I wanted to shed some light on why so many entrepreneurs find it difficult to “sell” their ideas or venture – especially in terms of obtaining funding.
Two words: information asymmetry.
Almost all business interactions involve information asymmetry: individuals on one side of the bargaining table have much better information than those on the other side.
In many instances, information asymmetry can work in your favour – if you have much better information, this can help you negotiate a better deal, get a better price etc.
When it comes to seeking funding, however, information asymmetry can be the “kiss of death”.
Information asymmetry often leads to what is known as ‘adverse selection’. If you’ve ever bought a “lemon” (i.e. a dud car) from a private seller, you’d know exactly what I mean by adverse selection.
When buying a car from a private seller, in almost all cases, the seller has the upper hand. S/he knows what is good about the car – and also what is bad. Unless you’re a skilled mechanic and have ample time to examine the car, you are largely at the mercy of the vendor to tell you all the pertinent information necessary to make an informed decision.
In a sense, when you deal with potential investors, they are in the same position as the car buyer. You, as the entrepreneur, know a lot more about your business, its future prospects and your capabilities, skills and experience, than they do.
Investors are very aware of this and, to protect themselves against being stuck with a lemon, impose high investment barriers.
When you deal with potential investors, it helps to understand their questions and information requests in the context of this information asymmetry. Investors want to rectify the imbalance, in the same way as potential car buyers will often request a test drive so they can drive the car to a mechanic to have it formally inspected.
Business plans, for example, can be seen as a “pro forma” disclosure document which provides an efficient mechanism for information exchange, bringing investors up-to-speed about your business and the market/environment in which it will be operating.
Viewed in this manner, much of what investors will ask of you is quite reasonable. Investors don’t know what you know. Prudent investors – like car purchasers – won’t assume the “seller” has told them all there is to know.
To increase your chances of securing funding, ask yourself what you would want to know about you and your business if, like the car buyer, you were a little suspicious of the vendor’s intentions.