In the last column I wrote, I talked about the conundrum faced by government policy makers as they attempt to craft programs to help the entrepreneurial space sector. One of the major dilemmas that they face is that all entrepreneurial companies depend on private investment to survive, succeed and grow. Helping those companies means being prepared to help investors.
This can be a challenge for government. The truth is that the private capital, or more particularly, the venture capital sector, does not enjoy wide public support. So, programs that support these groups are a “hard sell” politically. This issue is made worse by the fact that most government policy makers don’t understand what motivates private investors. In fact, much of the general public doesn’t either. And – I will also tell you for free, most first time founders don’t really understand how investors think, either.
All in all, I would say that the ways and means of the investment community are pretty poorly understood outside of that community. Yet, private investment is still very much one of the major lubricants of our economy. Without the activity of private capital our economy would literally freeze solid. So in this column I want to explore what motivates private investors in the hopes that this will be of interest to “the reading public”and of some specific use to both founders and government policy makers as well.
To be fully transparent, I am not now, nor have I ever been, an investor. Only in the last 5 years have I had any significant insight into the inner workings of that community. What insight I have gained is the result of working with, and listening to, investors as they try to guide and mentor founders of new space companies.
So, while I have genuinely enjoyed my interaction with this community over the past little while, I still possess only an outsider’s view of how investors think and make decisions.
The first and most important thing to remember about investors is that they are in business. And the business they are in is the buying and selling of companies. For some, this takes a bit of getting used to. Many of us are not really accustomed to seeing a company “merely” as an asset to be valued, bought and sold. For founders, who actually own those companies, their firms are always much more than “just an asset”. They are the means of livelihood for the founder and all of his or her employees. They are also something that the founders have created from scratch with blood, sweat, toil and intellectual property. Similarly, for government policy makers, companies are more often seen through the lens of their contribution to the wider public good. Companies employ people, they create goods and services and ultimately wealth for the country as a whole.
It comes as a bit of a shock, therefore, to learn that at some level, every company is an asset to someone. A price can be put on it and it can be bought and sold for that price. A company must be owned in order for it to exist. Whoever owns it can dispose of it as they see fit.
Now investors are interested in purchasing these assets – companies, or portions of companies – with the objective of seeing them – and helping them – increase in value so that they can be sold. In the investment world this is known as “an exit.” Understand that every investor goes into every deal with an exit strategy. They may not expect the exit to occur for a number of years, but they expect it to happen. It must. Otherwise THEIR business is not successful.
That means that the BIG QUESTION is really – how do you set a value on a company? This “valuation” as it is called in investment circles is at the heart of every investment deal. Some value has to be placed on the company in its current state and investors and founders must see some plan for increasing that value.
So, what is a company worth? Well, there are many different ways of assessing that involving the company finances, as well as current and future business, the value of intellectual property owned by the company, etc. etc. But all of this actually boils down to a very simple answer. Like anything else, a company is worth exactly what someone is willing to pay for it. No more and no less.
And this is where the world of investing crosses over from science to art. In order for any investor to be successful, they have to be adept not only at identifying potential value – but at promoting it as well. Investors can only be successful if they convince other potential investors that they have made good decisions, that they have seen potential value that others did not.
BUT, this also makes investors sensitive to the wider market and public opinion. It is very important to investors that the sectors and companies that they invest in be popular and well regarded because a good reputation is critical to convincing prospective new buyers of the value of the companies they have bought. Low profile and poor reputation tends to shrink the pool of possible buyers dramatically – which inevitably reduces the valuation they can set and the value they can obtain on exit.
This is the key point for non-investors – such as founders or government policy makers – to remember. In order to attract investment to a business or a business sector, it needs to be made attractive to as wide a community as possible. Investors need to be convinced that they can make deals that will allow them to realize significant financial returns. Investors need to be sure that when they decide to sell, there will be someone there to buy.
This is also a point which is often missed. Founders will tend to want to tell a story of how the company will grow. But they will often not explain how the growth will drive an increase in valuation and who will be convinced of that higher value. Government policy makers will tend to focus on arguments of public good and general economic well-being. For reasons of public perception they will find it difficult to promote programs as assisting investors in generating returns for themselves. This, in turn, can actually cause such programs to result in reduced profile and reputation for the targeted sector – which actually drives potential investors away.
As with many of my columns there is a common theme here. If you want to do a deal with someone sitting across the table you need to first understand how they think, what they want, and what value they place on that thing. In order to do that you have to be curious, you have to ask questions.
And crucially, you have to listen to the answers.