Vertical Pulse

The Pros and Cons of Receiving Funding from Strategic Investors

Entrepreneurs often seek funding from the venture capital arms of large companies. Receiving funding from the likes of Intel Capital or Comcast Interactive Capital does have its advantages. First, in today’s credit drought, capital from any source can be critical for a company’s survival. Second, obtaining funding from strategic investors does offer a certain panache, a certain validation of a recipient’s technology and business strategy. Third, the strategic investor could become a purchaser of the company’s products and boost sales further by plugging the company’s products through its distribution channels.

Despite the advantages of attracting strategic investors, entrepreneurs should be aware of the risks of accepting capital from corporate investors. A few of these concerns include:

·         Strategic investors often have interests that diverge from those of the entrepreneurs. For instance, a strategic investor might take an interest in an emerging company to incorporate its technology in existing products at below market rates. Strategic investors may also make an investment to keep the young company’s technology from reaching the market, thereby eliminating competition for its more established products. (One way to determine how likely these scenarios are is to ascertain how the strategic venture capitalists are compensated. If they are compensated for the strategic value that they bring to their company, be wary. If they are compensated for the returns that their strategic funds deliver, you can breathe easier.)

·         Strategic investors often invest in many competitors in a given market segment to hedge their bets. When this happens, there is a risk that some of the portfolio companies’ trade secrets and intellectual property will be compromised and find their way to competing companies.

·         Having a strategic investor can result in the loss of business opportunities. Competitors may not wish to purchase products from a young company, if doing so will enrich their larger adversary.

·         Many companies’ commitment to their venture capital units is tenuous. When the venture capital business experiences stress or a new management team takes charge, the venture capital divisions are susceptible to being shut down. This may result in the untimely liquidation of a fund’s investments.

·         Strategic investors have a reputation for being less valuation sensitive—because they are also calculating the strategic significance of their investments—during negotiations for subsequent rounds of financing. Thus, the entrepreneur may be disadvantaged when its existing strategic investors are less vocal in pressing for higher valuations. However, if the funded company becomes completely dependent on its strategic investor for further rounds of capital, the corporate investor would be able to leverage its disproportionate power in those negotiations.

·         Strategic investors introduce problems during exits. There is typically less bidding for companies funded by strategics because of the entanglements. Also, if the strategic investor declines to bid to acquire the portion of the company that it doesn’t already own, it sends a signal to other potential bidders that there is a deficiency with the company.

In conclusion, if you are contemplating receiving venture funding from strategic investors, I offer two final pieces of advice. Introduce your technology to the technical team at the target company. If you can recruit a technology champion within the large company, that advocate will have more influence as an insider with his counterparts on the strategic investments side. Technology champions can dramatically enhance your negotiating leverage. Secondly, partner with a strategic investor as late as possible in your capital raising campaign.

David Wanetick is a Managing Director at IncreMental Advantage, a research and valuation firm based in Princeton, NJ. He is an instructor at The Business Development Academy. His most recent book is The Power of Incremental Advantage: How Incremental Improvements Produce Dramatically Disproportionate Results.

Newest Sign of Corporate Distress: Selling Customer Contracts

In an attempt to squeeze some cash out of their assets, a few distressed companies are putting their customer contracts on the selling block. Warren Haber, Managing Director at Crossbar Capital said, “With capital for traditional corporate financing extremely scarce, some companies are looking to monetize their customer contracts. These companies intend to use the proceeds to fund other operations or to return capital to investors before liquidating.”

However, selling customer contracts won’t be a slam dunk. According to Charles McCormick, a partner with the law firm of McCormick & O’Brien LLP, “Many contracts contain unequivocal non-assignability clauses while many states have laws on their books that require customer consent in order to assign contracts.” Often customers originally chose the distressed company over the potential assignee and would object to receiving services from the potential assignee.

Despite customer objections to having their vendor contracts transferred to another service provider, many customers may not have much of a choice. A service provider that liquidates can’t fulfill its obligations and dealing with vendors in bankruptcy presents their own set of messy entanglements.

