Whether, When, and How To Deliver Bad News to Investors
What If You Can't Get Around The Fact That You've Really Blown It?
I’ve had a couple of recent conversations with tech founders that have gone something like this…
Founder: “We’ve got a great story, and the metrics are looking good. But…”
Me: “Yeah? . . . But what?”
Founder: “But if the investor asks about [something the investor will definitely ask about] we’re screwed because then she might find out [Romanov-sized family of skeletons in the closet].”
Many, many times, when this conversation comes up, it’s not nearly as bad as I thought it would be. I get a temporary tightening in the diaphragm as the entrepreneur’s body language makes it seem like he’s been murdering puppies, only to find that it’s really something minor:
Oh, this is your first real job, and you’re worried about your lack of experience? Big deal. You’re smart and hardworking, and you’ve got $1.2M in ARR. No one will care whether you learned “management” as a summer camp cabin leader.
Oh, you haven’t done any marketing, and you don’t have a “following,” “audience,” or “fans.” But you do have a few customers, and they are paying and staying with your product. Then that’s ok; you got the better end of that stick.
Oh, you can’t find the right talent because you’re building a consumer app in Lincoln, Nebraska, way outside the tech bubbles. Could be worse. You could be building the app inside Silicon Valley and competing for talent with Google and Facebook.
But sometimes, what comes to light is a serious flub. Sometimes the entrepreneur has really blown it, and sometimes, it’s his fault. Sometimes the screw-up has real, substantive implications for the business’s future.
Then what are you supposed to do? How do you know whether, when, and how to deliver bad news to the people you’re asking for money?
Whether
This is the easiest question to answer and the hardest to implement. If you want to know whether to tell an investor about the events of your startup’s sordid past, then all you have to do is ask yourself whether - if you were in her position - you would need to know those facts to make a good decision.
That’s it. Just the Golden Rule applied to startup funding. Some details really don’t matter, and you can safely skip them. But this is not a situation where “if in doubt, leave it out” is good advice. You’re brain’s internal bias is going to lean toward covering up unsavory but important facts, so try to make an effort to step inside the investor’s shoes, adopt her perspective, and decide what to share based on her self-interest.
The most important reasons to follow this rule are ethical, but there are important practical reasons as well, which I’ll cover in a bit.
When
You should share the bad news early in your pitch, but it shouldn’t be the first thing out of your mouth.
To understand why, imagine you’re back in the dating scene (for some of us, this requires a lot of imagination, but work with me here).
Feel free to mentally modify the below storyline however you please:
Imagine you’re having your first coffee with a really nice (and nice-looking) girl you exchanged numbers with at a mixer the other day. She’s funny, you share interests, she doesn’t appear to have a drug problem - like your last girlfriend - and your personalities really click.
Oh…and she has three kids. Or she just got out of prison. Or her dad is in the mafia.
Woah!
Ok, there’s no way that info can just drop. It’s going to change the dynamics. But how exactly?
It depends.
If that was the first thing you knew about her, you might not be on the date. She might have been disqualified in single-round elimination, but then you would have missed out on meeting such a wonderful person.
On the other hand, if you get through this date and the next six dates (another coffee, three nice dinners, a long stroll through the park, and a funny afternoon learning to rollerskate) without learning about her past life and its current implications, then you’re almost certain to feel deceived and betrayed.
In fact, the more you like her, the more betrayed you’re likely to feel.
What gives?
What’s going on is that there is an unspoken expectation in dating and venture capital that anything that might affect the other party’s willingness to deepen a relationship should be disclosed before the target depth is reached. Voluntarily disclosed. Not found out through tricky questions, verbal slip-ups, or mutual friends.
Not mentioning her brief stay in the penitentiary might be fine for the first coffee, but by the end of the second, a lack of disclosure starts to seem impolite. If you get all the way to the altar before she discloses her relationship to the ringbearer and flower girls, things won’t go well.
The reason you don’t have to blurt out the bad news in your first sentence is that it’s not important just yet. Your first job is to pique the investor’s interest in your deal - to tell her something amazing about your company that makes her dream about the possibility of a long and profitable partnership. If that opening step doesn’t work, then it doesn’t really matter what good or bad news you deliver afterwards. She wasn’t that into you anyhow.
If, however, you do manage to secure the investor’s interest in the opening of your pitch, then I hate to be the one to break it to you, but now’s the time to spill the beans. If you wait much longer, it will sound more and more like a cover-up. In the worst-case scenario, the investor will ask an obvious question which forces you to disclose, and the investor will wonder from that point forward whether you would have told her without her prying it out of you. You might lose her trust forever.
