A high risk tolerance is one of the hallmark characteristics of successful entrepreneurs. When an entrepreneur founds a company, she has by definition entered an extremely high risk situation. According to Harvard Business School 70% – 80% of new businesses fail when failure is defined as an inability to get adequate return on investment . Since VPA primarily focuses on founder-led businesses with no significant institutional investment, this means that failure for our clients means an inability to get an adequate return on their family’s investment or their life savings. Entrepreneurs know the new business failure rate is high but still endeavor to build something magnificent anyway; this is the definition of risk taking. When companies are just starting out they are faced with many critical decisions. What pain point should the product/service strive to mitigate? What are the key positions we need to hire for? How can I keep this business financially viable for 18 months without having to look for outside money? In the early stage of the business lifecycle entrepreneurs are consistently taking risks and seem more than willing to do what it takes to realize their dream of building a successful enterprise. Risk taking, a lot of hard work, and a little luck are what help a new venture ultimately become a legitimate business.
What happens then when a founder becomes risk averse because the new price of failure isn’t losing the dream of being successful but destroying existing value? Enter the Entrepreneur’s Dilemma. Simply put the entrepreneur’s dilemma is when the strategies that made an entrepreneur successful initially, risk taking and innovation, becomes secondary to maintenance and defense of the business. It’s much easier for an entrepreneur to take risks when her company is generating less than $1 million in revenue than when a business doing $20 million in revenue and $4 million of EBITDA (earnings before interest, taxes, depreciation and amortization).
So what’s an entrepreneur to do? To answer this question, you have to look at the root cause of the diminished risk appetite. The typical response is, “I don’t want to take risks or innovate for fear of losing my existing customers and the income associated with them.” It is understandable that after risking everything and essentially doubling down for years, an entrepreneur is not interested in getting back into a situation where a wrong move could put them back into a cubicle working for someone else. However, it is not necessarily in the best long-term interest of the company to have a risk adverse approach. We believe the most elegant solution to the entrepreneur’s dilemma is a minority deal which includes founder liquidity. In a minority transaction (defined as selling less than 50% of outstanding equity), the entrepreneur does not give up strategic control of her business but is able to get meaningful liquidity to assuage any concerns relating to her personal financial situation. After a minority deal, we find the entrepreneur can revert back to the mindset that made him successful in the first place: risk taking.