The Mindsets of Venture Investors and Entrepreneurs
Ask yourself this: If entrepreneurs and investors are like horses and wolves, which is the horse and which is the wolf? This analogy, the brainchild of Adam Rentschler, CEO and founder of Valid Evaluation, helps clarify the communication and perception challenges that exist between entrepreneurs and investors.
Interestingly, when answering the question, entrepreneurs typically say that the investors are wolves, because they are “vulture capitalists” trying to take away control and ownership of their business. Investors, on the other hand, typically say that entrepreneurs are the wolves, because they’re trying to take the investors’ money with wild valuations and without exercising proper care toward preserving their investment.
Clearly, when it comes to investing in early-stage companies, a lot of fear exists on both sides, and both sides perceive the other to be the aggressor that must be approached carefully.
So which really is the horse, and which really is the wolf? Investors are the horses, and entrepreneurs are the wolves. Surprised? The answer is in the eyes.
Horses (investors): Playing it safe in a risky world
Horses’ eyes are on the sides of their heads — perfect for prey animals that must always be on the lookout for wolves or other predators that may attack. With their eyes in this location, horses have a wide field of vision and can scan the horizon for potential hazards.
Now think of venture capital (VC) investors. If you were to visit the websites of a half-dozen wealth advisors and pay attention to how they position themselves to be attractive to investors, you’d find, almost without fail, the words “preservation of capital.”
Investors are interested in investing and making a profit in order to grow their portfolio, but they also want to maintain their wealth and preserve their capital. Their attitude is fundamentally conservative.
Why are investors so concerned about risk? Probably the biggest reason is that, for a typical venture fund, something like 60 percent of investments will return no money at all back to the fund. Venture investing is really that risky.
Venture capital funds need to provide high returns to their investors, so they must take risks, but they are also constantly evaluating those risks in order to preserve the capital of their limited partners.
Wolves (entrepreneurs): Keeping their eyes on the prize
Now think of wolves’ eyes. They’re positioned close together and focused forward. The wolf needs to focus on its prey, undistracted by peripheral vision. Entrepreneurs are focused on building a successful business to the exclusion of all else.
This single-mindedness can sometimes create a blindness to risk and excessive confidence in success which is all that some entrepreneurs can see on the horizon. This kind of personality can be a good thing; entrepreneurs who have it are the ones who can achieve success in the tough business of running a venture-class company — but it’s an inherently different attitude than the one investors have.
Learn to speak the language of risk
As an entrepreneur, you should always keep your eye on the ball while at the same time learning to speak “horse” — the language of risk — to your investors. When entrepreneurs show sensitivity to risk and an understanding of all the factors that can go wrong in pursuit of their goals, they’ll gain the confidence of the investor.
By speaking openly and transparently about risks, you’re speaking investors’ language, reinforcing that you both share a similar outlook, and giving them confidence that agreement in future decision-making is possible.
So should you reveal all the risks to potential investors? Won’t an excessive focus on risks cause investors to shy away from the deal? Although a pitch that focuses 100 percent on risk won’t be a compelling story for any investor, a pitch that avoids discussion of risk is also a turn-off.
The best pitch is one that balances the opportunity (the company’s competitive advantage in gaining market share in a large and rapidly growing market) with the risks (the challenges and milestones that must be overcome in order to achieve success).
Venture capitalists see hundreds of deals, all of which have significant risks. They see many companies in the same industry, all of which face similar risks. They’ve seen many companies fail and a few succeed. In short, VCs have the background and expertise necessary to be able to connect the dots between risks and rewards.
They have an extraordinary ability to hone in on what could go wrong and what needs to be done in order for things to go right. Despite this expertise, many investments that VCs make still end up in failure; therefore, they want to have a clear understanding of what can go wrong and what you plan to do about that.
The best way to create a compelling risk story for the venture capitalists you present to is to put yourself in their shoes. VCs have a duty to their limited partners (LPs) to invest carefully and to research every investment to uncover problems that may kill the company in the future.
Every investment that a VC makes needs to be able to return between 10 and 50 times (abbreviated 10X–50X) the original investment. (Remember, up to half of the investments made will end up as failures or “the walking dead” — companies that return minimal cash flow but don’t have any real opportunity for exit.)
Your job is to provide a great risk story: one that’s open about risk while simultaneously giving the VC a justification that he can provide to his LPs about why your company is a great investment.