational before they try to get a deal done, in a typical business deal, everyone’s in a hurry. And, because everyone wants to get to a deal, bad and ultimately unworkable agreements get made on a frighteningly frequent basis. Here are some of the things to watch out for:
Hard and time-consuming issues get papered over or buried to be resolved “later” by someone else (and sadly often through litigation) because no one wants to be the “bad” in someone else’s day.
Otherwise smart and prudent people gloss over or entirely ignore their attorneys’ advice on certain risks and with regard to undocumented or researched concerns (we regularly called our lawyers the Department of “NO”) and focus only on the upside prospects of the deal.
In the interests of smooth sailing (and often with the excuse that “we have to live with these people after the deal is done”), even seasoned veterans will accept superficial assurances and smiles instead of concrete answers and go on to confuse good manners, pleasantries, and bad jokes with real agreement. The technical term we used for this phenomenon was “grin fucking” (where people are smiling through their teeth, but don’t mean a thing they’re saying) although there are a host of other equally descriptive and suggestive terms.
Too often, the negotiators push the problems forward and assume/delude themselves into believing that the fine details and rough edges will all be taken care of during the implementation phase of the transaction. All I can say about this is that – as a general rule in complex deals – (a) the easier the deal is to get done, the harder it will be to implement and (b) deals rarely, if ever, get better during implementation. Problems don’t work themselves out or disappear – they fester and persist until someone takes responsibility for them and gets them resolved. Or, as the great playwright David Mamet once wrote: ‘you can’t polish a turd’.
Finally, instead of acknowledging and accepting that there are remaining open items and continuing uncertainties (that only time can resolve) and working together to construct metrics for determining the impact of possible outcomes as well as potential solutions to address changed economics, the parties engage in mutual fantasies and shake hands on deals which are full of holes and more porous than Swiss cheese.
Beware of Hurt Feelings and Hidden Agendas
Entrepreneurs are great rationalizers. Sometimes a modest delusion or a great rationalization is the only way you make it through the day when things are tough. As the old expression goes: if we knew how hard it was going to be and how long it was going to take; we would never have started on the journey in the first place. In start-ups, ignorance and lack of experience can sometimes be a competitive advantage – not knowing what you can or can’t do opens up a far larger world of possibilities than settling for what’s clearly doable and right in front of you.
In any case, in the context of negotiations, these traits play out in very specific and somewhat peculiar ways.
For example, to get a deal done, an entrepreneur will often accept (or really “settle for”) terms and conditions that are unworkable and unrealistic just to get the deal done. He will sign up for the deal, but actually be crossing half his fingers and toes. Because entrepreneurs are eternal optimists (at least some of the time), they don’t feel obliged to evaluate “either/or” equations because they think (but don’t necessarily say) that they can eventually have it all or at least recoup what they are giving up in the short term. When this doesn’t happen, you have one very unhappy camper.
Investors need to be careful that they never accept a commitment in words rather than in spirit. This is the same situation that all employers have when an employee asks for a raise and is turned down. You have to be sure that the employee didn’t “quit without leaving”. Happy to take a paycheck and do a half-assed job while looking for the next opportunity.
Another example is that entrepreneurs hate to lose control of any situation. But the very give and take that makes for successful negotiations and deals is a back and forth process of concessions and give-ups which can be viewed constructively or bitterly by the entrepreneur. Too tough or aggressive negotiations (even when the entrepreneur “agrees”) can build up resentments that accumulate and that will ultimately find expression in harmful ways as time passes and the business rolls out. It’s ALWAYS better for the parties to feel that both sides have left something on the table.
Finally, entrepreneurs are quick to feel victimized and taken advantage of and they fear getting screwed in a deal much more than any concern they may have about the business failing. Anger and paranoia are major emotional drivers and part of the personality of EVERY successful entrepreneur. Investors want to make sure that the underlying anger that’s always there isn’t directed toward them. One of the saddest things about even successful entrepreneurs is that – in retrospect – even when the deal has gone well, they still feel “cheated” late in the game because they are convinced that they gave up too much at the start. I don’t know what else to say about this except to point out that mental health has never be a prerequisite for entrepreneurial success.
Back Off the Gas and Tap the Brakes
As the new business develops and expands, the interests of the investor and of the entrepreneur can easily diverge – especially if the deal has misaligned incentives which may be inherent in all deals rather than the fault of the parties. It’s all about the relative perspectives of the parties.
