Ep. 32 Stakeholder Classes – The Investor

NOV. 1, 2020

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Some of you may have noticed that I am bit tough on certain stakeholder classes in my daily posts…especially investors, finance folks, overfunded white males and well, let me just stop there…yikes!

…the reason I bloviate a bit on investors is that many of these folks try to seduce my clients with the fuel of growth, otherwise referred to as capital, and yet these same folks are not very transparent about their own vested interests, motives and goals…Have you ever heard of an institutional investor who hands a founder a detailed warning sheet like you get when you sign a mortgage?

There’s more consumer protection for your f-in credit card or mortgage and car loan than there is for signing away a % of your company to strangers in return for a big check…

It’s like the regulators assume that only well connected, rich men surrounded by attorneys get institutional capital deals.

In fact, institutional investors have no incentive to be very transparent. If there were super-honest, it wouldn’t look very attractive to anyone.  It would drag out the term sheet iteration process.

No investor for example goes into a deal intending to earn less than the founder when all is said and done, because it doesn’t benefit their LPs on Wall Street to allow that to happen. I’m sure it has happened, but generally they are hell bent on earning far more than you on any exit deal.

And a messy cap table of angel investors will turn them off, even if it literally got your company to where it is today.

In a way, investors are a lot like retailers, who make far more money per unit than you ever will. That’s the privilege they Lord over you in return for getting your brand in front of millions of eyeballs every week in their stores.

I remember shocking one client once when I offered, unsolicited, the lesser known fact that there is a type of ‘deal’ out there in which the investor goes in with debt leverage (and more) because they don’t trust the founder at all and plan all along to replace him/her tout de suite. They wait for them to fuck up royally, and the debt converts to a controlling stake. The founder may be aware of this possibility intellectually or not, but it often doesn’t go over well.

There are many, many decapitated founders who simply get fired more or less. In better maneuvers, they get turned into figure heads.

The kind of take-over deals I’m referring to are product-driven deals coming from investors who never had the slightest faith in the founder and his/her team and have their own operating teams ready to assemble. I can’t say such investor take-overs have never led to good financial results for both parties. They have. But the entire process is incredibly shady, less than honest, occasionally bullying and very, very old school.

In this episode series, I want to try and keep things fair, and so, in that spirit I want to share more balanced thoughts on brokers, agencies, distributors, retailers and investors rather than highlight the negative patterns…

This is going to be a series though, since I can’t be fair to all five classes if I give them two minutes each. Not without speaking in shorthand.

So, who do I start with? Hmmm….Roll a five-sided die? Nope. Don’t have one anymore.

Well, let’s begin with our dear Lords of Capital.

Trigger warning: this series involves social generalizations. Social generalizations are valid if they apply to at least ¾ of group members and aren’t random coincidences. That’s my standard. You are welcome to argue that I haven’t met it, but not that any social generalizations are invalid.

While it’s true that fast-growing brands almost always need to raise outside capital to supplement their gross profits, it’s not true that the firms you read about it in the media are the ones you have to do deals with to succeed. Some just have good PR agencies.

I have a growing list of brands that grew steadily off of gross profits, commercial loans and angel rounds. It’s possible.

Institutional investors raise money from what are called Limited Partners or LPs. These folks manage large funds on Wall Street. These funds need ways to deploy enormous amounts of capital according to their particular risk strategies. Diversifying their investments into many splinters is key. Some splinters head toward private funds. PE or VC.

You’re not likely to ever meet these LPs. But the General Partners of institutional funds do, and their primary legal responsibility is to make money for them. Not for you. You are a secondary obligation. At best. At worst, you’re a tool to prove that ‘funds are being deployed.’

The better institutional investors in our world have accumulated a great deal of institutional knowledge of early stage brand-building internally and within their network of advisors. They are strategy types, like me. They are the ones who endorsed my book. Nothing is random folks. But, but they are not generally ex-operators like you. Remember that. There is always a gap of perspective.

Chosen well, these firms can deploy capital in much larger tranches than any bank will ever loan to you and without the crushing interest payments. They also can activate a network of other stakeholders to help facilitate a more strategic, and less capricious, sequencing of retail accounts. They can network you with peers who are ahead of you on the Ramp, the folks who are mini-celebs and very hard to get a hold of.

But you need to be ready for these kinds of assets. It’s easy to fantasize about the money and the connections early on. That’s when you’re most likely to be taken advantage of by venture capitalists who may or may not know what they’re doing. Or who may pretend to have access or networks they don’t.

There are two types of private institutional firm: the venture capitalist and the private equity firm. They differ in their investment theses, yes, but, to you, what’s more important, is that the private equity firms wait until you are larger and more stable and really will work hard to make their deal with you work out. They invest in fewer, bigger bets.

Venture capitalists have a very low success rate on average because they invest very early in unproven management teams. They therefore tend to invest broadly and don’t commit much time or money to any one portfolio company. They are far less committed than you, even if their check is a big deal to you. Choose very, very carefully here, because term sheets tend to grant them a lot of your company at your relatively low valuation. Unless you negotiate brutally. Which you should. Absolutely.

Generally, angel capital is a preferred alternative to VC as long as you have amassed advisors and others who can lend you advanced strategic wisdom. Not only is there more wealth out there to tap in family offices, they are far less likely to bully you into this or that strategy, because, they wouldn’t know what the hell a growth strategy is in CPG. And, even if they try to bully, it’s going to be a lot easier to counter-punch the paper tiger.

The grand bargain of institutional capital is very  influxes of capital in return for giving away a significant share of any exit price.

But do you need that much money all at once? Maybe. Maybe not.

I’ve seen folks squander it and achieve little, because they weren’t ready but their browbeating investors were happy to tell them what to do. Money may have get made, but a sour taste was felt.

All I can say is, you have to have very polished verbal skills to tell your lead investor that you disagree with their strategic recommendations…but I can advise you now that you’ll want to be super transparent and open when you do disagree, because if you hide your disagreement and then act unilaterally against a prior consensus, you will have a very painful lawsuit on your hands.

Are you ready for what I just described? If not, don’t take institutional money.

If I were you, I would stay away from VCs entirely, professionalize yourself and, if necessary, get private equity funds to help out later on up the ramp, where things like paid advertising become important and hard to fund off of your own P&L. I just pissed off some folks for sure with this one. I haven’t been impressed with most VCs in the CPG space…there are too many ideological missionaries and not enough savvy business strategists.

Remember, there is no rush to get this kind of money early on…criminy folks.

Look, if you’re growing exponentially off of a $500,000 base, you have at least 4-5 years before you need to scale tens of millions of dollars every year. Before you probably do need to raise amounts of capital to continue growing exponentially, capital sums that neither angels nor your local bank will offer you.

Use these early years to research the top PE players and financial brokers (Whipstitch and Aspect Consumer Partners are the most experienced here) who can help position you properly in front of them. This patient approach is far better than hastily getting in bed with VCs of dubious value other than a relatively small check amid many they write for every fund.

Regardless of which institutional investors you work with, work with the best of the best with a strong, serial exit track record and a track record of treating founders with respect privately and publicly.

Run from anyone who acts like they stepped out of the cast of the Treasure of the Sierra Madre.  The moral of that film is:  everybody is friends before a you hit gold. Then what?

Then, you find out who you really climbed into bed with…

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