6 Mistakes Investors Make

We have all attended those luncheon functions where the local entrepreneurial players assemble to pat each other on the back and give someone an award for something or another. I don’t remember most of them but one such event has become etched in my mind. It was MC’d by a local news personality, and the speaker was a widely known and successful local VC. During his speech he made one of the most profound statements I’d ever heard on the subject. I didn’t record it so I’m paraphrasing here. He essentially said:

‘Before we invest money in a project, we invest countless hours evaluating the opportunity, the product, the market, the management team, and especially the President of the target firm. We don’t invest unless we are supremely confident in the President/Founder, his industry knowledge, integrity, work ethic, and ability to make sound decisions. After all that effort, how is it that we still only get a satisfactory exit around 20% of the time, and about 65% of the time, we replace the President within a year or so? How could that be? Aren’t we supposed to be the experts? The interesting thing is, we never fire him if the accounting gets behind. We never fire him if the product is late, or doesn’t function exactly as expected. Why do we fire him? Because sales don’t measure up to expectations. That’s really about the only reason. If that’s the case, why do we spend so much time talking to the President, and so little time evaluating and speaking to the heads of the marketing/sales organization?’

I almost jumped out of my seat and screamed “AMEN!” You see, most of my career I’ve been that marketing/sales guy who the VC’s spent almost zero time talking to. More times than not, I’ve been the writer of the business plan, the crafter of the market research based products and strategies. I’ve been the guy whose job it was to keep the pulse of the industry, to know what the customers wanted, to know what the product should look like, to know what the obstacles are to sales success, to generate those sales that would keep the president from being replaced. Yet for me, many of those board meetings between the President and capital partners meant only that I would be given a new set of parameters, new goals and/or impossible promises to live up to, new strategies or tools to use in doing so, all decisions made by generals far from the trenches without visibility as to the real obstacles or opportunities. 

Having spent nearly 30 years behind the lines in those trenches, and having been able to see what really goes on before and after the board meetings, I have a unique vantage point from which to write this article.

Mistake #1: What’s the motive of the business plan?

Before an entrepreneur accepts capital, he has one of two jobs: Build a company that will succeed, or build a company that will look good to investors.  I know both goals should be the same but they rarely are, at least in the mind of the entrepreneur, or even the investor. Raising capital is a long and often difficult process. Throughout the process, Presidents often mistakenly find themselves altering the business plan and strategies to fit the requirements of their funding sources rather than the requirements of the market. When this is the case, how could the plan possibly succeed in the market? 

Mistake #2: Who are you talking to? 

From the moment a entrepreneur accepts capital, his job often changes from raising capital, to saving his job. Notice, his primary focus is still not on creating a successful company, but on impressing the capital partners. Again, while they should be the same thing, they often are not. In this case, rather than investing the funds on growth generating activities, they cut costs and try to make the capital last as long as possible in order to show the investors how frugal they are being. Where do they cut first? Marketing! Because they don’t make growth related investments, growth doesn’t happen. The next thing that happens is the sales/marketing leadership is blamed and replaced. The new leadership discovers the same problems and obstacles as the old guys, is again denied the resources, and they are let go soon after. It’s generally during the term of the third round of marketing/sales leadership where the President is finally replaced, often by the CFO.

Mistake #3: Who are you not talking to?

As the successful VC in the event story above so wisely put it: why do we ‘spend so little time evaluating and speaking to the heads of the marketing/sales organizations?’ If the primary measurement of a company’s success is sales, doesn’t it make sense that one of the primary contacts for anyone interested in a company’s success be the leadership most responsible for that metric?

Mistake #4: Is industry experience an advantage?

It’s hard to argue against industry experience as an advantage. What’s most important, and most often lost, is the relevancy of the experience. (Read the article "Industry Expertise: Advantage or Hurdle?") For example: Owning a mechanic shop is not the same as being a mechanic, and vise-versa. While each has an understanding of their specific rolls, the knowledge is not necessarily transferable. Yet they are often treated exactly the same. 

One entrepreneur I worked with had been in his chosen industry for over 30 years within two very large organizations. He had developed a highly efficient way to perform the function he was responsible for and decided to take his process to the market. But there were two significant differences between his familiar environment and the one he tried to sell the product into. 

• First, the very large firms he had worked for only serviced their own internal organizations, while the market firms had to respond to the needs of a market. 
• Second, his former firms controlled every employee and could dictate the tools they used, whereas the market firms used independent contractors and could not dictate their tools. 

These seemingly small differences should not have been a problem, except for the Presidents inability to adapt to a paradigm that was different than his own. It is often valuable for someone with no preconceived ideas to objectively evaluate a market and influence the strategies and products based on what the market says, rather than previously conceived beliefs.

Mistake #5: Is a brilliant idea good enough?

No. If good ideas are a dime a dozen, really good ones are about a buck a dozen. What is seriously lacking is the execution required to carry out good ideas and poorly executed good ideas are often worse than bad ideas and certainly more expensive. If the idea wasn’t a good one, the investors would not have invested. Most often, the execution is assumed and the President is left alone until it doesn’t happen. The result becomes the replacement of the president and potential loss of the window of opportunity. What the company loses with the President is the passion for the product and the market, as well as a lot of expertise.  If an investor is sold on the idea, the next, and even more significant issue becomes the execution of the idea, which includes measurement and milestones that measure the lead rather than the lag indicators.

Mistake #6: Shouldn’t we be focused on sales?

No. Early in an entrepreneurial venture, there are two problems with measuring by the sales yardstick. 

• First, sales is a lag indicator. Depending on the length of the sales and cash conversion cycles, this measurement may not indicate success or failure for several months. Then once corrections are made, they take several more months more to be realized.
• Second, if there are systemic problems with sales, there are generally several other factors that contribute to the problem. 

So where should the early focus be? Marketing. This is where the products and services are defined to match the demand of the market. In the example above, a complex sales cycle required months before any indications showed that sales were lagging and would continue to do so. Even when customers did purchase, they quickly stopped using the product, if they had ever started. Why? because the company was not responsive to market demands that were clearly identified early on. The international market demanded 24 hour support, and a simpler user experience that required less training since training was not billable or productive (two factors not present in the two large companies where the concept was developed).  

Market research and analysis can provide lead indicators that help companies respond more quickly. This is where initial sales hurdles are mitigated if not eliminated. Strong marketing shortens the sales cycle, makes sales easier and makes sales more profitable. It also ensures that product experiences that generate customer satisfaction and loyalty.

Summary

A first glance evaluation would lead you to believe that investors made mistakes in the evaluation process of the 80% that did not create a profitable exit. You might believe that the 80% should have been bypassed as not capital worthy. Having been in the trenches of several of those, I believe that the mistake was not made before the investment, but after, not in the development of the opportunity, but in the execution of it.