1 – Investor Incentives and Motivations

Ideally an entrepreneur would maintain complete control over the growth of their enterprise from beginning to end, never requiring outside investors to fund it. It is possible to self-finance a new enterprise. Serial entrepreneurs often have sufficient funds from a previous venture to fund a new one.  An entrepreneur may have accumulated savings they can use to get their enterprise started. And, if a minimally viable, profitable enterprise can get off the ground quickly enough, retained earnings may be sufficient to fund growth. And while banks do not generally fund enterprises they do help finance them with loans against receivables and other assets as collateral that can help.

Yet beyond self-financing, many enterprises require investor funding at various stages of their growth before they become viable and profitable. When an entrepreneur involves investors in their business some control over the affairs of the enterprise is inevitably lost and potential conflicts can arise between them when both party’s incentives and motivations are not aligned. The motivation of the entrepreneur is productive achievement in pursuit of their vision. Money is an incentive, but primarily viewed by the entrepreneur as a tool to achieve that goal. Many investors, however, are primarily motivated by making money with the pursuit by the entrepreneur of their vision merely a means of achieving it. Depending on the type of investor and at what stage of the business they become involved investor’s incentives and motivations can be quite different from those of the entrepreneurs. Let’s discuss these individually by investor type and how they can come into conflict and how they can be aligned.

“The businessman carries scientific discoveries from the laboratory of the inventor to industrial plants, and transforms them into material products that fill men’s physical needs and expand the comfort of men’s existence.”

Ayn Rand

The first investor in any business is the entrepreneur them self. Their investment may be in the form of “sweat equity”, with the entrepreneur investing their time and energy to define their vision, create a business plan, and perhaps develop a product prototype. Beyond this, entrepreneurs may also invest a minimal amount of money to fund initial efforts before seeking outside investor funding to grow their business before it becomes self-sustaining. This may even be a requirement from some investors as they often demand entrepreneurs have “skin in the game” before they will consider risking their own capital on a new venture.  At this stage, with the entrepreneur being the initial and sole investor, their incentives and motivations should be in alignment with pursuing their vision. The only potential conflict that can arise is when the entrepreneur places monetary incentives ahead of their motivation to produce something of value. Entrepreneurs that pursue money rather than the means of producing it through productive achievement rarely if ever succeed at producing either.

“Money is only a tool.  It will take you where you wish, but it will not replace you as the driver.”

Ayn Rand

An entrepreneur may solicit friends and family to become investors in their enterprise. While these investors may have an incentive for financial gain, their primary motivation is usually tied to the entrepreneur’s success, defined by their personal relationship with them. As friends and family they respect and admire the entrepreneur’s effort to create an enterprise and want to help them succeed.  Thus they usually place more value on their relationship with the entrepreneur than they do the enterprise itself or the products created. While the support of family and friends is always welcome, when money is involved this can prove problematic if the enterprise does not succeed. Outside investors may feel disappointed if the enterprise fails, but when family and friends are the investors it is more than disappointment that may result.  Relationships can be jeopardized and acrimony may prevail when family and friends lose their money in a failed venture. This potential combined financial and personal loss makes family and friend investment doubly problematic for the entrepreneur unless everyone acknowledges the risks involved are both personal and financial. As the saying goes amongst investors “no tears, no blame.”

“…friendship, respect, admiration are the emotional response of one man to the virtues of another.”

Ayn Rand

Employee stock options are a valuable but limited source of investor funding. Their primary value to the entrepreneur is not financial but motivational. Motivating employees to view the enterprise as something they are personally invested in is the greater value. Most individuals are careful with their own money, but far less so with others, especially company money. Employees, as shareholders in a company and thus part owners, will view the company’s money as partly theirs and thus be more careful on how they and others in the company spend it. With the enterprise viewed as the vehicle for achieving their personal success (Employer/Employee Relationship) they view it as something to be valued and protected not exploited.

“Nobody spends somebody else’s money as carefully as he spends his own. Nobody uses somebody else’s resources as carefully as he uses his own.”

