A common statement we hear from the founders of high-growth companies looking to raise capital is that they want an injection of ‘smart’ money. What they typically mean is they want a value-add investor who can not only tip in cash but who can also add value to the business.
Most commonly, the added value comes in the form of the investor having extensive experience growing companies as well as helping them to prepare for and complete liquidity events such as IPOs and trade sales. An extensive network of industry contacts and other potential investors also doesn’t hurt.
In our experience, while virtually every high-growth company founder claims that they are seeking a value-add investor, the reality is that many founders are far more attracted to the idea of so-called smart money than the reality of taking a serious, value-add investor on board.
Why is that?
The Downsides of a Value-Add Investor
First, value-add investors are typically highly successful people. At the very least, they are sufficiently successful to have excess funds available to wager on the future performance of a relatively young and fast-growing business. In our experience, these sorts of people are results-driven and never accept excuses when a company fails to deliver.
That’s not to say they are necessarily heartless or unrealistic in terms of their demands – though they can be. What it definitely means, though, is that if a founding team commits to certain activities and outcomes and fails to deliver, serious investors will hold them firmly and uncomfortably responsible.
This sort of focus can be tremendously beneficial for a business in terms of keeping everyone focused and accountable on results. However, it can also significantly increase the levels of stress founders feel and as a result, for some founders, it’s simply too much.
Indeed, we have found that while many company founders think that the reason they have gone out on their own is to build a high-growth company, often it is really just as much about getting out of the corporate rat race where they are ultra-accountable for their every move.
There is nothing wrong with having a lifestyle element to a business. However, such a motivation can quickly put founders in conflict with a hard-charging value-add investor who is driving for a rapid exit that achieves many times their original investment.
Another reason why founders may come to ultimately regret taking on a value-add investor is because such investors will typically be forceful in offering their views and opinions on how best to manage and grow the company.
That’s because value-add investors will generally have many years of corporate success behind them in terms of starting, running and exiting companies. Indeed, it is this background and experience – something that founders usually lack – that makes them a potential value-add for the business.
Once a value-add investor comes on-board, however, the business is no longer a couple of mates or former colleagues getting together to have a crack at running a company of their own. The business now has a whole new class of stakeholder who will vigorously express their point of view.
Suddenly, the company’s founders will need to start justifying why they are, say, focusing on one market over another or why they are allocating their limited capital to product development, for example, instead of business development or concentrating on one marketing channel and so on.
These can be tough questions and they can lead to intense and even heated internal debate.
Some founders will relish the opportunity to constructively butt heads with an experienced investor to ensure that every strategic move and operational decision has been rigorously kicked around to ensure it is the best available alternative.
However, for others, things can rapidly devolve into what they were trying to escape from by launching a business in the first place: having to justify their every decision to their corporate overlords.
Indeed, an incoming investor will often be even more focused and aggressive than standard corporate bureaucrats because it’s ultimately their own money and reputations that they are putting at risk.
So, what is the best way forward?
Always Road Test a Value-Add Investor
Our advice is to thoroughly road test the relationship before diving in. If it doesn’t feel right for both sides after a few weeks of engagement, you can be almost guaranteed it won’t be any better after a few months, let alone years.
A little while back, we were working with an experienced investor who was looking for early-stage opportunities within a given industry for him to invest some capital and to take on an executive chairman-style position.
This individual was well-credentialled: he had global executive management experience in a blue-chip company and had also built and sold a business in an adjacent industry.
We introduced him to a company that we had been working with to see whether he might be a fit in terms of smart money. After the mandatory introductions, information exchange, question and answer sessions and the like, we decided to have the prospective investor make an informal presentation to the company on how he would tangibly take the business forward.
Following the presentation, the investor confided in us that in his view the company was not ready for someone like him to come in and ‘turbo charge’ the operation. In his view, while the company’s product was interesting, management lacked the necessary clarity of purpose to accelerate to the level he was comfortable travelling at.
Fascinatingly, the company’s founders also came away unconvinced that the relationship would work out and the deal was never done. A key concern for them was the loss of control that taking that investor on board would entail.
There was certainly nothing wrong with their mindset. Through discussion it became clear that part of their motivation was simply to be their own bosses and that key meeting helped clarify that for themselves.
It’s a great example of founders doing their homework properly and being sufficiently self-aware to understand that while they theoretically wanted a value-add investor to help them grow, they were ultimately reluctant to take on everything that would entail.
When it comes to wanting a value-add investor, be careful of what you wish for.
If you want to discuss how CFSG can assist you to identify and reach out to a value-add investor, we invite you to contact us.