Basically, the investor is always “on a clock” with at least one eye toward the door because his job is to ultimately harvest returns for his own funds or investors. More importantly, the investor knows that he will only have a small percentage of winners in his investment portfolio – some will be flat-out mistakes, some will be OK deals and some (maybe the worst outcome of all) will be the living dead – sideways deals that just hang on. So, when the investor sees a deal with real upside, he goes for the gas. He wants accelerated growth and he wants it sooner rather than later.
On the other hand, the seasoned entrepreneur certainly wants to expand his business, but he is usually focused on reaching profitability first and then growing from there. The main reason for this attitude is pretty obvious – the longer the business is losing money, the more likely the prospect that additional (dilutive) funding from the investor or others will be required. And, until the business is making a profit, other traditional and less costly means of financing growth simply aren’t available. The second reason for the entrepreneur’s attitude is that this is his business and he typically expects to be in it for a much longer time than the investor.
Bottom line - one is looking for a salable asset (near-term exit) and the other is looking for a self-sustaining and profitable business (long-term value).
“Business as Usual” Rarely is for the Entrepreneur
Every business encounters bumps in the road. They come with the territory and they are unavoidable. But, as inevitable problems arise, the older and more experienced investors react to the situations calmly and treat these things as “business as usual” problems to be dealt with rather than major catastrophes that are about to kill the company. In a real sense, “they’ve seen this movie before” and they’ve seen plenty of worse cases where some time, some planning and maybe a little luck got everyone through the storm in one piece. One of my favorite old-timers used to say that “things were hopeless, but not serious”.
It’s a completely different reality for the young entrepreneur who’s going through the entire process often for the first time. To him or her, every problem is unique; they’re all huge; and each one presents an existential threat to the business. While you might think this sounds a little extreme and over-wrought, it’s completely real for the entrepreneur and it results in three material reactions which actually can have very serious consequences. In a sense, the business can get killed – not by the disease or problem – but by the reactions and the “cures”.
In these cases, you can expect the following:
(1) The entrepreneur quickly concludes that the investors (because they aren’t frantic) don’t “care” or aren’t interested in the business. This leads to ugly conversations and intemperate accusations which aren’t helpful or constructive for anyone.
(2) The entrepreneur is irresistibly drawn to action – to doing something – pretty much anything – not because it’s the right thing to do or a well-thought solution, but because the action itself is an antidote to the enormous anxiety that the entrepreneur is feeling. This leads to knee-jerk responses and wasteful actions which can usually be expected to do more harm than good. As Yogi Berra used to say, “we may be on the wrong road, but at least we’re making good time.”
(3) When you let everything become a crisis and be treated as an emergency, you lose control - not only of the agenda and of your scarce resources – but also of the ability to address and deal with the higher priority issues which are far more critical and which – if unattended to – can threaten the enterprise.
Better an Unwanted Guest than a Broken Business
Sometimes, like it or not, the investor needs to be a bit of “a bull in the china shop” and barge in even if he’s not welcome. Denial is a powerful tool for entrepreneurs, but it can also be a big problem. It’s not a process where you can ignore the facts and try to make the circumstances fit the plan – all the parties have got to be willing and open to changing the plan. By and large, if you don’t think your business has any problems or room for improvement, then you probably have a big problem. And, in any case, I’d rather see a pivot than an empty pot.
It’s been my experience that entrepreneurs pretty much never want to or know when to ask for help – a smart investor needs to invite himself to the party. Asking for help is embarrassing to these guys and most of them would rather die than die of embarrassment. The fact is that, in many cases, the growth rate of a start-up is directly proportional to the entrepreneur’s tolerance for embarrassment. The thicker your skin – the further you’ll go.
Bite the Bullet When Things Go Bad
Words that you want to watch out for.
Investor’s Perspective:
This is Just One of Many Deals – I Need to Cut My Losses
I Can’t Afford the Opportunity Costs of Spending More Time
Deals that Go Sideways are the Living Dead - Fail Fast and/or Pivot
We’ve Got to Sell It to Somebody/Anybody
It’s not Actually My Money Anyway – “Out of Sight/Out of Mind”
Entrepreneur’s Perspective:
This is My Only Business – It’s My Life and My Livelihood
We Need to Keep Fighting the Good Fight – We Never Give Up
We’re Just “this/close” to Turning the Corner
There’s Always Another “Other” - Constant Excuses or Explanations
It’s Just Money to You – It’s a Crusade for Me
PP: “You Get What You Work for, Not What You Wish for”
