Even though so much self-serving, retrospective nonsense has been written about the tricky relationship between investors and entrepreneurs, almost all of it is supported only by itself rather than by anything so useful as evidence or even (Lord help us all!) genuine insight into investment psychology. What is more, atop these wobbly foundations is perched a massive secondary industry of advisors, strategists, consultants, books, courses, lectures, business school modules (and even alleged courses in entrepreneurship, for crying out loud), all promoting the supposedly mythological archetypes of angel investment.
This congealed toxic mass of self-supporting tosh is what gets passed off as business ‘collective wisdom’, and – tragically – is all that many entrepreneurs have to work with. Once you get the hang of reading that kind of stuff, it practically writes itself: which is presumably why the brain-damaged business shelves of bookshops groan under the weight of me-too inspirational business writing – let’s face it, anyone with a word processor can knock their own out, it’s not exactly hard, right?
Underlying this whole sorry mess sits a single core investment myth – that of the positive, win-win, genuinely strategic investment. You’ve surely read the same ur-story a hundred or more times: go-getting garage entrepreneurs and experienced cashed-out investors joining forces to create high-growth economic entities with both brains and brawn, the best of both worlds…
…ummm, don’t make me laugh too much, I’ll choke.
The thing nobody tells you is that (outside of the US startup bubble, and I’m guessing at a figure here, though it is based on what angels have told me) I believe roughly 75% of angel investments are opportunistic – decent little companies typically stuttering over liquidity issues, dropping large amounts of equity into angels’ laps to stay in the game.
Hence any time you see aggregate figures for angel investments into companies, I suspect you should divide them by at least four: strategic, ‘business school’-type positive investments are the sub-25% minority. I’ve previously called this approach towards investment “TK Maxx” mode (i.e. “if it ain’t a bargain, I ain’t gonna buy it“), but I now suspect it’s actually part of a wider trend: investing not to grow a trend (companies on the way up), but to stop the rot (companies on the way down).
Part of this is probably to do with inadequate valuation skills, for an inconvenient truth about angels is that most lack sufficient financial accounting or management accounting skills to properly value startups with any confidence (which is also why ~75% never lead). Part is marital – think of the frosty stares over the breakfast table each time another of your £25K investment goes belly-up, even if your overall portfolio is still (theoretically) in the black. But part is undoubtedly to do with investment psychology – for, as I’ll explain below, I’m sure most win-win angel investments are done not out of hopefulness but out of fearfulness.
Even though there’s a lot of rational calculation going on in investments (i.e. poring over optimistic cashflow forecasts and unbelievable hockeystick graphs), more or less all of this is post-rationalization. In the end, angels either like & trust the person pitching to them within 30 seconds or not at all. It’s rare (I believe) that they talk themselves into a deal with someone they don’t immediately ‘get’: as a rule, it’s 100x easier to talk yourself out of something than to talk yourself into it.
Timing is also a key issue here: companies on the way down normally have a timetable of impending doom – they have bills they can’t pay, orders they can’t fulfil, export markets they can’t service, etc. Their dynamic is often that of a succession of short-term ‘wolves at the door’, no matter what their abilities and customer relationships are: they need equity investment by a certain date or the door shuts (on wolves and customers alike). These are relatively easy to value, and easy to negotiate a good deal with: the gun to the head helps a lot.
Compare this with investing in companies on the way up: what makes this such a hard sell is that it relies on positive market sentiment, trust, credibility, positive social capital, financial optimism… in short, all the things that society is in such short supply of these days. At the same time, most business books you’ll see treat the challenges young companies face as if they were purely technical engineering puzzles: yet for the most part these are actually social challenges masquerading as high tech problems, e.g. ‘route to market’ is about social collaboration, ‘product/market fit’ is about social negotiation, ‘pitch optimization’ is about credibility and excitement, etc. In the end, the entire startup issue reduces to this: have you got what it takes to start a social revolution?
I think this explains a great deal of why UK entrepreneurs with win-win pitches have such a hard time: angels (and indeed most entrepreneurs, truth be told) have been conditioned to believe that the startup world is all about technical challenges, when it’s much more about social challenges. Both groups are ill-equipped for tackling such mountains, and the tools they have for communicating with each other – pitch decks, business plans, cashflow forecasts – fixate on arguably the wrong aspects entirely.
I firmly believe that very few angel investors have sufficient faith in hopefulness to put money behind it: what actually drives the hand to write the cheque is fear of missing out on a big opportunity. People often talk about ‘first to scale’, but the real deal is not so much ramping up the scale of production, but ramping up the scale of opportunity. That is, at a certain point in a proper startup’s growth curve, its scale of social opportunity leaps off the graph, way ahead of the J-curve of its financial execution. It’s hard to define precisely when that is: but that’s the point when angels have only a few months (or indeed weeks) to get in before it’s too late, before the boat sails without them.
So, it’s fear of missing that boat that drives angels to invest, not hope of catching some mythical future curve.
Compare the two types of investment: whereas stabilizing a failing company is largely a technical finance challenge, building and growing a new company is a social challenge – angels look at the two side-by-side, and routinely put their money into the former category because (frankly) it’s easier to quantify. Yet basically all the presentational tools that win-win startups use are aimed at solving technical finance challenges, not social challenges: it’s no wonder they so often bite on stone, achieving nothing, going nowhere slowly.
Bearing all this in mind, I’d say that the ‘2011’ way to pitch win-win propositions to angels isn’t with a sharp suit and a carefully rehearsed slide deck, however much of a presentation buzz you can build up. Rather, you need to sit down in front of them with one or two customers and field questions about what you’re doing, open up a dialogue. Simply put, you’re trying to start a social revolution: so why not show angels how you’re going to achieve it?