A new business requires resources such as funds for R&D, equipment, marketing, and inventory. These funds are obtained by attracting stakeholders. Financial stakeholders are most at risk – these include banks, bond holders, investors, and venture capital firms. However, employees, customers, and suppliers of a business also are at risk. Employees may not receive some of their pay if the business fails, and they may have given up lucrative positions to which they no longer can return. Customers may find that they are stuck with a non-supported product, and suppliers may lose the opportunity to recoup their development costs or to receive their accounts receivable. Because of the risk of failure, attracting stakeholders is more difficult for a new venture than for an established, successful company.
Minimizing Downside Exposure
One way to make a new venture more attractive to potential stakeholders is to minimize their downside exposure to the fullest extent possible. For example, non-transferable R&D costs can be reduced by using off-the-shelf technology wherever possible. Investment in capital equipment can be made somewhat reversible by using more general machines that can be used for other purposes, thereby enhancing their liquidation value. The initial marketing expenditures can be reduced by marketing to people who are in a position to influence the opinions of many other decisions makers, thus reducing promotion cost. Employee risk can be reduced by using standard tools of the trade so that they easily can be out-placed, and by choosing a location that has many opportunities for the employees should they need to find another job. Customer risk can be reduced by designing a product to use standard components and to be compatible with other products. Taking such measures to reduce stakeholder risk may increase variable costs and compromise the product – this is a tradeoff that must be considered when making such decisions.
Finding Risk-Tolerant Stakeholders
Stakeholders must be found who are willing and able to accept the downside risk. Such stakeholders tend to be diversified, have experience with start-ups, have excess capacity, and be risk-seeking. Diversified financiers are those who invest in multiple businesses. Diversified distributors are those who carry many other products. Diversified customers are those who use multiple suppliers on whom they can fall back if necessary. Those stakeholders who have experience with start-ups are more comfortable with the downside and better understand the potential rewards. Stakeholders with excess capacity incur less opportunity cost and therefore have less risk from participating in the start-up. A engineer who has time in the evening or a manufacturing firm that has upgraded its production capacity are examples of stakeholders with excess capacity. Finally, risk seekers who enjoy the uncertainty associated with start-ups are potentially good candidates for stakeholders; however, if a start-up portrays too strong of a risk-taking image, more conservative stakeholders will be scared away.
Selling Potential Stakeholders on the Venture
Once potential stakeholders are identified, they must be sold on the venture. To do this, the entrepreneur must have faith in the venture and show enthusiasm for it. A record of success helps, but the main thing is that he has honored past promises and has not abandoned a venture in mid-stream when it encountered difficulties. A common problem for start-ups is securing the commitment from stakeholders who are waiting for other stakeholders to sign on first, or “ham and egging”. The ideal way to do this is to convince each of the stakeholders simultaneously that the others have signed-on or are very close to signing on. An alternative method is to get a small commitment from one stakeholder and use that to get a small commitment from another and so forth. It helps to have a “bell cow” – someone who has the reputation of being a leader with foresight. When acquiring the commitment of stakeholders, one needs to have a schedule, know what the start-up needs, be able to anticipate and handle objections, and deal with withdrawals after sign-on. A schedule is important so that the entrepreneur can measure whether the stakeholders really have committed to the venture as evidenced by the intermediate milestones. The entrepreneur needs to understand the actual needs of the venture in order to negotiate for that and only that.
Potential stakeholders may voice objections and concerns before committing. Many of these can be dealt with by openly discussing issues such as the “fume date” (the date at which the venture is to run out of cash) and by presenting well-thought-out contingency plans.
Maintaining Stakeholder Commitment
There may be cases in which a stakeholder wants to back-out of a commitment. For example, a talented employee who signed-on to the venture may have a counter-offer to remain with his employer. The entrepreneur constantly must follow up with the stakeholders to prevent such problems and to deal with them when they occur.
Mark Van Osnabrugge and Robert J. Robinson, Angel Investing : Matching Startup Funds with Startup Companies – A Guide for Entrepreneurs, Individual Investors, and Venture Capitalists