How to Make Investors Sit Up and Notice #2 - Be in the 1%
The world is crowded with capable entrepreneurs. In fact, I'll go so far as to say that virtually everyone reading this blog is a capable entrepreneur. If you weren't capable and driven and creative and brilliant and a host of other attributes, and if you didn't have a great innovative idea, you wouldn't have even tried the entrepreneurial game. Because it's simply too difficult for the average person.
But here's the rub . . .
Being capable (and having all those other attributes I listed above) won't make you stand out in a crowd. It puts you IN the crowd and that's a great thing in and of itself; but you won't STAND OUT in that crowd unless you have something else -- at least in the eyes of the investor community.
That something else has to do with contrarianism, in a surprising way. Here's what I mean:
You need to be different in some way in order to stand out. And you want to stand out for the RIGHT reasons -- things that make you memorable in a positive way. When it comes to investors you might be surprised at what that quality is that will make you stand out in a positive and memorable way.
Let me introduce this with a question:
Would you say entrepreneurs are more, or less, cautious than the average person?
While you think about that question let me pose one more:
Do highly successful entrepreneurs fear failure or "not trying" most?
Adam Grant, a professor at the Wharton School of Business, in his book "Originals," has some interesting thoughts on these questions -- and they're not just thoughts, they're the product of interviews with highly successful entrepreneurs like Mark Cuban, Elon Musk and Google Co-Founder Larry Page. It turns out that highly successful entrepreneurs are actually more cautious than the average person and fear the regret of not trying more than they do failing.
In other words, the fear of failure was not as great as the fear of what would happen (regret) if they didn't try.
"This tracks with what we know from psychology about how people experience regret," says Grant. "In the moment it often feels like we're going to embarrass ourselves if we fail, but in the long run, our biggest regrets are not our actions, they're our inactions — they're the moments where we didn't take a chance or take a risk.
I was initially. But then I delved into the particular kind of caution that top-producing entrepreneurs employ and it all made sense. You see, it's not caution like avoiding a hot burner on the stovetop that we're talking about here. It's caution in the form of an almost obsessive level of preparation that sets highly successful entrepreneurs apart from everyone else. And that level of preparation answers our second question -- the best of the best fear, not trying, more than they fear failing. Their incredible level of attention to detail and preparation obliterates fear of failure. If you're passionate and driven and impeccably prepared, what you fear most is not trying -- not getting 100% into the game and going for it.
So if you accept this as true then consider how investors assess risk. In short, most investors want to mitigate downside loss and maximize upside potential -- that's the Holy Grail of investing. But, we all know this is the ideal, not the norm. For those who make investments for a living (in other words professional and institutional investors) this is played out in a game of averages because they make many investments annually. So, your opportunity represents one of many they might accept and they're assessing your opportunity as part of an overall portfolio plan for managing risk and maximizing returns.
How do they do this risk assessment?
One common way is the Sharpe Ratio. The Sharpe Ratio is the standard way of measuring risk in a portfolio, designed by Nobel Laureate William F. Sharpe. It works like this:
Sharpe Ratio = Total portfolio returns (minus current risk-free returns) / standard deviation.
In other words, an excellent portfolio is considered to be a Sharpe Ratio of 3 or more, where the total portfolio returns are about three times greater than the standard deviation. Any ratio larger than 1 is considered good.
The standard deviation is the proxy for the risk in the portfolio. This is because, if investment returns don't vary very much in the portfolio, the assumption is that the portfolio is less likely to unintentionally lose much in the worst case. Here is how Investopedia explains Sharpe Ratios:
"Usually, any Sharpe ratio greater than 1 is considered acceptable to good by investors. A ratio higher than 2 is rated as very good, and a ratio of 3 or higher is considered excellent. The basic purpose of the Sharpe ratio is to allow an investor to analyze how much greater a return he or she is obtaining in relation to the level of additional risk taken to generate that return."
Now you know more about investor risk-assessment than 99% of your peers. But here's how to use that knowledge to your advantage:
If you can demonstrate that your particular opportunity, compared to other similar opportunities the investor may be considering, will generate a particularly high Sharpe Ratio, this will shift the entire portfolio to a higher Sharpe Ratio. In other words, your opportunity helps make the entire portfolio score higher.
How do you do that?
You demonstrate potentially high returns and minimizes chances of loss. But here's the secret:
Everyone else will be focused on high returns. Your job is to be different -- to stand out from the crowd -- focus on lower downside risk. What will make your investor sit up and notice is the same thing that distinguishes any extraordinary entrepreneur - an almost obsessive concern with mitigating risk. This will make you Super Business Man (or Woman).
In future posts, we're going to discuss how to do this in more detail. For now, here are four very useful ways to demonstrate this to an investor:
1) Show how your management team inherently responds quickly and effectively to changing circumstances;
2) Select a "beachhead market" that is systematically chosen for ease of access, ease of sale, compelling need, and most effective leverage into adjacent markets (see The Disciplined Entrepreneur by Bill Aulet);
3) Show the investor you have a deep and bottom-up understanding of your customer, including buying process and buying motivations; and
4) Demonstrate that you've employed deal structures that are unlikely to lose the principal invested, while retaining the likelihood of stellar returns.
While everyone else is talking about high potential returns, you'll stand out from the crowd by discussing risk mitigation -- and the high returns will be a given. By the way, in case you haven't thought about it, showing how diligently you've prepared to mitigate downside risk is a very good way to engender trust with your investor -- because you're thinking the way he or she thinks.
Key Takeaway: Risk and reward are natural parts of business and everyone knows that, yet investors want to know that you've taken pains to mitigate downside risk -- what I call "looking Sharpe." Everyone else will be pitching the upside potential. Stand out by assuming the upside and pitching what you've done and will do to mitigate the downside risk. You accomplish this through an impeccable almost obsessive attention to risk assessment and abatement. Show them you understand the downside and have taken every step possible to mitigate it and you'll wow them by being different.
If you have not enjoyed How to Make Investors Notice #1, here you go!