This article appeared in November 2019, in Romanian, in BIZ Magazine
The Goldilocks principle is derived from a children’s story in which a little girl tastes from different bowls and finds that she prefers porridge that is neither too hot nor too cold, but has “just the right” temperature. This principle is applied in a lot of areas, from math to medicine, as a metaphor for the balance between opposites.
I recently spoke with a group of entrepreneurs about the factors that influence an investor’s decision to invest in a startup, and I realized that the Goldilocks principle also applies to them. In the first two or three years of entrepreneurship, startup founders need to know how to navigate through straits where any wrong move can sink them.
And these straits are not even one after another, but all at the same time. Like an acrobat riding a unicycle on a wire, juggling balls and holding a stick with a spinning plate on his nose, all at the same time, the entrepreneur must find “just the right” way between:
1. How to wear different hats
People usually start businesses in areas they are good at. However, the problem is that being a good specialist (employed in a large company, for example) is different from being able to run a company in that field. Let me give you an example: a very good software developer who wants to make his own company will need to know, at the beginning, how to divide his time and attention between the product, generating and implementing a marketing and sales strategy, finding investors, team management and dozens of small problems.
The pitfall of focusing too much on the product, because he knows it best, can lead to failure in a thousand ways, from software engineers who resign by the score on a Wednesday to a wrong pricing policy. The best solution is to have a team of founders with complementary skills, a solution that is somehow suggested by potential investors, who prefer a team of 2-3 co-founders over one single founder.
A complicated situation occurs especially before rounds of financing, when the cash flow threatens to hit the bottom line. The CEO has the pressure to know how long he can leave the fragile business on autopilot to put on his finance manager hat, a role that involves dozens of meetings, sometimes on several continents, pitching at various conferences and hundreds of hours of talk. The answer is simple: just right.
2. What percentage of the company to offer investors
Startups, especially tech ones, have to choose between accelerated growth and disappearance. In an ecosystem with dozens of young companies struggling for the same market segment and with a wider and more accessible spectrum of funding through accelerators, incubators, business angels, VCs, IPOs and strategic deals, slow growth through the reinvestment of profit has unfortunately become synonymous with failure.
Startups grow fast through successive rounds of financing that cover the high costs of accelerated development. All these rounds mean that the founders transfer a percentage of the shares (equity dilution). The Goldilocks principle appears again. If in one of the first rounds of financing the founders give up too few shares, the money obtained will not be enough and they can’t go back to the investors so often.
On the other hand, if the founders give up too many shares from the beginning, after another one or two rounds of successive dilution, the company won’t be good enough for investments because no one puts money in a company where those who run it have insignificant shares.
Of course, there are mechanisms by which the shareholding structure can be adjusted later, but it’s better for the founding team to have a direction for at least three rounds before the first investment. This direction should be included in the business plan that is presented to any potential investor. Okay, but how much, for example, should the founders offer in the first round? 10%? 25%? The answer is simple: just right.
3. How flexible should they be to the board’s suggestions
After an investment, the decision-making structure of an entrepreneurial company changes. If there was no board before, then it is set up and, for example, for a first angel investment, one investor becomes a member of the board.
Both in the general assembly and in the board, the investors will therefore have a minority vote, correlated with the stocks they own. This means that in many decisions their role is rather advisory. And then the question is: what should the founders do? To do as they know best? Follow the advice of investors, who usually have more experience? I think you can guess the answer.
Investors prefer to have flexible partners who know how to stay in control. In the initial investment decision, the quality of the team often weights more than the product (Americans say: “Bet on the jockey, not on the horse”). A quality of the team that is evaluated from the beginning is the balance between knowing how to listen to advice and then knowing how to decide on your own. How flexible should the founders be? The answer is again both complicated and simple: just right.
I wrote about three kinds of balance that founders of a tech startup need to manage in search of funding. Obviously, my metaphor with the acrobat and the Goldilocks doesn’t apply only to this kind of entrepreneurship. Every entrepreneur must keep an eye on the ship’s dashboard to find the fine-grained setting that will move it forward. Apart from the quality of the decisions, the result also depends on the context, so I wish all these navigators a favorable wind!