A Better Way To Do a Deal
What, exactly, is a 90-Day Wonder? It's a special kind of deal. The kind where, 90 days after you sign the papers, you wonder why you ever did the transaction in the first place.
For many investors, each new deal and each new entrepreneur is a distinct set of experiences - some good, some not so much - and it's an ongoing education for both sides. It can be very instructive and also very painful. Education is expensive, no matter how you get it.
If you want to avoid the 90-Day Wonder, it helps greatly if investors and entrepreneurs have a little insight into the way the other works. In this column we'll look at the biases that can trip you up before you get to the term sheet. In the next column, we'll look at what happens when you get down to brass tacks.
At the outset:
Don't Starve the Baby
Building a business may take less money than it used to, but it still takes some basic amount of capital. In negotiating an initial deal, both sides are perversely incented to starve the business. The entrepreneur wants to conserve equity to avoid early dilution at a low valuation. The investor wants to put as little capital at risk as possible. The upshot: A very real chance that the business is undercapitalized from the outset and never has the resources necessary to get a serious start.
Go Beyond the Boy Wonder
The investor, not the entrepreneur, has to make sure that the final deal provides for the entire management team and for players who will be named at a later date.
Many entrepreneurs see their business as a mission and a sacred crusade. He or she would basically work for free. This isn't usually the case for most of the other senior people, especially if they were lateral later additions rather than co-founders or early members of the team.
Because entrepreneurs are so intensely committed themselves, they very often fail to appreciate the differing levels of commitment that exist among the rest of the members of their team. They almost always fail to adequately provide for the rest of their team when they are dealing with the investors. It's very rarely an issue of selfishness. Usually, it's just the fact that they're so focused that they're oblivious.
Ask the Hard Questions
Making an investment is very often a time-constrained process. In a typical business deal, everyone's in a hurry. Because everyone wants to get to a deal, bad and ultimately unworkable agreements get made on a frighteningly frequent basis. Here are some of the things to watch out for:
- Hard and time-consuming issues get papered over or buried to be resolved "later" by someone else (often through litigation) because no one wants to be the "bad" in someone else's day.
- Otherwise smart and prudent people ignore their attorneys' advice on certain risks and with regard to undocumented or researched concerns. Instead, they focus only on the upside prospects of the deal.
- In the interests of smooth sailing, even seasoned veterans will accept superficial assurances and smiles instead of concrete answers, and will then go on to confuse good manners, pleasantries, and bad jokes with real agreement.
- The negotiators push the problems forward and delude themselves into believing that the details will all be settled during the implementation phase. It just doesn't work that way. In complex deals, you can bet that the easier the deal is to get done, the harder it will be to implement. And deals rarely, if ever, get better during implementation. Problems don't work themselves out or disappear - they fester and persist until someone takes responsibility for them and gets them resolved.
- Finally, instead of acknowledging and accepting that there are remaining open items and uncertainties, and instead of working together to construct metrics and contingency plans, the parties engage in mutual fantasies and shake hands on deals which are full of holes and more porous than Swiss cheese.
HOWARD A. TULLMAN is the CEO of 1871 – Where Digital Startups Get Their Start and the General Managing Partner of G2T3V, LLC and of Chicago High Tech Investment Partners. He is a member of the Chicago NEXT & Cultural Affairs Councils and the Illinois Innovation & Arts Councils; an adjunct professor at Kellogg; and an advisor to many start-ups. He is the former Chairman and CEO of Tribeca Flashpoint Media Arts Academy. Over the last 45 years, he has successfully founded more than a dozen high-tech companies. @tullman
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