David Wanetick is a Managing Director at IncreMental Advantage, a research and valuation firm based in Princeton, NJ. He is an instructor at The Business Development Academy. His most recent book is The Power of Incremental Advantage: How Incremental Improvements Produce Dramatically Disproportionate Results.

The Perils of Entering into Negotiations

“There is no harm in entering into a dialog,” is a common refrain in the Board Room. So too is, “We have nothing to loose by negotiating. If we don’t like the deal, we can always walk away later.” Far too often, when it comes to negotiations nothing could be further from the truth.

Some negotiations are unavoidable and negotiations are an imperative step in actualizing a company’s business plan. However, negotiations are not cost free. Negotiations are a tax on a company’s resources, represent a diversion of focus, and heighten your company’s vulnerability to competition.

While we advise companies on developing a range of negotiating strategies, the first strategic question that should be addressed is, “Should we entertain the proposition?”

Here are some reasons why you should reject unessential opportunities to negotiate:

·         Time  -  Negotiations consume tremendous quantities of time. Since senior executives’ time is quite often the scarcest resource that a company has, senior leadership must be very selective about choosing the negotiations that it will enter.  

·         Diversion of Attention  -  Entertaining too many overtures to negotiate transactions causes executives to loose focus of their business objectives. Negotiating indiscriminately risks causing senior managers to forget which businesses they are pursuing and which markets they should be serving.

·         Risk of Being Seduced – Many years ago, when the American Nazi party petitioned to march in Skokie, Illinois, columnist George Will argued that they should not be granted this right. His argument was that if you give fascist parties a right to compete in the marketplace of ideas, they might just win. If you put yourself in a position of being seduced to do something that is not in your company’s best interest, the other side just might be successful in convincing you to take such action.

·         Information Leakage  -  Competitors know that feigning interest in your business is a proven tactic for gleaning critical information about your company. Despite executing non-disclosure agreements, even seemingly innocuous off-handed comments can convey critical insights to your interlocutors.

·         Delay – In addition to capturing vital information about your company, competitors conducting due diligence on your organization can use prolonged negotiations to delay you from taking actions that you need to take. For instance, if you are negotiating a potential research alliance, you may not pursue your internal research efforts as aggressively as you otherwise would during the course of the negotiations. The competitors with whom you are negotiating may be disingenuous about forging such an alliance and may be vigorously pushing ahead with their research initiatives.  

·         Contamination  -  Simply entering into negotiations with one party can contaminate your relationships with other parties. For instance, during the latter part of World War II, the Nazi’s concocted a disingenuous scheme whereby the Western Allies would supposedly be able to save the lives of 800,000 Hungarian Jews if they provided the Wehrmacht with 10,000 winterized trucks to be used solely on the Eastern Front. The trap was that the moment the Western Allies entertained this proposition, their alliance with the Soviet Union would be attenuated since the trucks were to be used against Soviet troops.   

·         Being Used As A Pawn  -  Sophisticated negotiators know that their leverage usually rises when they negotiate with multiple parties. Be aware that the other side could use the negotiation with you to demand more attractive terms from a company that they are genuinely interested in doing business with. They could be using discussions with you solely as a means of legitimizing valuations that they desire.

·         Concern Among Employees  -  Transactions designed to transform your company (or departments such as marketing or research) are of concern to your employees. Unless you are setting the stage for negotiations with your employees, you don’t want to unnecessarily scare your employees that their jobs could be imperiled in light of an impending business (or departmental) combination.

·         Intellectual Straight-Jacket  -  Due to the tremendous resources required and emotional investment expended, negotiations tend to take on a life of their own. It is often psychologically easier to consummate a bad deal than it is to terminate prolonged discussions. The most troubling aspect of deal fatigue is that the organization becomes so emphatically committed to “getting the deal done” that it refuses to acknowledge foul play on the part of its counterparts. A host of Israeli governments have embraced “the road map to peace” so tenaciously that acknowledging the culpability of the Palestinian Authority in a multitude of terrorist acts has become impossible since doing so would make a mockery of the negotiations.

