Even in the Best of Times, Do the Work: How to Pick the Right Capital Partner
[An abridged version of this piece was featured in Utah News.]
As Q1 of 2022 winds down, events on the global stage may be turbulent, but the entrepreneurial arena is enjoying robust growth. For more than a decade now, the Fed, on the back of the Great Recession, has stimulated the US economy by printing unprecedented sums of money and pegging interest rates at zero. In turn, asset prices have increased as more dollars (demand) have chased a similar number of assets (supply). And because bonds have been yielding close to zero, investors have funneled more and more capital into riskier assets, including private companies, in search of higher returns.
The year 2021 eclipsed venture capital and private equity records, as both spaces nearly doubled their 2020 figures. According to Pitchbook, Venture capitalists invested more than $325 billion in US startups, and PE saw an additional $2.8 trillion in US mergers and acquisitions. In short, it’s never been a better time to be an entrepreneur and raise capital.
In the midst of so many new drivers of deal activity, entrepreneurs have begun to consider the merits of bringing on partners/investors to strengthen their balance sheets and add value to their organizations. Yet some of them, lacking the right tools to choose wisely, make a reflexive decision that is based primarily on price. Optimizing for price may be the right choice if you’re selling to exit a business, but if instead your plan is to build your company and continue investing a material portion of your net worth in it, the quality of your partnerships warrants greater focus.
Jim Collins, in his book Good to Great, posits that “the most important decisions that business people make are … who decisions.” When it comes to choosing an investor, the “who” is always as important as—if not more important than—the “what” or the “how much.” A higher price today will do little to compensate for the brain damage you incur from working with a difficult partner who may also cause your business to be worth less down the road. Conversely, a few percentage points cannot compare to missing out on a partner who is more enjoyable to work with on a day-to-day basis, especially one who can also deliver a higher upside and higher-probability outcomes.
For any entrepreneur concerned with picking the right capital partner, these three simple principles will produce the best possible scenario:
1. Assess fit. Take a close look not only at your business needs but also at your personal needs. When considering any prospective investor, ask yourself, “Is this someone I like and would enjoy working closely with? Are we aligned in terms of both my vision for my company and my personal values?” Values are where you spend your time, money, and mindshare. If you don’t have strong overlap with your capital partner on your real values, you’re setting yourself up for significant pain. This sort of outcome is so common as to be a trope—“We were happy until we brought in our investor”—yet many notable exceptions exist. The difference is values alignment, and it is an important principle to get right if you want to avoid misery.
2. Consider business needs versus investor experience and resources. Do your prospective partner’s experience and resources add enough value—however you define it—that you feel good about selling a portion of your business? Where this equation yields a positive output, your dilution in equity is accretive, meaning the value created through the partnership is greater than your decrease in ownership. You may own a smaller portion of the pie, but a larger overall pie increases your ownership value. In other words, dollars matter more than percentages.
I learned this lesson the hard way as a young entrepreneur working on one of my first deals. We brought in a coinvestor to support the investment and based our decision largely on price, opting for the one who offered a few additional equity points. We also thought we could have a good working relationship with the deal partner. Unfortunately for us, once the deal closed, he left us stuck with a new team who cared mainly about calculating things to the fourth decimal place, calling foot faults on our every misstep, and demanding more and more reporting—all of which took us away from building the business. Ultimately, the incremental equity we gained was not worth the constrained growth and poorer quality of life we experienced.
3. Do your homework. Capital providers invest considerable time and resources examining you and your business before making an investment, so why would you consider jumping into a long-term relationship without doing your own diligence? You shouldn’t make impulsive decisions about investors any more than you would about marriage or any other long-term commitment. Remembering that you have the capacity—the obligation, really—to vet potential partners as much as they’re vetting you can be empowering. Rather than taking at face value an investor’s claims about their value, gather as many references as possible from those who know best—your fellow entrepreneurs. You have a wealth of information to gain from your community. Consider asking:
- In what ways did they deliver on their promises to add value?
- How were they supportive in tough times?
- Did they consider the interests of all shareholders and stakeholders, as well as what was best for the business, versus being singularly focused on their interests?
The proof will be in the pudding, meaning the feedback you get from these reference calls should be consistent with the claims the investor has been making about the ways in which they can benefit your business. If not, you’ll be best served by moving on to other prospects.
While running Marucci Sports, I saw firsthand how references can make or break a partnership. At the time, the company was an upstart wood-baseball-bat manufacturer trying to break through at Dick’s Sporting Goods, the largest sporting-goods retailer. We didn’t have much going for us financially, but we made great bats and had several MLB All-Stars swinging them, one of whom was Sean Casey, a larger-than-life personality who went on to be a popular television broadcaster. Back then, Sean lived in the Pittsburgh area, where Dick’s is based, so we rolled him into a meeting with the buyers. After they tried convincing him to join their company softball team, they asked him what he thought about Marucci. Sean sat back and thought about his reply for a moment, before bursting out, “The proof is in the pudding!” As he unpacked why Marucci bats were superior, we realized nothing we could have said or done before or after would have had a greater impact than his glowing review of our product.
No matter what type of business you’re building, following the aforementioned advice and thinking broadly—not focusing myopically on financial gain—is what will ensure that your partnerships center on alignment and accretive dilution.
One such example is Rails, a contemporary fashion brand based in Los Angeles, which founder Jeff Abrams bootstrapped, turning a $5,000 investment into a widely admired label followed by numerous A-list celebrities.
Peterson Partners first met Jeff 18 months after an exhaustive sales process that yielded several attractive offers to sell his business. After assessing his goals and the growth opportunity, Jeff ultimately resolved to retain control and attract a partner that could help him grow his team and build omnichannel distribution, particularly direct to consumer. Following months of exploring how Peterson could help him accomplish his goals, Jeff agreed to partner with us at a valuation that was fair but not the highest he was offered. Was bringing on an investor at a lower price the right choice for him to make? Only time will tell. What is certain is that our partnership is anchored in mutual trust, a strong working relationship, and a shared value system. Neither party knows all the answers, but collectively we’ve surmounted the obstacles we’ve faced so far. And since our relationship began, we’ve worked closely together in making several strategic hires, including the chief operating officer, and developing robust e-commerce and retail distribution, all of which has helped Rails more than double its revenue.
However, financial gain is only one of the myriad benefits this and other Peterson partnerships have engendered, thanks to the fact that we continue to make questions of fit our priority. As long as investors and entrepreneurs alike continue to appreciate the “who” as much as the “what” or the “how much,” even and especially in the best of times, we can trust that we’re doing the work to ensure our continued success when challenges arise.
The portfolio companies identified and described herein do not represent all of the portfolio companies purchased, sold or recommended for funds advised by Peterson Partners. The reader should not assume that an investment in the portfolio companies identified was or will be profitable. Past performance is not indicative of future results. For a list of all of our portfolio companies, please visit https://www.petersonpartners.com/. This is not a solicitation of an offer to purchase securities and may not be relied upon in connection with the purchase or sale of any security. Interests in the Peterson Funds, if offered, will only be made pursuant to a confidential offering memorandum and subscription documents.