When it comes to the growth of small businesses, nothing could be more important than the relationship between entrepreneurs and investors. Investors have what entrepreneurs need: capital and know-how (as I’ve found that many are or once were successful entrepreneurs themselves). On the other hand, entrepreneurs have what investors want: a vehicle that offers the potential for a return.
In theory, this relationship works beautifully. These separate entities share common and joint interests: growth of the business. Yet theory rarely plays out in practice. What should spur collaboration instead often creates turmoil. What should conduce transparency and regular communication instead stifles it. The entrepreneur-investor marriage is one that can end in divorce, an ending that looks dramatically bleaker than its prospects during the honeymoon phase.
And the reason? I believe it has everything to do with trust — or the lack thereof.
What causes a lack of trust?
Trust is a social resource that, when leveraged, can empower teams and organizations to achieve the remarkable. Trust fuels collaboration, inspires innovation and defies the improbable. Yet when you look at the entrepreneur-investor marriage today, it remains in scarce supply. And that’s because the current system in which entrepreneurs and investors coexist is designed to erode trust rather than engender it. And that erosion occurs in cycles that follow a common narrative.
Entrepreneurs often set wild expectations in their pitches to investors, including revenue that’s off the charts, an exit in two to three years, a high and near-guaranteed return, etc. Then the first quarter passes, and forecasts are way off. Entrepreneurs make excuses, and they talk about positive developments that have only tangential relevance to the bottom line. Trust erodes just a little bit.
Then the next quarter comes and goes, and the same scene repeats: Forecasts are missed. Excuses are made. Positive developments become the focus. Trust erodes a little bit more.
Quarter after quarter, this cycle continues for years. By the end, you have a relationship enveloped in mistrust and misrepresentation. Eventually, it passes a point of no return. Entrepreneurs lose the most accessible and efficient source of capital when they need reinvestment. Investors write off these businesses as failures, even though they stand a better chance of generating a return than startups with no record of success. This vicious cycle of trust erosion remains the reason many businesses fail or never reach their potential.
Building trust starts with setting realistic expectations.
But imagine a different process that I argue is not far-fetched and is quite possible. It starts with investors and entrepreneurs becoming transparent about the concept of trust and the factors that erode it. For investors, this new model would call for setting realistic expectations with yourself and then entrepreneurs. Investing in any business is a marathon. Rarely will you see a return in two to three years, despite nearly all pitch decks making this promise.
After you become honest with yourself, share the same set of expectations with entrepreneurs. You’re not expecting hockey-stick growth, but sustainable results that will eventually lead to a return. And the sustainable part depends on a transparent, open and communicative relationship. By setting these expectations from the start, you free the business and entrepreneur to pursue a natural course of growth, one free of and unhindered by falsehoods and misrepresentations.
For entrepreneurs, they, too, must be open and honest, starting with themselves. That means accepting that their company is likely not the next Facebook. Once entrepreneurs become honest with themselves, they can begin to understand the longevity needed to win and start adopting the sustainable practices that will get them there. In other words, they’ll begin to understand the dangers of building a business focused solely on the speed and velocity of growth. Instead, they can focus on adopting the methodical practices that create enterprise value. Suddenly, planning takes precedence over action. The long-term view materializes and coincides with a focus on the short-term.
Improving the investor-entrepreneur relationship is possible.
It’s not sexy to talk about trust. It certainly isn’t as inspiring as hearing entrepreneurs talk through PowerPoint slides that depict rapid growth. Nor is it as exciting as preaching the get-rich-quick prospects of your company to a room of salivating investors. But here’s the thing: Business isn’t supposed to be sexy. Business is supposed to be smart, and the smartest move is to set expectations destined to preserve trust rather than lose it.
And it can be done. I’ve applied this style of expectation-setting as an entrepreneur and investor. As an entrepreneur, I’ve focused on building relationships based on transparency and honesty. For instance, I made the perceived mistake of telling a room full of investors that our company wouldn’t achieve the rapid growth promised by other startups. I told them they wouldn’t see a return in three years, but more realistically five.
I lost some potential investors as a result, but I also earned others who were more patient, understanding and invested in our success. These were individuals who trusted me because I hadn’t sold them on a promise I couldn’t keep. And our business exited as planned. I attributed our success to the healthy relationship we managed to foster and sustain with our investor base.
And as an investor, I’ve also continued to reinvest in our portfolio companies that are beyond the startup phase and no longer bring the intrigue of being new. This reinvestment is not only capital, but also guidance and mentoring, which I believe remains the biggest untapped resource in the entrepreneur-investor marriage. Many investors have exited their businesses and know the challenges and successes that go with the terrain. Yet few entrepreneurs and investors capitalize on this all-important asset.
From my perspective, we can start building better businesses, jobs and an economy by fixing the relationship between investors and entrepreneurs. But it will take a new approach where both sides adopt a mindset of “we” versus “me.” It’s not “How can I benefit the most?” but “What can we accomplish by working together?”