Is There Such a Thing as Dumb Money?

“Dopus. I already had the money in my hand.” – Comicus quote from “History of the World” by Mel Brooks

At times, an entrepreneur is so focused on closing the deal for financing that they forget some of the long-term ramifications. In this scene from History of the World, Comicus is willing to say almost anything to get his weekly stipend. But is this approach dangerous for a business owner seeking financing? After all, money is money and it doesn’t come with a personality — or does it?

We have all heard the expression “smart money”. When one is discussing a successfully funded venture, it is common to hear the phrase “that’s where the smart money is.” Investment advice is often laced with terms such as “that is what the smart money is doing.” While I think you get the point, the question has to be raised: “Is there such a thing as dumb money?” I submit to you that there definitely is. The real question is how to avoid it.

Most owners seeking financing have this uniform image of an investor — serious, numbers-oriented, like Jack Webb (there’s a dated reference for you) they just want the facts. But smart owners do some diligence on their potential partners, and the wise ones know those traits that can come back to haunt you. So here are some warning flags.

Watch out for self-promoters. There is nothing wrong with having some pride in what you have accomplished, but the potential investor who goes on and on about their value proposition, including name dropping like they are some gossip columnist, has to be vetted with a cautious eye. When the next words you expect to hear are “enough of me talking about me; why don’t you talk about me for a while,” it is time to put your private eye glasses on.

The over-promiser is another type to take with a grain of salt. I have been in many meetings where investors are making their pitch and they mention connections they have that can really help the business grow. I can’t count the number of times these conversations resulted in companies accepting these investors, only to find that the two or three contacts they mentioned at that key meeting are in fact the only contacts they have. This is what I call the “big hat; no cattle” approach.

Finally, be careful when confronted by the smartest person in the room. This type tends to look down on the entrepreneur as if they are not worthy to be on the same planet. Without really analyzing the facts, they are quick to point out how something should be done differently and how they will add value by their vast knowledge.

The one common element is: if an investor is really going to help you (besides funding you), they have to understand you. As Stephen Covey advises, “Seek first to understand; then to be understood.” The types noted above may be past the point of being able to listen and understand. And by the way, it is not so much that they are dumb as it is they are not capable of using their smarts effectively. So make sure when you seek investment, you do not get stuck with dumb money because, in the long run, it will be a very painful step in your journey.

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Profit is Not an Ugly Word

Leo Bloom: “Heh, heh, heh, amazing. It’s absolutely amazing. But under the right circumstances, a producer could make more money with a flop than he could with a hit.” – quote from the movie The Producers by Mel Brooks.

Some of you may recall this memorable line which was the premise of this classical movie. The plan was to raise a significant amount of money, find a play that would “flop” on opening night and keep the unused funds. An ingenious ploy; save for the fact that the play was a hit, more than 100% of the equity had been sold and the main characters ended up in prison.

So, let me begin by apologizing for the somewhat dour tone of this blog. I think of this line as I see pitches that seek to raise more and more capital with an apparent disregard for the spend or “burn rate,” with entrepreneurs chalking up their expenses to the investment needed to grow. Every entrepreneur I ever met believed they could grow faster with more dry powder. But the successful ones realized that just like one’s personal finances, at some point, you must “pay the piper” (face the music, come to Jesus, yada, yada, yada).

I would have thought we learned our collective lesson from the dot com boom / bust. Back then, despite substantial losses, valuations were sky high and investors began to focus on other “metrics” which soon took the place of the old reliable P & L. Just like the Cabbage Patch Kids, one day someone decided that these companies were in fact ugly, and shortly thereafter, most were trashed and entrepreneurs were sent home to live with their parents.

I want to be clear here; if you are running any type of business, you need a clear path to profitability. I saw a recent article with an entrepreneur calling out investors for just asking when the company would turn a profit, which the author interpreted as just stifling growth. How dare they? Well I ask, how dare you build a business model without such a pathway and put your stakeholders (especially employees) at risk with the hope that someone will be smitten with your traction or stickiness and rescue you with an acquisition deal? That’s not building a viable business; that’s the equivalent of legalized gambling.

Please do not get me wrong. I am not implying that one must be profitable to attract investors. If I believed that, I would not be so respectful of angels and VCs that make the early-stage ecosystem work. Thank goodness for them. But if you think investors do not believe that a sustainable business is nirvana, you just have not asked the right questions. That path to profitability must not only be clear but in sight.

The great entrepreneurs I know are better than that. They realize that this not a Max Bialystock shell game. They need to seek profitability and realize the clearer the path to this goal, the more likely it is their journey will be successful.

Who Do I Leave My Business To?

Quote: Don Corleone: Well, Michael is now head of the family and if he gives his permission then you have my blessing.  Mario Puzo – The GodfatherMichaelcoreleon

This question is perhaps the most important decision for any parent who has owned a business.  Though ownership and leadership are often tied together, I want to focus on succession planning from the management… not the ownership perspective.  At times, other factors such as economics and estate planning may dictate successor ownership but it is the successful transition of management that allows the business to move ahead.

It is interesting to consider The Godfather as an example of succession planning.  If you recall this classic movie, no one thought that older brother Fredo (Freddy) was strong enough to be a leader and Santino was unceremoniously removed from the process.  However, even the Godfather stated that Santino would not make a good Don.  Michael was the strong, silent-type who effectively thought out strategies, was effective in execution (poor choice of words, here) and was able to command loyalty and respect.  These are some of the traits of a leader and that is what your successor should be.

Like many things in the business world, succession planning is a process and I have assembled a few pointers that may help you deal with it in your business:

  1. To start; are you ready to step aside?  As the current leader, you have to get yourself emotionally prepared for the fact that you will no longer be in charge.  Simply stated, if you are not ready to do so, I would not suggest implementing a succession planning process.
  2. Focus on the business.  This process should always have the major income generator front and center; a sustainable business that needs to continue to grow.  By design, this has to be an objective versus emotional process.  That is easier said than done when family is involved.
  3. Look for the leader.  In many cases, it is the person who has core values similar to yours even though their approach and methodology may be a little bit different.  It is those core values that will carry the day.
  4. Map out management, family and ownership and try to seek common ground.  Once you are out of the picture, these three constituencies will have to work together.  Consider that as part of your process.
  5. Don’t be afraid to use your gut.  In my experience, your true belief as to who you think will succeed has been right many more times that it has not.  Be careful of the advice of “influencers” who may only tell you what they think you want to hear.
  6. Use outsiders.  A close advisor like a board member, your accountant or your lawyer can bring an objective view to the process.  Good advisors are anxious to see the key economic engine continue to go forward.
  7. Finally, it is a process.  Keep in mind that it may not always go in a straight line but with some patience and structure, you will get there.

The success rates for succeeding generations are not high.  Studies have sighted the success of first to second generation transitions at about 33% and succession from second to third-generation at about 3%.  Not great odds, but, with a good process, some perseverance and the right intentions, you can beat those odds.  We help companies do it all the time.  Just think about The Godfather; it looks like he did just fine.