An Exchange of Values

(sixth of a series)

By Frank Demmler

Last week we took a look at the term sheet and its role in the deal making process.  This week weÕre going to take a look at how the two parties in a deal view the transaction and one another.  While I might have been accused of taking poetic license in the past, I plead guilty in advance with regard to the characterizations that follow.  The perspectives that I will describe will be closer to caricatures, than reflections of real people dealing with real deals.  I am doing this intentionally to make some important points.

As noted last week, the first-time entrepreneur may think that the transaction to be completed between the company and investor is a simple exchange of cash for some number of shares of stock in the company.  I then went on to say that deals were really more complicated than that and listed some of the other elements of a deal and their importance.

This week weÕll take a step back to see what is really going on with the participants in an investment.  An investment is really an exchange of values.  What the entrepreneur is ÒsellingÓ and what the investor is ÒbuyingÓ are actually quite different.  The inverse is true as well.  What the entrepreneur is ÒbuyingÓ is not the same as what the investor is Òselling.Ó

To understand this, letÕs take a look at how an entrepreneur and an investor may approach a potential deal - their perspectives and expectations.  Remember, these are exaggerations, but they do contain kernels of truth, so donÕt ignore them out of hand.

The EntrepreneurÕs Perspective

The first-time entrepreneur often has an emotional bond to his business that is impossible to translate into dollars and cents.  ItÕs almost like putting a value on his first-born child.  While he knows that he needs capital to grow his business, he is reluctant to put his ÒbabyÓ in those terms.


ÒI need to raise some cash to grow my business. When all is said and done, thatÕs what all I need.  All the other stuff about Ôvalue-addedÕ services doesnÕt apply to me.  As far as IÕm concerned thatÕs just extra baggage that I have to take if IÕm going to get an investorÕs cash.  IÕve heard all about ÒvultureÓ capitalists, and IÕm not going to let them take advantage of me.  I ÔknowÕ that my business is worth a lot. The fact that these investors just donÕt Òget it,Ó isnÕt my problem.  TheyÕre the ones who are going to be crying the blues when my company hits it big, and they werenÕt smart enough to invest when I gave them the opportunity.

 ÒGive me your money and get out of my way.  Down the road, youÕll be very happy that I allowed you to invest in my venture.Ó


ÒIÕve put my heart and soul into this business.  IÕve depleted my life savings. IÕve taken all sorts of abuse from my friends and relatives, but IÕve persevered and now IÕve got a business that is on the cusp of being a phenomenal success.  It really rubs me the wrong way when I sit down with an investor and they start talking about how much of ÔMY COMPANYÕ they want for their cash!  For them to even think that something as common as cash can be equated to my hard-earned effort is insulting.

ÒYes, I know I need their money to move to the next level, but that still doesnÕt justify the level of importance they subscribe to their cash.  After all, itÕs only cash for goodness sake and there are lots of places I could go to get it.Ó

ÒThe investor just doesnÕt seem to Ôget it.Õ He should be beating down the door to give his money to me.  Instead of that,   heÕs playing hard to get.Ó

Expectations for the CompanyÕs Performance Moving Forward

ÒI have spent an extraordinary amount of time on my business plan and IÕm convinced that itÕs doable.  IÕm not so na•ve as to think there wonÕt be any surprises along the way, but I am confident that we have adequate contingency plans to cope with anything that comes our way.

ÒIn fact, IÕve been so conservative in my assumptions, that I am sure that we will out-perform the plan.

ÒI donÕt understand why everyone seems to make such a big deal out of the fact that this is the first time IÕve started a company myself.  IÕve been involved with such companies.  IÕve studied them in books and magazines. IÕve taken courses and seminars.  IÕm ready.Ó

Quality of the CompanyÕs Management

ÒMy team and I are committed to this venture. Whatever shortcomings we might have in terms of experience, we more than make up for with our intelligence and technical domain expertise.

ÒWhen we need to add to the team, IÕm sure we can find people.  WhatÕs the big deal?Ó

The InvestorÕs Role

ÒIÕve been warned that the investor will try to stick his nose into places that it doesnÕt belong and I will have to guard against that.  After all, theyÕre only money people and canÕt possibly be able to bring anything helpful, other than maybe banking relationships, or something like that.

ÒAlso, I refuse to give up control of my company, so if thatÕs what theyÕre thinking, they can forget it.  ThatÕs a deal breaker for me.