Milton Friedman

Often early in the funding of a new enterprise angel venture capitalists provide “seed money” and “startup capital” to develop a product and ideally prove the market viability of the enterprise, even if only a minimally viable one. But beyond the value of this funding, the real value an angel venture capitalist can provide is mentorship to the entrepreneur.  Angel venture capitalists are most often individuals who have been successful entrepreneurs themselves. They are true examples of successful capitalists who have proven the value of Capitalism.Their mentorship guiding the decisions the entrepreneur makes daily can help them move ahead, avoid pitfalls and prove more valuable than the investment they make in the enterprise.  They do seek a financial gain as a measure of success and as an incentive for investing in the enterprise. But they are equally impassioned as the entrepreneur in the pursuit of the vision to produce a product of value.  They live vicariously, motivated by mentoring and supporting the efforts of the entrepreneur to succeed. An entrepreneur that recognizes and embraces this support doubles the value an angel venture capitalist brings to the enterprise.

“Capitalism demands the best of every man—his rationality—and rewards him accordingly.”

Ayn Rand

Entrepreneurs often involve venture capitalists and venture capital firms when large investments are required for an enterprise to sustain growth or expand. They usually but not always become involved later in an enterprise’s development when it has established a minimally viable business with proven validity in the marketing and sales of its products. But the incentives and motivations of venture capitalist are often quite different from those of the entrepreneur. Venture capitalists generally prioritize their incentive to make substantial financial gains on their investments over the motivations of the entrepreneur to pursue their vision. When either party fails to recognize this difference in priorities conflict can arise. Venture capitalists need to recognize that it is not just financial incentives that motivate an entrepreneur in pursuit of their vision to produce something of value.  Enterprises have failed to create products of value when the motivations of the entrepreneur have been subordinated to the financial incentives of the venture capitalists.  Similarly the entrepreneur needs to recognize no venture capitalist will finance an entrepreneur’s vision if it doesn’t produce products that generate substantial revenues and profits. Entrepreneurs have been pushed out when they fail to deliver products of value sufficient to meet the financial incentive goals of venture capitalist. Keeping these priorities in alignment is an ongoing effort on the part of both the venture capitalist and the entrepreneur to assure the ultimate success of the enterprise.

“ ….nature does not guarantee man’s success, neither on a farm nor in a factory. If the venture fails, it means that the goods have been consumed without a productive return, so the investor loses his money; if the venture succeeds, the producer pays the interest out of the new goods, the profits, which the investment enabled him to make.”

Ayn Rand

Last and probably the largest form of investor funding occurs through an initial public offering (IPO) of a company’s shares. The company’s shares are no longer privately owned but sold to the public and traded on stock exchanges. It is both a means of raising capital as well as providing a way for early investors to sell their shares, “cash out”. This is the objective of venture capital investors who use the cash to invest in other promising ventures. However, the incentives of the public investing in a publically traded company are almost exclusively financial. The motivations of the entrepreneur toward productive achievement are often subordinated to these financial goals, but not necessarily so. Apple became a publicly traded company in 1980.  But by 1996 was on the brink of bankruptcy largely because the CEO, John Scully, had no creative vision for the company.  With the return of Steve Jobs as CE0, his vison and creative genius inspired everyone within Apple to produce innovative products of high value and Apple recovered dramatically.  As of 2022 Apple has the highest capital valuation of any company in history at $3trillion, demonstrating that the passion of an entrepreneur as CEO in pursuit of their vision is not only possible but essential to sustain long term growth and profitability.

 “I view Microsoft as a platform for me to be able to pursue my own passions,”

CEO of Microsoft, Satya Nadella

An Objectivist entrepreneur would ideally never require outside investors, whose incentives and motivations may not be alignment with theirs. It is far better for an Objectivist entrepreneur to be in full control of the execution of their vision to create a product of value without the risk of their efforts being undermined by investors who may not be able to see or share that same vision. However, this is often not possible and varying incentives and motivations have to be negotiated to mutual agreement between all parties. For the entrepreneur money is primarily a means to an end.  For investors money often is the end. But through negotiation not compromise (Compromise vs. Negotiation) a mutually beneficial relationship can evolve that satisfactorily meets the incentives and motivations of all parties leading to success.  More importantly, an Objectivist entrepreneur who produces something of sufficient value does not need to find investors, investors will find them. As the old yarn proclaims, “Build a better mouse trap and the world will beat a path to your door.”

“Contrary to the fanatical belief of its advocates, compromise [on basic principles] does not satisfy, but dissatisfies everybody; it does not lead to general fulfillment, but to general frustration.”

Ayn Rand

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