Relationship “contracts” need to be based on our inability to predict the future.

April 8th, 2009 Comments

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Continuing to think about early stage investment structures to “enable flexibility, create more intermediate decisions and tie payments to actions, not to negotiations” in a world where we are increasingly “unaware of the long-term implications of our short-term decisions”…

Originally posted as a comment by Brooks Jordan in response to Venture capital is not broken. But it could use an alternate incentive structure.:

… I love your articulation of the fundamental problem (which absolutely exists):

“. . . how can investors and consultants help entrepreneurs start businesses and get fairly compensated for the value they create?”

Your third goal also jumps out at me:

“Create structures that enable flexibility, create more intermediate decisions and tie payments to actions, not to negotiations.”

And your proposed solutions have got me really thinking about what it would take to create a contract to support these goals.

You’ve hit on such an important issue. Starting-up a business is inherently uncertain, but the potential value is the natural counter-balance, so how do we share the risk and rewards of the germination phase given different types and amounts of investment?

If we had a new type of contract, as you’re suggesting, to allow a consultant or freelancer to “invest” in the company with services as well as allow others to make small seed investments in such a way that they could be compensated as the business matured and revealed itself, that allowed them to ante up or cash out or trade that value horizontally (other investors at their “level”) or vertically (with angel or VC investments), then it would allow for a lot of tinkering and innovation that’s not happening now.

I want it!

There must be some kind of cash/debt/equity structure, some of which I’m sure is contained in your post, that can make it a reality.

Perhaps it’s time to refresh my previous thoughts on creating cash + equity + debt structures for entrepreneurs, investors and consultants by focusing on the goals rather the (admittedly overly complex) mechanisms.

Relationship “contracts” need to be based on our inability to predict the future; our current legal structures and contracts were based on a world where we fooled ourselves about the quality of our predictions.

Financial structures need rebooting; legal structures need hacking; tomorrow’s world can’t look like today’s; in all of these cases, change is good.

Returning to the false reality of the past invites disaster; believing the “doom and gloom” predictions of the future stifles innovation and dampens our near- and long-term future; our actions today will shape the models, structures and incentives of the future. Let’s pay very close attention to what we’re creating.

SIMILAR THOUGHTS

Amar

Taylor - I have tried what you suggest re: offering a fraction of the payoff to collaborators instead of boatloads of upfront cash with mixed success. As with all such investment offers, I found that there's much more acceptance at later stages of a venture, e.g. a concept has been proven, business plan has been vetted, etc., than at an early, formative stage.

For instance, one consultant wanted to help me evaluate a number of new market opportunities. I asked if they'd be willing to give a big initial discount in exchange for a payoff if any of the opportunities took off. They balked.

I offered another consultant - this one, more technical in nature - a percentage of revenue for a fixed period of time in exchange for a significant discount on initial prototype development. I set it up such that we'd have to hit a certain volume for them to break even. This second consultant accepted -- possibly because the path towards growth was visible by the time I started working with them.

Some other channel partners have asked me for market exclusivity in exchange for initial help at low cost. Exclusivity is a big no-no, even at the cost of losing an important partner!

Taylor Davidson

Amar: but why do you find that difference between late stage and early, formative stage?

There's a couple issues here:
- Early stage businesses are as much about the people than the idea; thus if the consultant doesn't have a solid pre-existing relationship, it might be hard to commit time behind any business idea
- Information asymmetries make it pretty difficult for any consultant to understand the business idea and prospective market as much as its creator, making it difficult to assess risk and reward in the same way

What you're really alluding to, though, is that cultural values and expectations play a large role in framing decisions and that different systems change at slower rates; legal, political, cultural, business, technology...

It's human nature to react to change by resisting and attempting to return to the past, but the real opportunity (and need) is to look for new structures instead of attempting to recreate old, broken, misunderstood systems.

Amar

Taylor - I should have mentioned earlier that I had worked with the first consultant - who didn't agree on my proposal - before. So I had a solid, pre-existing relationship and information asymmetry wasn't as big of an issue IMO, except perhaps in the sense that they may not know how decisions are made at my firm and where a specific project fits into the big picture. It is a small firm and maybe the risk wasn't for them, especially after having been burnt by some startups.

Taylor Davidson

Still, an individual case is still just an individual case :)

Aaron@iPadApp

Wow, I finally see how disruptions in finance, legal etc can be leveraged on to create new forms of startup investment ventures. Thanks for clearing my perspective!