Money with strings hangs on

Venture capitalists and angel investors (wealthy individuals) like to give money to entrepreneurs in stages, which they call tranches.

An entrepreneur, excited to hear their investor has committed $1 million to commercialise their business, finds that it comes with strings. Each parcel of money is contingent on reaching certain measures of performance.

This is a sensitive arrangement. It can be used for excellent reasons, or it can be used for all the wrong reasons.

An investor in life sciences explained recently the idea: he might put in $200,000 to take some cancer research from the laboratory bench to a rat test. If it works in rats, he might invest another $300,000 to test the drug in dogs. Good results? Let’s invest more to do a safety test in humans. And so it progresses.

In the field of drug development, it can take eight or nine years to get from lab bench to market. If the drug fails at any stage, the investor and entrepreneur must then decide whether it is worth repeating that stage, or simply cutting their losses. Difficult.

I’ve heard some sad cases over the years about investments gone wrong. In one case, the entrepreneur told me the investor drip-fed him such small amounts that he couldn’t keep the business going. When the company collapsed, the investors bought the intellectual property from the liquidators for a song. It was a bitter lesson. Certainly, be very clear about what each payment and milestone is, but the lesson from that mistake is probably about misplaced trust. Not all investors are angels.

However, investing in tranches has benefits for both sides: investors don’t tie up their money too soon. The clock is ticking to deliver a return as soon as the money leaves the investor’s account and hits the entrepreneur’s.

For entrepreneurs, too much money can be as problematic as too little. It can lead to waste and pressure to deploy it before the company is ready. One example is putting on too many sales staff before there is a big enough market to keep them busy.

For both sides, staged investment allows time to develop openness, good communication and trust before there is too much on the line.

And those are the magic ingredients that turn ideas and hard work into gold.

BRW

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