Don’t Brag: An Entrepreneur’s Guide to Getting Capital
Young firms seeking outside funding can attract investors by acknowledging they have room for improvement, while also playing up their strengths.
Bottom Line: For young firms seeking outside funding, making a positive first impression on investors counts for a lot. They should refrain from bashing the competition and acknowledge they have room for improvement.
Entrepreneurs attempting to secure early-stage funding should strike a delicate balance between confidence and restraint when spelling out their business plan, according to a new study. Although investors appreciate an entrepreneur’s bold vision, they frown upon overly bombastic claims about a venture’s certainty of success or the competition’s shortcomings. And in a counterintuitive twist, the study adds that entrepreneurs can actually improve their prospects of receiving funding by revealing some of their flaws and downplaying the uniqueness of their business model; these are moves that investors regard as responsible and mature rather than as signs of weakness.
Because early-stage ventures usually revolve around untried technologies, novel products and services, and uncertain levels of market demand, investors can’t base their bets on the firm’s proven track record. Instead, they must weigh the promises and assertions made by entrepreneurs. As a result, one of the most important tasks confronting fledgling companies is to engage in what researchers call impression management, by presenting their business plan in a cogent, captivating manner that appeals to investors.
The authors analyzed all 595 entrepreneurial firms that sought financing from a prominent network of New York City angel investors during a recent three-year period. Angel investors typically put up their own money, either individually or in small groups, to back early-stage ventures that have high growth potential and a product either entering the marketplace or in the testing phase. (This approach contrasts with venture capitalists—whole firms that tend to fund more established or proven businesses.)
The angel network studied reflected the typical portfolio of similar groups in the U.S., seeking to reap a 10- to 30-fold return on its investments within two to seven years. The average firm seeking funding in the sample was three years old, employed seven people, had raised US$850,000, and was seeking another $1.7 million in first-round funding.
The investors based most of their initial judgments on a one-page application submitted by entrepreneurial companies. In it, entrepreneurs provide information on their firm’s finances, prior investors, and management team; they also describe their business model, rivals, marketing plan, and any competitive advantages they might have. Because the applications were all the same length and covered the same topics, the authors could isolate how the language and tone used by entrepreneurs affected their likelihood of gaining funding.
Investors become wary when entrepreneurs place too much emphasis on breaking the mold.
The authors found that companies using the right blend of impression management techniques could significantly increase their prospects of raising money. Specifically, entrepreneurs that employed an optimal impression management approach had a 20 percent higher chance, on average, of being invited to present their full business plan to the angel investors group than companies whose strategies were slightly below this threshold. Similarly, firms that used the right tactics to make a positive first impression were 26 times as likely to secure funding as their counterparts that used a less-than-optimal approach.
What is the best strategic blend to seduce early-stage investors? Moderation comes first, the authors found: It’s counterproductive for entrepreneurs to take either an excessively bullish or an extremely conservative stance toward their company’s prospects.
Investors do attach some importance to the uniqueness of a business concept—an innovative model based on novel distribution systems or cutting-edge marketing strategies can help up-and-coming firms break out of the pack. But investors become wary when entrepreneurs place too much emphasis on breaking the mold. They may interpret a too-innovative business plan as one fraught with challenges in developing and commercializing products, finding a new customer base, and overcoming unforeseen risks. (It should be noted, however, that investors still prize a firm’s actual innovativeness, measured as the number of patents pending.)
“In the minds of potential investors, [an entrepreneur’s conformity to common societal values] might translate into an ability to appeal to and collaborate with a diverse group of stakeholders—a trait deemed to be of the utmost importance for the ultimate success of any new venture,” the authors write.
Furthermore, entrepreneurs that revealed some of their weaknesses received more support in their initial fund-raising. It could be that investors respect honesty, appreciate a realistic point of view, or are simply so accustomed to entrepreneurs focusing exclusively on their strengths that they view those who don’t take such a focus as inherently trustworthy. But this type of disclosure only worked up to a point; if entrepreneurs dwelled too much on their failings, investors inferred they lacked competence or confidence.
Young companies should also strike a balance when discussing more established organizations. Given the intense competition that nascent firms face, it might seem natural for them to bad-mouth the competition. But although blasting rivals may initially help entrepreneurs distinguish themselves, the authors found that it’s probably not worth the risk: Investors regard this type of boasting as arrogant and immature, perhaps reasoning that such entrepreneurs fail to grasp the volatile and cutthroat nature of what it means to be a pioneering company.
As for the firms in the study, after submitting their application, 21 percent were asked to present to the angel investors, and only 8 percent eventually received funding. As the authors warn, “It has been said that an entrepreneur who claims to have no competition is an entrepreneur who does not understand his market.”
Source: How Entrepreneurs Seduce Business Angels: An Impression Management Approach, by Annaleena Parhankangas (University of Illinois at Chicago) and Michael Ehrlich (New Jersey Institute of Technology), Journal of Business Venturing, Jul. 2014, vol. 29, no. 4