The myth of misalignment

All too often novice entrepreneurs are given advice that goes something like this:

“You can’t trust VCs. They have the power and control in the relationship, and inevitably, your interests will diverge and they’ll screw you. Protect yourself and be wary at all times.”

Some entrepreneurs are so fearful that they let this advice severely impact the important investor/founder relationship by intentionally keeping their investors at arms length, carefully guarding (read limiting) information flow and eschewing VC advice and assistance. 

What I find so odd and troubling about this far too common condition is that it is rooted in and rationalized by the concept of ‘misalignment‘. VCs and entrepreneurs have different utility functions – VC’s are required to optimise for maximum returns (a condition of their fiduciary responsibility as managers of OPM, ‘other peoples money’), while entrepreneurs may have other considerations like lifestyle, independence, control, life-changing financial security, etc. – and as a result, the story goes, VCs and entrepreneurs are plagued by innate conflict and are inevitably at odds with each other. 

Of course, the misalignment described above absolutely exists (and is most pronounced in financing and exit situations – the details of which will be saved for later posts). 

But so what? 

Let me put it to you this way – every relationship in the world is plagued by misalignment. By way of example relevant to the world of entrepreneurship, a founder and his/her employees are often misaligned. The founder owning, say, 33% of the company may be inclined to sell, if given the chance, for $30mm. The founder will walk away with $10mm – clearly a life changing event. But what about the employee who owns 0.5% of the company? Sure, the employee walks away with $150,000 – not a terrible outcome – but that’s a far cry from the home-run opportunity many startup employees sign up for (and in most cases, it’s likely the founder recruited the employee by selling the dream of the 9-figure opportunity). 

But back to the point, every relationship has some degree of misalignment – manager/shareholder, employee/employer, husband/wife, parent/child, friend/friend. Misalignment is caused by a simple truism – everyone has a unique personal utility function composed of financial motivations, personal presences, interests, temperament, tastes, likes and dislikes, hopes and dreams, fears and risk tolerance, etc. It is an inescapable reality that no two utility functions are the same. 

And yet we engage with people everyday building intricate and deep relationships. How do we do it?

For one thing, we try to minimize misalignment using financial and legal structures. In the case of employer/employee we create economic incentives using equity to encourage a shared desired outcome – maximizing a company’s enterprise value. In the case of investor/investee we create legal provisions in the deal agreements to address potential misalignment. Nevertheless, as described above, there are many scenarios in which even the best intentioned alignment strategy fails. Plain and simply, there is no conceivable way to fully structure away misalignment. 

So the question remains, how do we engage one another given innate misalignment?

The answer boils down to two primal things – trust and respect. The most important piece of relationship advice, period, is that you only engage in meaningful relationships with those whom you trust and respect. If you do not trust and respect the people with whom you do business, partner, build a home, share life experiences, etc, then you are doomed to get screwed.  

Of course, this prescription is not fail safe, you’ll inevitably engage some people whom you deemed worthy of your trust and respect and these pathetic souls will prove unethical, immoral and just bad. But our intuition of trust and respect, our discerning eye that allows us to distinguish between ‘good’ and ‘bad’ people, is the best tool we have to navigate the natural condition of misalignment. 

So next time some ill-informed ‘advisor’ gives you blanket advice to be scared and wary of your investors (your partners!), please do yourself a favour – spend time with your investor partners, build a relationship with them, and let your intuition for trust and respect, good and bad, show you the right way. 

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