How
It's important how you spill the beans, though. Here’s the methodology for delivering genuinely bad news—news that could scuttle your deal.
Tell the Truth
Depending on how bad the bad news is, it might blow up your deal. It might be so genuinely awful that you can’t raise any more money. Even if you suspect this might be the case, you should still tell the truth. This is just the right thing to do. It’s right by the investor - if you were in her shoes, you’d want to know all the ugly details before you stroked a check.
But it’s also right by you…in the long run. You might be able to get away with this little “omission,” but from the investor’s standpoint, it amounts to a lie. And chances are, it will come back and bite you, either later in the company’s life or later in your career. Because, you see, the willingness to sacrifice someone else’s interests (even an investor’s) to advance your own operates globally. If you do it once, you’re more likely to do it again…and again and again. One or more of these little dishonesties is almost sure to surface later on - probably at a highly inopportune moment.
Trust also operates globally. If an investor walks out of your deal because of details you willingly disclosed, you’ve given her reason to trust you, making her more likely to do business with you in your next deal. She might still take your calls, she might still make connections, and she won’t poison your deal with other investors. On the other hand, if she storms out of the deal feeling deceived and betrayed, you’ll probably never do business with her again. And she might plant the seeds of your destruction with her entire network of investor friends.
Even at a brutally pragmatic level, assuming no backbone or moral compass, it seldom makes long-term sense to lie about or cover up important details. Sure, a single pitch or even a single funding round might go better if you’re sneaky and deceptive, but once you’ve developed a reputation for sneakiness and deception, every other funding round at your current company and your next one will be harder.
And chances are, the news you deliver isn’t as bad as you think it is. The investor might not really care. In this case, you’ll gain trust points and dodge a bullet at the same time. So tell the truth even if it hurts, but it will probably hurt a lot less than you think it will.
Take Accountability
Now that you’ve aired your dirty laundry, you need to establish a scapegoat, and you don’t have to look far to find one: You.
You’re the boss, you made the dumb decision to switch databases, you hired the toxic, inept CTO, you frittered away your Seed round playing startup.
But you don’t have to make a big drama about it. No one wants to see a grown man cry. Everyone already knows it was your fault, so just state the facts, acknowledge personal accountability, and move on.
The biggest danger at this stage of disclosure is determining the middle ground between “It was all my fault.” and a line-item description of what went wrong. Too much detail, and you’ll sound like you’re making excuses. Too little, and you’ll sound like you still don’t know what happened and are just trying to band-aid over the chest wound. You should aim for a 10,000-foot view - low enough to see a few particulars of what went wrong but too high to take much time describing them.
Move Along
I’ve probably taken more time explaining the first two steps than you should take in covering them. In a typical first pitch to an investor, the first minute or two should still be spent highlighting what’s amazing, intriguing, and interesting about your deal, and if you need to drag a skeleton or two out of the closet immediately afterwards, the process shouldn’t take more than a couple more minutes.
The point of delivering the bad news early is to clear the air for the good news. The good news is that even though you’ve had some stumbles, the current state of affairs is full of promise. You’ve dealt with the shadows from your past, and now you can step into the future unencumbered.
This is probably the biggest disconnect between you and the investor. For you, all the $#!+ you went through is still fresh in your memory. You might still be digging it out of the soles of your shoes. But for the investor, what’s past is dried up like a crusty old cow patty, and as long as she doesn’t have to step in it, she’s not going to dwell on it.
Did Seed investors (your mom and uncle) have to take a down round? Not her problem as long as the current cap table is acceptable.
Did you lose six months of sleep and invest your life savings in underperforming Google ads? Good to know you’re not going to quit. Oh, and how’s your current pipeline?
Did you have to fire your best friend or hire over his head to finally build a product that actually worked? Well, does the product work now?
If the current state of the union is strong, then most investors don’t give a flying fart about what’s gone on before - all the angst, wasted opportunities, busted relationships, and permanently-seared retinas staring at code that just wouldn’t run. It seems insensitive. Even a little heartless. But it’s actually exactly what you want.
You want investors facing forward, excited about the present and the future - which you will use the rest of the time pitching them. You’ve delivered the bad news, taken the blame, cleaned the slate and set up for round two - all in two minutes.
No one is perfect. No company is perfect. We all have a little baggage. Some of us have a lot. But you’ll probably be surprised how little of that baggage the typical investor cares about. It just doesn’t affect her that much. As long as you’ve been honest that it’s there, you don’t have to carry it through your whole pitch.