In short-sighted efforts to convey the accrued wisdom and tenets of their craft, venture investors occasionally declare their due diligence dogmas by way of the fallacy of false dilemma…a distorted line of reasoning where an outcome must be the result of either of two options. Often referred to as “black and white reasoning”, a false choice is offered up between two scenarios when in fact many more scenarios are probable.
Our false dilemma du jour is; which venture investment in a startup is positioned for a better outcome…the “A” idea with a “B” management team, or the A team with the B idea?
[Of course, it is never this simple, as the query ignores other critical items such as market size and maturity, competition, barriers to entry and of course, deal terms…but let’s play along…]
I opt in favor of the A team with the B idea. The B team may not be able to execute on the A idea, but I have seen many A teams successfully monetize B (and C) ideas.
I would postulate that the majority of angel and venture investors concur on the acute importance of the quality of the team engaged to execute a new venture’s business plan. But I diverge from the consensus when that same conventional wisdom subsequently surmises that the A team’s commitment is not validated unless those “founders” have contributed a material amount of their own personal financial assets to the venture.
The notion of a founder’s cash as an indication of their “skin-in the-game” ranks among the myriad of myopic and misplaced myths of venture investing. It is derivative of another false dilemma fallacy that evaluates the involved vs. the committed startup founder by pitting the pig against the chicken as the sources of a traditional bacon and eggs breakfast. (The pig has truly “committed” by providing the bacon, while the chicken is merely “involved” in providing the eggs.)
I recently attended the road show where an ambitious retail venture (redundant, eh?) was presented by a genuine A team of co-founders comprised of a young entrepreneur and a seasoned C-level executive CEO. It only took a few minutes into Q&A for an experienced institutional investor to impugn the initiative by inquiring about the absence of co-founders capital committed to the enterprise.
In this particular instance, the young entrepreneur was early in his career with a very young family and simply lacked the personal financial resources to allocate any capital to his vision. On the other hand, the seasoned 60-year old CEO walked away from a prestigious C-level position where he enjoyed a high six-figure compensation from a venerable multi-national concern at the peak of his career to take a flyer on a yet-to-be-financed retail startup…during a recession.
It is certainly appropriate to question a founder’s commitment as long as the answer is evaluated in its appropriate context. The CEO was “all-in” career-wise and the young founder had the chops, but lacked the bacon to commit to the plate.
Considering founder’s personal financial assets to be prerequisite skin-in-the-game simply ignores the lessons of ventures past. Steve Jobs was 21 when he founded Apple and his partner Steve Wozniak was 26. Gates and Allen were 20 and 21, respectively. Google founders Page and Brin were both 25. Hewett and Packard were 26 and 27 and Michael Dell was merely 19.
None of these extraordinarily successful founders had any meaningful cash to invest in their own startups. If they did, angel and professional venture capital investors would have been deprived of billions of dollars in long-term capital gains and carried interest.
Of course if a founder has a material amount of personal financial assets—it is appropriate for an investor to expect those funds to be committed to the venture. Moreover, it is prudent for the founder to use proprietary resources as it enables him to ultimately preserve more equity in his enterprise. But, career risks, opportunity costs and reputational risks can be far more consequential to a founder than losing several dollars or pounds of flesh.
In fact, our only 100% write-off in this decade was an investment in a serial internet entrepreneur who already had committed $13 million of his own funds to the startup. He had the bacon, but not the chops or experience to execute in the specific sector. The ensuing high-profile strikeout subsequently insured that the failed venture would be the entrepreneur’s final turn at bat, as he was no longer considered bankable.
Before you judge a venture based on a founder’s capital as skin-in-the-game, make certain that you fully understand the emotional commitment, as well as, the actual impact that the demise of the startup will have on the founders. A skin tight founder is not, by itself, a reason to walk away.
Album: Skin Tight, Ohio Players, 1974
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