ÒMy fear is that I will have to spend too much time educating the investor about my business.Ó

MurphyÕs Law

ÒMurphy said, ÔWhatever can go wrong will go wrong.Õ ItÕs a cute expression, but it doesnÕt apply to me.  Among my intelligence, the quality of my team, and the quality of our business plan, we wonÕt be caught off guard.  MurphyÕs Law only applies to people who arenÕt prepared.  We are prepared.Ó

The InvestorÕs Perspective

The investorÕs perspective is a little different, as you might imagine. Remember, these representations are exaggerated, so donÕt take [all of] them literally.


ÒWhen the day is done, IÕm looking to make investments that return a lot of money.  While an overstatement, the companies that I evaluate might as well be black boxes. My job is to pick those black boxes that will change a little bit of cash into a lot of cash.

ÒMany investment professionals specialize in other financial sectors (real estate, bonds, stocks, and the like), and I specialize in early stage companies. Like all professions thereÕs an art to the business, much of which is only gained through experience. The fact that I am managing the fund that I am is testament to my professional reputation; otherwise I wouldnÕt have the confidence of the investors who invested in my fund.

ÒEarly stage companies are an exciting sector in which to participate.  The wins can be enormous.  By proxy, through my portfolio companies, I have a chance to change the world for the better.  With the depth of my experience, I can really contribute to the success of my portfolio companies.

ÒUltimately, though, I must believe that this particular Ôblack boxÕ is better, along many dimensions, than the other companies that I could invest in.  Fortunately, the flow of deals that I see never ends, so if I donÕt do this particular deal, another one will be coming tomorrow.Ó


ÒMy money is only a small piece of what I deliver to my portfolio companies.  The fact that IÕve Ôbeen there, done thatÕ can help the company avoid mistakes that others have experienced, and take advantage of their successes.  ItÕs rare that a company wonÕt need follow on funding and my relationships within the venture capital community can facilitate and optimize the terms of such financings.  IÕve got many connections within the venture-backed company community and can play a material role in recruiting key employees at the right time.Ó

Expectations for the CompanyÕs Performance Moving Forward

ÒA business plan is out-of-date the moment itÕs printed.  While I will probe and prod on the business plan, I donÕt interpret it literally.  It is important for me to see the quality of managementÕs thinking and how realistic they appear to be. As we discuss the plan, I can judge how ÔcoachableÕ they seem to be.  NothingÕs worse than a management team that thinks it knows it all, particularly if theyÕve never done it before.  Intellectual arrogance in an early stage business is often fatal.

ÒMy expectations are that the company will move from one crisis to another.  I need to judge whether I think it can survive those crises and whether the team can adjust appropriately and quickly enough to continue an upward trajectory for the business, regardless of the hits it takes along the way.  If it survives, I expect the business that we will be working with in 24 months will be materially different than the one that is characterized in the plan today.Ó

Quality of the CompanyÕs Management

ÒThis is always a difficult issue for me in early stage businesses. I wonÕt do a deal if I donÕt think the team is the right one to launch the business. Further I have to look into my crystal ball and predict the ability of the team to grow as the companyÕs needs change over time, its ability to recruit quality members in those areas that will need to be filled, and some sense of how tough personnel decisions in the future might be handled without jeopardizing the viability of the venture.  I know that industry statistics say that 60% of CEO/founders are no longer with their businesses within 4 years. My experience is consistent with that.

ÒThat said, IÕm betting on the jockey, while knowing that the jockey may not be with his company long term.Ó

The InvestorÕs Role

ÒI donÕt think itÕs misplaced ego to say that I can be the difference between success and failure for a company thatÕs fortunate enough to attract me as an investor.  My experience and contacts, alone, will be invaluable. My ability to provide mentoring to the founder and his team will help to short circuit their learning curve and help them to avoid making fatal errors.Ó

MurphyÕs Law

ÒAs an investor, I subscribe to SchwartzÕ Law.  Schwartz said, ÔMurphy is an optimist.Õ Time after time, unanticipated events occur that threaten the very viability of a fragile early stage company.  Its resiliency to survive those body blows and emerge the stronger for it, often determines the ones that ultimately succeed in a significant way.  S___ happens.Ó


When one thinks about the different perspectives the parties are bringing to the negotiating table, itÕs amazing that deals ever get done.  But they do. They symbiotic relationship between entrepreneurs and investors in early-stage companies is incredibly dynamic.  The term sheet is the first step at recognizing these different perspectives and trying to reconcile them is a mutually agreeable and constructive manner.  To the degree that the term sheet and ultimate deal can productively align agendas, the paths to mutual success can be traveled with a minimum of distraction and turmoil. [ThatÕs Òminimum,Ó not Òno.Ó There will be distraction.  There will be turmoil.  But at least some of it can be avoided.]

Advice to Entrepreneurs


Frank Demmler ( is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at Carnegie Mellon University. (