RRE partner (and BI investor) Stuart Ellman wrote this post a couple of years ago. In light of the recent cult of startup-worship and controversy about whether it’s appropriate or “nice” for anyone to observe that entrepreneurs occasionally fail, it seemed worth publishing again.When I grew up, it was hard to get a trophy. To get one in sports, you had to play in a competition with a large number of teams and come in at least second, if not first.
Even more vividly, I remember the ice cream. To get an ice cream after the little league baseball games, you had to win the game. Not tie, not come in close, but win.
I remember clear as day my Little League team losing the first 5 games and not getting an ice cream at Friendly’s or Carvel for the whole first month. But when we did get it, it tasted sweet.
Sometime after my generation, everybody became a winner just for trying. Everybody got an ice cream. Everybody who participated got a trophy. It wasn’t about winning or losing but about trying hard.
It sometimes feels like this attitude has crept into the psyche of some entrepreneurs. I respect nothing more than someone who quits a safe job and takes a huge risk to start something new. I did and I know how scary it can be. But startups are a brutal business, where few make money and many lose. The following are situations where I find myself having to tread carefully when I know what the right answer is.
1) Don’t tell me my idea won’t work
The right answer: Look, I do not know for certain as I have been wrong before, but I am highly confident your idea will not work or ever get funded. The key to being a venture capitalist is pattern recognition. I have seen what you are trying to do many times in many industries, and it has never worked. There is a small chance that I am wrong, but a much larger chance that you are about to waste years of your life.
What I feel I am supposed to say: It’s an interesting idea but we cannot fund it at the current time.
Why? Because it would be hurtful to say that I don’t believe the idea won’t work. But maybe being truthful would save this entrepreneur years of his career or his life savings. If I tell the truth though, then I am arrogant or dismissive. I gain a reputation as being a jerk and won’t see the more interesting deals. So, what is the upside for me to tell the truth?
2) Don’t tell me I am not an entrepreneur
The right answer: Look, if you are telling me that you don’t want to take any risk in your job and need at least the same amount of cash as when you worked for IBM, you are not an entrepreneur. Startup guys (and gals) take a lower cash salary for the higher upside they get in stock. They love working without a bureaucracy, contributing concrete results, are OK making do with less and having no staff.
What I feel I am supposed to say: You have a great background; sorry we have no openings right now at our portfolio companies.
Why? Because it would be hurtful to tell the truth. But, by not telling the truth, certain people will continue to seek jobs where they will not excel and will likely get fired. But if I tell people that, again, I will be called an arrogant jerk. So what is the upside for me to tell the truth?
3) Give me a follow-on as convertible debt
The right answer: Look, you have missed your budget or tried a different business model. You are not worth as much as the last time I invested but I still want to back you because I believe in you. Go out to the market and get a term sheet from an outsider. That will be the right price for the company at this time. I will do my part once new money has set a price. But don’t push me to give you convertible debt at a price that both you and I know is too high.
What I am supposed to say: Go to market and get a term sheet. I don’t know whether you are worth more than the last round or less, but we need to let the market decide it. If you can’t then I will likely support you anyway.
Why? Nobody wants to admit their pride and joy is not performing while the team tried really hard. But, get ready to be known as a monster if you try to explain to the CEO what the company is really worth right now.
4) Don’t disagree with me on selling the company
The right answer: When you (the CEO) raised money from me at $25 million post, you showed me how you were going to sell it for $200mm or more. Now, you have an offer for $30mm to sell the company and you are upset when I am unenthusiastic. Why? Because you personally own 20% of the company and will make $6mm. I get back $6mm on my $5mm investment, for a profit of $1mm after x number of years, leading to a poor return, on a company I believe has a huge upside. It is not a good deal for me as an investor, and you promised you wouldn’t sell it at a cheap price like this. Now that you can put away $6mm personally, however, you don’t care what you told me. If I try to block the deal using the terms we both agreed on when I invested, I am an ogre, a financial engineer who doesn’t understand entrepreneurs. But I am the one holding true to my word, you aren’t.
What I am supposed to say: I really think there is a huge upside to this business and believe we may be selling it prematurely.
Why? Who wants to be called an ogre.
5) Pay me a bonus whether I hit my plan or not
The right answer: It is a pay-for-performance job and if the company doesn’t perform, then investors and our limited partners make no money. You have a guaranteed performance bonus and you missed it. It doesn’t matter if you tried really hard. You didn’t win, you lost.
What I am supposed to say: Yes, you tried very hard and we will come up with a bonus that reflects your efforts.
Why? Perhaps in part because I need to keep the employees that are critical to the business, but increasingly often it has more to do with an expectation that trying hard = winning.
This is a black and white business. You either make money or you don’t. Somewhere along the line, being politically correct has entered the fray. And when that happens, people stop communicating honestly. Bad things tend to follow.
Stuart Ellman is the co-founder and managing partner of NYC venture capital firm RRE Ventures. This post was originally published at the RRE blog, Five Years Too Late; it is republished here with permission.
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