Even if you disagree with the above reasons for declining to accept every invitation to negotiate, there is one final point that I would like to make. If you insist on negotiating promiscuously, you should put up some initial resistance to negotiating. Voicing some level of apprehension to embarking on negotiations leaves you in a stronger negotiating position should you decide to proceed. More successful negotiators go one step further and amplify their reservations in order to win pre-negotiation concessions.

Best Practices for Hiring Executives

It was just a few short years ago that I couldn’t find qualified candidates for a variety of open positions that we had for our research, advisory and training company based in Princeton, New Jersey (USA). Now, recruiters are calling me weekly to pitch candidates. The employment pendulum has swung 180 degrees in less than 24 months. 

   Today, employers have the benefit of being able to choose from among a large pool of candidates to interview for the relatively few positions that are vacant. However, the traditional interview process is not a reliable method for evaluating candidates. Brief interviews with candidates are comparable to first dates: the interviewee is inclined to say whatever he believes the prospective employer wants to hear.

 

Hire Specialists, Not Superstars

The first step in hiring is to make determine the exact mission you want your new hire to accomplish. You should review your business plan and determine which targets are unlikely to be met without recruiting additional talent. Then, you should match the goals spelled out in your business plan with the expectations that will be placed on your new hire. To increase the likelihood that a new hire will meet these expectations, you should only recruit executives that have the specific skills and backgrounds that are conducive to them meeting their objectives. You should be unambiguous in communicating to interviewees what you would expect them to accomplish and what the timelines for such goals would be. Once a new hire comes on board, he is actually more likely to execute according to your expectations since he will not have guess what is expected of him.

   While it may seem counterintuitive, it is often damaging to hire superstars. Superstars are unfairly expected to have all of the answers at their immediate disposal. Conducting due diligence or asking probing questions would be an admission that these luminaries do not always have solutions to problems. Superstars would often rather conduct less research and make worse decisions than damage their ego by admitting that they are not omniscient. Highly accomplished people often worry more about acting smart than learning new things. Many highly intelligent people serve up plenty of ideas but deliver few tangible results. There is a big difference between having great credentials and being a great contributor. Further, many superstars are more concerned about using their current positions to catapult into other opportunities in their career paths than to make a solid contribution to their existing employer.

   Many companies that cultivated star talent have crashed. Examples include Enron, Arthur Anderson, and Drexel Burnham Lambert. Nick Leeson, a young trader, single-handedly caused Barings Bank to collapse. Not only was Barings Bank acquired for a symbolic ₤1 by ING but ING even dropped the Barings name after one year as the new Dutch owners believed that the Barings name was a liability. As noted author Malcolm Gladwell pointed out "the organizations that are most successful are the ones where the system is the star." These are typically organizations that have built-in redundancies and are not overly reliant on a few key employees.

 

Overweight Intelligence

You should make a serious effort to ascertain the raw intelligence that a candidate brings to the table. Intelligence is the single most telling variable in determining an executive's success. It is intelligence that will equip an executive to make decisions when no precedents exist. It is intelligence that can maximize opportunity and avoid obstacles. It is intelligence that enables an executive to defuse a tense situation. It is intelligence that will enable superiors to effectively delegate authority and responsibility.

   The best way to evaluate an executive's intelligence is to ask them to recommend a solution to a problem that the business confronts. The articulation of the recommendation will reveal their thought process and therefore their strengths and weaknesses. Research shows that an aptitude test predicts performance just as well as a structured interview. (Interestingly, it is more important that executives can express themselves verbally than in writing. Crises require immediate response which can only be delivered through verbal communication. You can't spend an afternoon writing a memo to address a crisis. Also, verbal communication can better motivate the troops than memos and communiqués.)

   Another method for sussing out a candidate’s intelligence is to ask them brain teasers. It is not the answers that are of importance during these exercises but rather the thinking processes that the candidate brings to bear.

 

Enhancing the Interviewing Process

Now that you know to recruit specialists, seek highly intelligent candidates and avoid superstars, I would like to present you with a few suggestions for adopting a more rigorous interviewing processes.

 

·         Interviewers should listen to what candidates are saying far more than they should speak. Many interviewers try to sell the prospect on accepting the position before they have determined if the candidate is truly suitable for the job. It is natural for people to believe that what they say sounds intelligent. Thus, interviewers who speak too much believe that the interview went well despite their inadequately vetting the candidate.

