A disclaimer before I begin. Actually a few of them.
- I am not a financial expert. While I’m fairly good at financial management and analysis, I cannot be considered an expert in the field.
- I am the type of person who tends to give more importance to things other than money – things such as principles, values, creativity, fame and such fairy tale-ish immaterials.
I might have said this in my tweets (@raviwarrier) many times before or in person when I speak to startups and entrepreneurs, “Forget the money. If you create value, money will come!”
When I was 16, I was asked by a girlfriend, “Do you want money or fame?”, and I replied without much thought, “Fame!”. I followed it up with, “If I create some value for the world, money will come!” That was 22 years ago and it still holds the same mantle in the principles’ shelf.
But there are a few things that need to be understood clearly. And at no point, am I ever saying, “Money is bad!” like the antagonists in Ayn Rand’s novels. (Being a capitalist, I can see no ill in making money based on the value you create!) And I can only hope to make you understand by using anecdotal examples.
Illustration 1: Mo’ money, Mo’ problems
Do you remember a time, perhaps a birthday or some festive moment, where the elders of your family, gave you money? In all those years, there must have been one where you received far more money than you expected. What did you do with the extra cash? If you were like most kids, you probably spent it on stuff that you can’t even remember today.
Extra cash does that to people. And since people run companies (including startups), extra cash affects them as well.
If you scan the business literature, you’ll see many case studies of executives of companies making, in retrospect, of course, the stupidest of decisions that either tanked their companies or brought it to the verge of collapse, just because they had huge cash reserves. These executives may have decades of experience in running business, but when they get extra cash, even they turn into imbeciles.
And if seasoned CEOs and board members can make mistakes, startup founders are never on safer grounds themselves.
One of the principles of sound business management is to always balance your cash reserves. Apart from a lot of financial and business reasons, the underlying (and perhaps unspoken), reason is to stop executives from making stupid mistakes.
Illustration 2: Value is (still) like the bullion in Fort Knox
In 1971, the world (led by the United States) left the old method of calculating exchange rate – based on the gold reserves and the ability of the International Monetary Fund to make available loans to bridge gaps. What we use today is the Bretton Woods System. There are multiple reasons why we moved away from the older method, but the primary reason was that the economies of the world were becoming much bigger (and thus more valuable) than the gold reserves that the countries could hold or had held.
We wouldn’t be living in a world that’s economically advanced if we had continued the old way, but there’s an argument to be made for the other side. While we are in an economically advanced world, we are also in an extremely fragile economic world. We are all living in a matryoshka of bubbles.
And the reason (with the last recession of 2008 to testify for it) is the over-valuation of things.
Startups are no different. In an article that I wrote a short while back – “The Indian Startup Bubble“, I questioned how a company that’s a few years old be valued in billions? Especially, when they don’t have the value to support the proverbial “exchange rate”?
It’s nice to have a billion dollar company, especially when you are a Gekko fan and the guy with certificates that say you own a piece of the pie. It’s also good when you want to have blinders and avoid reality checks. (I have been called cynical for this, but at least I’m not blind!)
We have rationalized for our wanton desires. And we have played the game. I don’t blame most them because that’s the only game they know. Heck, we are in the game ourselves! The only thing that saves me (or us) from getting washed away in the torrents is that we still think and want to think a bit like old-schoolers.
The value of the company: not the perspective one of the Gekkos, but the real one, is still based on some tangibles. You may be able to sell your company to a greater fool, but eventually, someone is going be left with only non-magical beans.
Illustration 3: Purple’s not going to make you rich!
I get a bunch of people (especially first/second-time entrepreneurs) who tell me in conversations about fund-raising, “We want W because these other companies got X, Y and Z respectively. If they got it, so can we.”
I used to tell this to people but eventually stopped. My last such conversation was two days back with one startup that we are considering for the next cohort. I used to tell people about luck and the factor it plays in a lot of things, including the success of your business and fund-raising. Another big factor is the set of things that you cannot see.
Most entrepreneurs, to use a crappy analogy (why don’t I?), think like this: “That guy’s baby was purple and she turned out to be a rich person. My baby’s also purple and so, she’s going to be rich too!”
A student of logic should instantly see the flaw in those statements! But somehow the same student of logic, cannot see the obvious flaw in that reasoning when they become entrepreneurs asked about their valuations.
I guess, one or both of these sentences are true: “Love is blind!” and “Love makes you stupid!”
Illustration 4: You sold it? You broke it!
One of the first things that we were told in our entrepreneurship class during our MBA was a statement that was drilled into us like a multiplication table is drilled into a seven-year-old. As soon as we started the first class on the first day of the module, our professor goes (something like this), “The day you’ve been invested in, is the day you’ve sold your company! Period!”
In cohort one, I had a conversation with a founder about this. And I told him, “it doesn’t matter if the investor holds 5% or 95% of your company, his stake is still heavier than yours.” Take for example, if the (only) investor with only 5% holding in your company suddenly decides to pack his bags and leave, demands that he paid what’s owed to him. Of course, this is hypothetical and there are agreements to stop things like this from happening, but imagine if this was your story. He wants his money… right now!
So what he’s holding 5 percent? He can still rock and sink your ship!
I knew someone long time back who were rented a place to stay. They stayed in the lovely apartment for years and after a long time, the owners came back to the country and asked this family to leave. This family demanded a huge sum to vacate the place. The owners had no option but to pay them. (Of course, this is a really simplified version of the story). The laws are in place. The agreements were in place. Morals and ethics are well understood, but the owners couldn’t do sh*t except pay the family to leave. I’m sure you got the gist of this story!
Illustration 5: Size does not matter!
Another thing that I learned in that MBA program’s entrepreneurship classes, was the simplicity of logic behind something that seems so obvious once you read/hear it.
“49% of millions is far better than 100% of $0”
See? So frigging logical, right? And yet, entrepreneurs get anal about giving away equity.
Of course, giving away equity because you can’t afford to pay salaries or for something you can’t afford is stupid, but giving away equity to someone who can help you make the pie or make it bigger is a no-brainer.
Let me use another analogy (be warned, it may also be crappy!):
Let’s say, for some reason, one of your hands are in a cast. You feel like eating a cake and hence decide to bake one. But since you can’t use one of your hands, whipping and kneading are not possible. And your friend comes along and says, “I can help you whip the eggs and knead the dough, but I want a slice of the cake!” What would you do? If you are rational (as the economist would have you believe), you’d say, “Sure buddy!” “A big slice?”, he goes and you respond, “Obviously!”
Now, why is it that it makes sense in this story, but not in real life when your startup is concerned. (that’s why the quip on economists!)
It’s Over (Phew!)
All these are things that I observe almost every other day in my interactions with startups, founders, entrepreneurs (though I still don’t know why I keep using all these words in unison). My intention with this post was to hopefully, help you understand, in the simplest of ways, the fallacies that surround fund-raising notions, ideas and activities.
Don’t say you weren’t told so!
Got comments? Want to rant? do that below! Or just follow me on Twitter (@raviwarrier)