Starting a company is really, really hard. Helping entrepreneurs start and build companies is really, really hard. Much has been written about the mechanics of entrepreneur/investor interaction, from how to pitch investors, structure the round, assemble board decks, undertake strategic planning, etc. But after more than six years of seed stage investing, perhaps the most important and least well-understood aspect of the relationship is the implicit covenant that exists between entrepreneur and investor. Expectations. Transparency. Honesty. Safety. Both sides generally enter the relationship with the best of intentions and wanting things to go smoothly, but in seed stage companies this seldom happens. Development deadlines are missed because ________ (pick your reason). Recruiting is more time consuming and difficult than originally thought. Seemingly fertile markets are brutal to break into, taking longer and costing more than expected. Runway is shortening at a horrifying rate. More often than not this is the way of things, but divergent expectations, poor communication and lack of trust can doom a company at this critical stage. So why isn’t more time spent on hammering out these issues in advance of the inevitable struggles and challenges?
The way I think about it is that a covenant exists between entrepreneur and investor, one which acknowledges and reinforces the importance of partnership but isn’t shy about owning up to the potential conflicts that might arise. It’s how these conflicts are handled that govern the success of the relationship, not when things are rosy and everything is up and to the right. In thinking about the elements of this covenant, I have started a list of the obligations that each side has to the other. You’ll notice a ton of overlap, most of which apply to healthy relationships in general and not simply in the business start-up context.
The Investors’ covenant to Entrepreneurs:
Honesty – Insights, concerns and doubts all need to be conveyed. It is hard to be blunt, but pussy-footing around does nobody – especially an entrepreneur fighting for their businesses – any good. Let the entrepreneur know where you stand at all times, good or bad.
Respect – Even in duress, an investor needs to respect the entrepreneur and their efforts. There are times (many, many times) when entrepreneurs and their investors have divergent views of the world. It is important at these times to disagree respectfully and to remain constructive, otherwise the message gets lost in the medium and it becomes a rapid race to the bottom (behaviour-wise, that is). Investors that act like a**holes generally get what they deserve.
Timeliness – Entrepreneurs are working hard and often in stressful, highly time sensitive situations. Investors need to be able to act quickly and to engage in discussion and joint problem-solving in a timely manner. The outcome might not be to the entrepreneur’s liking but that isn’t the point. Engagement and jointly working towards resolution is.
The Entrepreneurs’ covenant to Investors:
Sacrifice – This means being all-in, no joke. It means that not doing your company was keeping you awake at night, making you grumpy and irritable and that the inevitable pain, risk and financial sacrifice of doing your start-up was a price worth paying. Taking other people’s money conveys a different kind of obligation than simply hacking around and testing new ideas. It means that you are going to do everything in your power to help your business succeed, provided you are honest with yourself and your investors about your ability to succeed (see Honesty below). Starting a business is among the hardest things you can do, and it will cut deeply into other aspects of your life. There is simply no way around it.
Honesty (external) – In short, this means NO SURPRISES. I know, I know, s*&t happens, but there is nothing worse than a leader that hides the ball out of fear, embarrassment or concerns about consequences. If entrepreneurs lack sufficient confidence to lay problems on the table and to deal with them in a straight-forward and forthright manner, there is a big, BIG issue. Investors will rapidly lose confidence and it will be extremely hard (if not impossible) to recover.
Respect – Same as with the Investors’ covenant. By taking on investors the entrepreneur has partners, and they should be treated with respect and listened to with an open ear. Treating investors as second-class citizens to be “dealt with” and not collaborated with is wrong, short-sighted and potentially destructive. Often times investors have a lot more data than entrepreneurs on situation-specific issues, and good ones will coach entrepreneurs through potential minefields. Yes-ing investors to death and not really engaging with them is done at the entrepreneurs peril.
Honesty (internal) – The first Honesty has to do with external dealings. This has to do with honesty with oneself. Sometimes, things just aren’t working. Sometimes the market opportunity isn’t nearly as good as originally thought, and it’s difficult or impossible to adjust with existing financial resources. Perhaps it costs much more to build out a functioning alpha product than expected, and the risk/reward calculus went from attractive to poor. Maybe you’re just not the right leader. Bottom line, self-awareness is essential in the fast-moving, high risk world of founding companies.
This is an incomplete list, but hits on a few of the high points I’ve learned over the years having been on both sides. Bottom line, I think these are issues entrepreneurs and investors need to discuss in advance of doing a deal together because the stakes are so high. Clarifying expectations, roles and responsibilities can only smooth the way in relationship-building and establish a strong foundation for handling the inevitable ups-and-downs of the start-up journey.
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