Start-ups, venture capital investors, beware of this trap.

Over time, as I’ve been in the investment business for just about 40 years, I get asked about private equity, venture capital or so-called start-ups.  Here are some thoughts on that.

BTW, at the outset I want to say its far more important to know/like/admire the leaders/founders in these start-ups then cranking through all the numbers, like a nerd analyst might do.  Of course along with the inherent attractiveness of the core new idea, service or product.  Even while we can’t always make sense or objectively evaluate how likely successful it may be. Not least, because these days it often requires an expert to evaluate potentials.  And even those regularly get it wrong.  Yes, it’s a minefield.

Here I just want to address one core, yet critical issue, too often emerging in time!   This trap comes about past its initial stage and assuming some success is already apparent.  Then, this scenario too often evolves, beware:

Assuming the start-up biz. starts to take off, often then, and in little time, a new "big Man" investor comes on board. Yes, this could also be a woman. I am talking about a person with some means/connections besides capital which now smells the potential success -and eagerly wants to be part of due to the initial risks being reduced.

He/she invests more than any other to date and so leads-in on the Board of Directors -and it goes without much imagination so increasingly dictates directly or indirectly what transpires.    If somebody objects to some new ways, he threatens to resign from the board which surely would be an undesirable set-back to this still fragile start up.  Ha, he may in time insist to install/employees, some of his cronies, or a friend CEO?  After all, becoming now the largest single investor.

With his own particular investor objective in mind, along being the new biggest investor:  it then no longer matters much what the majority or original shareholders truly want, nor what the investor objectives, at the outset, was/were.  As this "big Man", let's say as we call him, then dictates direction & control....alas then too often as well has the Chairman “in his pocket”, which succumbs to him.  Et voila. (And so it goes). 

As time goes by and assuming the start-up becomes a successful operating company in time, there surely may come an opportune time for “an exit”.  At a selling price far above the original big risk taking founding investors and some others paid, at the outset.   These original investors along with smaller investors since, are excited and much desire this, so to cash-out with likely a big profit.  It meets the original investor objective and is what the majority shareholders want, including like the (or most) founders.  Hurray.  

But, alas, it's not what the “big Man” wants.  As he has other considerations, parameters, objectives.  As if an exit/sale take place he likely would endure high capital gain taxes, resigning from the Board, losing his investment -and glory.  Not least, not really having any great ideas what to do with the new windfall gotten.  As he already owns the big home, a few holiday homes/cars/boats/assets etc.   Well, we can say, the “big Man”, unlike all the others, does not really need the money!   His investor objective is very different compared to the founders.  So he convinces the Chairman to be, can we say, “sell-shy” -and so in a subtle way discourages the sale.   There are many ways to orchestrate this, like get greedy on the price -or make some "off-the-book comments" to the potential buyer-group, which due to being the “big man” -he is always part/privileged to the close selling negotiations.  Maybe he (the big-Man) tells the buying principal in the parking lot, off the record, "ha if we don't get our full asking price I just won't vote for it."   The buyers then senses greediness which nurtures second thoughts on buyers remorse -and backs-off.  Et voila. (And so, it goes).

This, or other potential buyer(s), so gets discouraged and walk away.  Then, time passes by…the market invariably changes, an economic recession comes, interest rates or oil prices etc spiral-up -or other new risks/changes emerge. Like new competition.  And so the grand exit, cash out, is missed. Alas, in vain.  

It then all sort of gets camouflaged along the way as the original shareholders don’t really know what truly transpired, except that there was “no exit sale”.  Even the Board of Directors may not know why it did not happen, in the end.  (Maybe the "big Man", just managed to discourage the buyer)?  Only time will tell if another opportunity emerges along the way, or maybe not?  Alas, in time markets always change and so the original potential buyer is no longer interested -having found another acquisition…not least as so often, new competition -or copy-cats emerged, or obsolescence came about with the original meaningful synergies often lost,  "like tears in the rain".

I wonder if this scenario which often happens, is much discussed in so called guru-MBA classes, articles or books on all this?  Or, how this is prevented to begin with?  Let us just say it’s a hidden veritable risk, rarely brought up.  Start-up investors, beware of this one more potential trap!   Call it the big-Man comes along with a different investor objectives, trap. 

Best Regards,