 

·         When asking open-ended questions—such as “What are your long-term career goals?” or “How would you describe your greatest strengths and weaknesses?”—make sure that you ask these questions before you provide the candidate with insight into the position or background on the company. Doing so will eliminate the possibility of the candidate crafting his responses to the contours of the opportunity.

 

·         In interviews, managers need to focus on specific past experiences and job-related hypothetical scenarios. The idea is to focus on relevant data and squelch any questions that invite the candidate to predict the future, reconstruct the past, or ponder life’s big questions. According to research we have reviewed, one of the most revealing questions to ask a candidate is “What do you know about our company?”  Any serious candidate would have conducted significant research about a company that they proclaim to wish to work for. Also, candidates cannot bluff when answering this question.

 

·         When interviewing a potential employee ask yourself: Where is the logic in this applicant's career path? Is the job a natural progression or is the applicant just looking for an income? If the applicant is just looking for an income, rewarding him with a lavish compensation package will not increase his loyalty. When people join a company for money, they will leave the company for money.

 

·         According to extensive research conducted by Robert Gifford of the University of Victoria, one of the most telling signs of a candidate’s motivation is how far they lean forward during the interview.

 

·         Employers should take measures to ensure that they do not fall victim to the Availability Bias which holds that people base their judgments on information that is either the most recent or the most emotionally vivid in their minds. Thus, candidates that interview last for a particular position often benefit from the Availability Bias. Companies should structure their interview series in such a way that no candidate is the last interviewee for all of the company’s interviewers.

 

·         Here are a few tips for checking references. First, during the interview with the candidate stress the fact that you will (not may) confer with their references. The result is likely to be that the candidate will be more honest during the interview since he knows that his contentions will be verified. Secondly, you must remember that past employers who make uncomplimentary statements about former employees put themselves in legal vulnerability. With these legal constraints in mind, one tactic is to place calls to former employers when you suspect that the reference is not available to speak such as before working hours or during lunchtime. You should leave a message stating that you are seeking a reference. This tactic requires the former employer to make a special effort to speak positively on behalf of the candidate. If the reference does not return the message, he has still spoken volumes about his assessment of the candidate.

 

Final Thoughts

There are two additional points I would like to make about hiring. First, is the issue of balanced selection which originates from the disciplines of genetics and psychology. Balanced selection means that even though a particular trait in a candidate may be helpful in some cases, it can be damaging when too many people in a division have it. For instance, if a marketing department has an abundance of people on staff who are inclined to develop edgy or risky marketing campaigns, there is danger in hiring more people with similar propensities to take risks. The marketing department could be better served by hiring marketing executives with proclivities to develop more mainstream or traditional marketing campaigns.

   The second issue relates to the formula for determining behavior. Many executives hold that the sole predictor of one’s behavior is resident in the personality traits specific to the individual in question. They completely disregard of the impact of situational forces. However, the equation for predicting one’s behavior is individual traits x given situation. Indeed, the Fundamental Attribution Error holds that when making judgments, we tend to over-attribute personal factors and under-attribute situational forces. Thus, no matter how rigorously you scrutinize candidates, you must realize that their behavior—and effectiveness—will be influenced by the environment in which they work.

Leadership Can't Be Measured by Applause

In May, I spoke before the Ohio Chapter of the Project Management Institute. One of my comments evoked a lively debate with the attendees on one side and myself on the other.

 

I was talking about the importance of confidence in leaders. During this part of the presentation, I said, “You should not overly solicit customer suggestions or ‘constructive criticism’.”  The argument that I was making was that leaders must lead and not be overly subservient to the wishes or whims of their customers, employees or other constituents. You can’t measure leadership by applause.

 

Winston Churchill said that the populace will never be able to look up to a politician who is kneeling down to place his ear to the ground. John F. Kennedy said that he was not elected to office to become a seismographer of the public mood. The populace most respects institutions that are managed by leaders whose decisions are not designed to reflect the popular will. In The Future of Freedom, Fareed Zakaria wrote that the three most respected institutions in America—the military, the Supreme Court and the Federal Reserve—are not democratic but they demonstrate leadership.

