Honesty is The Best Policy; Be Straight With Your VC, and Your Associates
- Posted by Jeff Carter
- on August 27th, 2011
At Hyde Park Angels, we see a lot of start up companies. They submit their business plans and we go through them. If they are really interesting to us, we start a due diligence process. That’s when the tough questions get asked and answered.
I have found that a few businesses are so worried about pricing themselves for perfection that they will fudge facts in order to get investment. Once we find that things aren’t what they seem, it makes us probe even deeper. The odds of them getting funding when we find something peculiar go down significantly. Trust has been broken.
At the Funding Post Consumer Products panel I was on last week, a question came up about honesty. Moderator Ted Wern, echoed my remarks. He said he couldn’t stress enough that the entrepreneur should be honest with the VC. It enhances credibility down the road. Conversely, the VC ought to be honest with the entrepreneur too. Honesty is a two way street.
This not only goes for your business, but for your personal life too. More and more I hear people say things that they either don’t really mean or don’t have any intention of following through on. It’s entirely possible that our lives are so hyper busy and our attention spans are decreasing because of internet effects. When was the last time you spent longer than 3 minutes on a web page?
Honesty reminds me of a discussion I had in an accounting class at the University of Chicago. Dan Bens was the instructor. He is now enjoying the sun in Arizona.
With good accounting practices, accurate financial pictures emerge. That is the goal of accounting-to present an actual picture of the business as a going concern. Good accounting entails a lot of judgement. When do you recognize revenue? What discount factor should you use? Accounting is not a black and white business, contrary to what most people think. Read the notes in an annual report sometime. They can be eyeopening.
We were discussing how things you bury in financial statements eventually rear their ugly heads when one student asked about Enron. They said, “They kept the thing going long enough to get rich.”
Bens turned, and looked at him and said, “But they went to jail.”
The student said, “But they got rich.”
The professor wouldn’t yield, “They went to jail.”
A little chuckling in the class.
The student said, “Did they keep their money?”
Actually a classic economic question. Because the student was weighing opportunity cost of going to jail versus making a lot of money. Jail is never worth it in my opinion.
The point of the discussion is that Enron’s accounting shenanigans eventually came out. They did go to jail. Shareholders were destroyed. America got a bad law in Sarbanes-Oxley. There are consequences to shady behavior that might not present themselves the first time you think aobut it. Entrepreneurs presenting their companies should contemplate the after effects of their presentation when they feature their companies financial statements and financial projections. The deception always comes out, and it’s worse if it happens after an angel or VC gives you money.
Now suppose you are a company and you get away with your misdirection. You get your funding at the valuation you want. You won’t be able to hide any longer. The VC will find out. Now, if you don’t hit your benchmarks what happens? The next round of financing you need won’t come. It will be a down round, and the VC probably won’t reinvest. Or if they do they will scrap the entire management team. The choices aren’t pretty. You are out of a job running your company, or the company goes bankrupt and out of business at the next stage of financing. Is that worth the tall tale in the beginning?
There is no doubt that you are selling yourself when you present your company to an investor, or present yourself to an employer. Understandably, you don’t want to sell yourself short, but you don’t want to present a false picture either. The repercussions down the road are never worth the pomp and circumstance at the beginning.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Jeffrey Carter is an angel investor and independent trader. He specializes in turning concepts into profits. He co-founded Hyde Park Angels one of the most active angel groups in the United States in April of 2007. He previously served on the Chicago Mercantile Exchange Board of Directors. He has done market commentary for (More...)
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