Ode Chapter 5 — The Scorpion and the Entrepreneur

It was late at night during my first year after business school and I was on the phone with my friend and classmate, Mariam Naficy. I had helped Mariam and her co-founder with their financial model and business plan during school, and recently I had introduced her to the VC fund where I was working. My bosses were eager to invest.

It was 1999 and Mariam was launching Eve.com --- the first ever DTC beauty ecommerce business. She intended to focus on prestige brands like Estée Lauder, and she was on the verge of closing her first round. She had three VC offers on the table and needed to decide.

My fund was part of the DLJ Merchant Banking group, the LA office of which was famous for big, bold investments in consumer and retail. We often co-invested with Jerry Gallagher's fund and a successful Bay Area firm called Trinity Ventures. All three had invested together in iMotors --- my company --- and all three were also investors in a small, struggling beauty retail concept called Ulta. The connection to Ulta made Trinity and my fund particularly interested in Eve.com. Jerry had decided to pass.

The third suitor was an LA-based vehicle called Idealab, run by an entrepreneur-investor named Bill Gross. Idealab was an incubator and probably the largest ecommerce investor in the country, maybe the world. eToys.com was already massive, as were CitySearch.com and GoTo.com, which invented the pay-per-click model. Bill had made Mariam an offer for a few hundred thousand dollars in funding and some "in kind services" like accounting and marketing in exchange for equity --- and this offer would expire the next morning if she did not accept it. She was calling me that night to say she had decided to turn it down and go with Trinity instead, which was several million dollars (along with an office that Mariam could work out of on Sand Hill Road).

"Don't do it," I told her. "If you turn down Idealab, you'll regret it forever."

What I knew, and could not easily explain without betraying my employer, was this: one of the managing partners at my fund had discovered that Mariam preferred Trinity and had devised a plan to block her. As part of their joint investment in Ulta, my fund, Trinity and Jerry's fund had agreed that if any of the three wanted to invest in anything beauty-related, the other two had an effective right of veto. Mariam was about to turn down Idealab and find herself with nothing.

I couldn't let that happen, so I told her the truth.

Mariam says, "I still remember the call from you and my blood running cold as you told me. We had actually already accepted the Trinity offer and received the keys to the office suite. We were about to make a courtesy call to Bill the next day to turn him down. If you hadn't called us, I don't think Eve would have been born.  Business is a remarkably relational profession --- the friendships you have, and whether you have ethical people in your corner, really matter."

Mariam changed course and accepted the Idealab offer. Eve.com went on to generate \$10 million in sales, and the company sold for over \$110 million in cash two weeks before the dot-com bubble burst. She went on to build The Body Shop's first ecommerce site and then founded Minted, the online stationery and design marketplace. Today she is one of the most celebrated female entrepreneurs in Silicon Valley.

Ulta did pretty well too --- making up manifold for the losses those three VCs had incurred with iMotors.

Stanford Business School later wrote a case study about my moral conundrum, and I got to sit in the back of the room as students debated whether my possession of inside information and loyalty to my employer should have trumped my allegiance to a friend and my own conscience. It remains one of the more interesting two hours of my life.

I am telling this story because it was the moment my worldview of investors shifted --- and because everything that followed only confirmed what I learned that night.

At Stanford, we were taught that investors' incentives are aligned with those of entrepreneurs. The VCs who cycled through campus were the geniuses who had believed in Steve Jobs and Jeff Bezos and earned their fortunes by nurturing fragile ideas into world-changing companies. The message was clear: find the right investors and they will make you.

My friend Tevya --- one of the most successful haircare entrepreneurs I know --- used to open every session at Bumble and bumble University with the parable of the scorpion and the frog. Look it up if you don't know it, but the core idea is simple: a scorpion is a scorpion, even when it promises to behave otherwise. That is how I have come to think about professional investors. Not because they are bad people --- most are not --- but because their incentives make certain behaviors inevitable, regardless of their intentions.

The biggest misalignment is time. Investors are judged on compounded annual returns. An investment that doubles in two years produces a 41% CAGR --- heroic. The same investment taking ten years to double produces 7% --- a failure. The clock is always running, and it is always running faster for your investor than it is for you.

The second misalignment is diversification. A venture capitalist knows that most of their bets will fail. Their strategy depends on it --- they spread risk broadly, accepting many losses in the hope that one or two investments will generate returns large enough to cover everything else. The entrepreneur, by definition, has only one bet. There is no diversification for you.

Put those two forces together and you get a perverse incentive that is quietly ruinous for founders: investors want their failures to fail fast. They need to cut losses and concentrate attention on their winners. And so they push --- go big or go home, grow fast or get out. The entrepreneur, meanwhile, needs time. Time to test assumptions, to find the right customer, to pivot when the first plan turns out to be wrong. Anything that artificially shortens that runway lowers your probability of success.

iMotors had a real business. We had inventory, customers, a working model. But our investors had run out of patience and appetite, and a company that might have found its footing was pushed to go big or die --- and died. I have watched versions of that story play out many times since.

So what should you do instead?

Bootstrap for as long as you possibly can.

If your idea is worth pursuing, it is worth carving out time to pursue it before you need anyone else's money. Work on it nights and weekends if you have to. Your own behavior during that period will tell you more about your conviction than any amount of deliberation. If you find yourself making excuses not to work on it, that is information. If you cannot stop working on it, that is information too.

When you are ready to commit fully, raise from friends and family first. Make every penny last as long as possible. The goal is to get as far down the proof-of-concept curve as you can before you ever sit across a table from a professional investor. Every milestone you reach on your own increases your leverage and decreases your dependency.

When we launched Hairstory, we raised from a group of friends. There was already a product --- New Wash --- and already a base of sales, but also a team to pay and a business losing money. We acquired the assets, rebuilt the brand, relaunched the website and rewrote the business model. Eighteen months later we hit cash flow breakeven. At that point we controlled our own destiny. No one could force our hand.

That moment --- breakeven --- is the most important milestone an entrepreneur can achieve. Not a Series A. Not a valuation. Breakeven. It is the point at which you stop needing anyone's permission to keep going.

The venture capital culture has quietly convinced an entire generation of founders that the goal is to raise money, then raise more money --- Series A, B, C, onward through the alphabet --- with growth measured in funding rounds rather than in the fundamental truth of any business: does it generate cash? That model works for a small number of companies. It quietly destroys many more.

Businesses exist to generate cash. Everything else is a means to that end. Keep that truth in front of you, especially when someone with a large checkbook is telling you otherwise.

The scorpion cannot help what it is. But you can choose not to get in the boat.

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Mariam Naficy