 

According to my Theory of Customer Malleability, customers do not know what they want. Their buying decisions are more a function of persuasion, influence, and social pressure than internalized desires. (Eric Hoffer said, “When people are free to do as they please, they usually imitate each other.) The link between internalized desires and buying decisions is bracketed by what is available. Customers are particularly bad at providing insight into new product initiatives. Henry Ford said that had he surveyed the population about what they wanted in transportation, they would have lobbied for “faster horses”.

 

Since there are often big gulfs between what customers say they want and what they buy, basing product development decisions on what customers say they want is risky. Encouraging customers to free associate the kaleidoscope of possibilities untethered to the practically of delivering such products to the market is often a futile exercise.

 

I believe that it is far better for an organization to assess what its customers and potential customers are actually doing. This information should be collected from the variety of touch points—e.g. sales and customer service—that the company already has with its customers. When well-run companies want to know what is on their customers’ minds, they shouldn’t have to put them in a sterile room with a swinging light bulb.

 

The following are some of the reasons I believe that relying heavily on customer surveys is a mistake:

 

• First, conducting customer surveys is expensive and time-consuming. While most professional surveys are outsourced, the sponsoring company still must dedicate substantial resources to providing insight into the survey design, desired learnings and interpretation of collected data.

 

• Second, obtaining an accurate read on customers’ thoughts is nearly impossible because customers’ responses can be swayed by one word or by the order in which the questions are asked. Some have compared trying to read customer sentiments to the soothsayers of yesteryear who tried to divine meaning from chicken entrails. Consider how one word conjures up drastically different recollections in this real-world exchange: 

 

Lawyer to Witness:   How fast was a car traveling before it ran into a telephone pole?

 

Witness:   45 miles per hour.

 

Lawyer to Witness:   How fast was the car traveling before it smashed into the telephone pole?

 

Witness:   65 miles per hour

 

Of course, the integrity of customer surveys can be compromised when the wrong people are surveyed as well as when the right people are surveyed in the wrong setting. The fact that respondents to many surveys are self-selecting is one instance of how the surveys are skewed. Sometimes, asking the same people the same question at different times of the day— or before or after a meal—will yield different responses.

 

• Third, customers do not want to be bothered answering surveys. Being requested to complete a survey that takes longer than the delivery of the service in question is annoying. Just the act of sending a customer a survey can so greatly annoy some customers that the company’s brand will diminish in the perspective of many customers. Customers will often race through surveys just to get them over with. Their haphazard responses are a precursor to the collateral damage that will result from relying on such feedback.

 

• Fourth, being overly solicitous of feedback will inevitably result in criticism. (Unwarranted criticism is most likely to be evoked when people in a group believe that their ability to criticize is a sign of their intelligence.) A serious problem arises when this criticism shakes the employees’ confidence. If salespeople hear this criticism, they risk becoming demotivated and therefore, less effective.

 

• Fifth, it is important to realize that some customers are not worth having. The peril in soliciting extensive feedback is that the most critical and demanding suggestions are likely to come from customers who offer the company diminishing prospects for profitable returns. 

 

• Sixth, customers who are only moderately disappointed with a company become irate when their concerns are not addressed. Thus, companies that rely on extensive surveys are faced with a dilemma: either bend to the customers’ wishes or suffer their wrath when failing to do so.

 

A similar problem arises with focus groups. In many cases, a dominant personality takes over and discourages others from expressing opinions that deviate from his.

 

All of this is not to say that there is no merit in conducting customer surveys. One often overlooked benefit of conducting customer surveys is that they can be used to justify terminating employees (e.g. when customers are consistently disappointed with a customer service representative’s service).

 

Some of the most revealing customer surveys can be quite simple. I believe that there is a lot of merit in Fred Reichheld’s idea that customer surveys designed to measure customer satisfaction with an existing product or service can be distilled down to one question: “Would you recommend our service to your friends and colleagues?” The reason this is such a powerful question is that it gauges whether or not customers like your product enough to put their own reputations on the line with their friends and colleagues.