Buffett on The Investor/Entrepreneur Dance

What is the right role for an investor with a portfolio company? When VC’s make an investment in a company, the founder/entrepreneur is often concerned about what impact his/her new partner will have on issues like control, degrees of freedom to operate, core decision making and future employment. There are many stories of VC’s swinging into companies, taking control of most core decision making and eventually forcing management out. However, there are many more (often untold) stories where this is not the case. In fact, I would argue that we would not have a venture industry if this were the norm.

At the two ends of the VC/Entrepreneur relational spectrum are a) the passive investor and b) the hyper-involved investor. Neither works well or benefits the entrepreneur. In the passive situation, the investor provides money and that is it…no advice, no networks, no assistance in recruiting, just money. In the hyper-involved case, the investor pushes to have a say in many day-to-day decisions, often second guessing the CEO and creating significant tension between investors and managers.

Experienced VC’s realize that there is a much more practical middle ground. It is based upon the simple tenant that it is the CEO’s company to run and it is the VC’s job to provide him/her with the extra resources, connections and advice needed to achieve his or her goals. My partner, Ed, has a great framework for this, which he describes as Principle-based management. The investor needs to be clear about expectations and key constraints (key milestones, certain end results, basic principles) up front. Once agreed to by all parties, it is the CEO’s show. By being clear in setting these up, it is easy to monitor progress without the need to be continually second guessing each other.

We have another saying: when the VC is making the core operational decisions, it is time to take a write-off. There is no way a VC will be more knowledgeable about the specifics of a given company, industry dynamics or customer interactions than the entrepreneur. Furthermore, we rarely make money when we end up usurping the CEO’s role. We do well when we pick the right partner to run an investment.

The other side of the coin is that the entrepreneur needs to have similar respect for the investor. While an investor might not be as experienced as the entrepreneur in that one business, he/she is much more experienced in the process of building businesses and in risk management. VC’s have seen a lot of successful and failed models. The entrepreneur can either learn from this experience or learn by making the mistakes themselves. Some feel a need to be self-reliant and this is big mistake. It is surprising how similar different situations are across industries and companies. It is, of course, most valuable if the VC is familiar with the company’s industry and has relevant experience in it as well as connections. 

Warren Buffett recently spoke to a class of students at Wharton. During the Q&A, he had the following to say about his approach to management. In short, it is his job to find those entrepreneurs that are capable managers and let them do their job. His job is to understand their business and to provide both support and encouragement. Here is his quote:

“So with respect to managers/entrepreneurs, I look them in the eye and ask, do they love the money or love the business?  If they love the business, then if they are NOT jumping out of bed (to go to work) it’s my fault.  So I have to give them two things, which are ability to paint their own painting, and applause.  The applause will come from me, and I think they see it as intelligent applause, because I know their business.  If that works for me, why won’t it work for other people.  Most people I buy businesses from are independently wealthy.  I need them to look me in the eye and say whether they love the money or the business.  I have zero contracts – the manager needs to have a better answer to say to his wife when he gets out of bed at 630am and she says “why do you get up just to send money to Omaha.”  I want a rational compensation scheme – not options on Berkshire stock [which is not driven by their performance].

I have caddied for Tiger Woods.  I try to find the Tiger Woodses of their industry. 

The most important things about work are to do something you love, and hire/work with people you like.  It just doesn’t work if you don’t admire or trust them.  I do not hire people I would not want as friends or as neighbors.  I work with people who make my life easier.  You can’t work with people who make your stomach grind.”