Startups often wonder what went wrong when an investor turns them down. We have already discussed the numbers that attract the investor’s attention more. However, there are other important aspects that a startup either ignore or believe that can be manipulated to get more from the investor.
A successful investor probably receives dozens of requests from upcoming startups who are searching for funds and is capable of separating the chaff from the wheat of a startup’s arguments. Recently, we chanced upon this article from accountingtoday which explains how an investor is most likely to see through boastful and implausible explanations provided by companies. This article is more geared to big businesses but the learning from it are as much applicable to growing businesses. Below is a summary of the article:
Businesses tend to attribute their bad performances to extrinsic factors such as economy or supply price rise, while attributing their success to intrinsic factors such as cost control or management change. Self-serving attributions such as these, which typically blame outside factors for negative developments and claim that their own internal initiatives led to positive results, are a traditional part of corporate earnings reports and press releases. But that doesn’t mean investors generally believe them.
“…investors neither completely ignore seemingly self-serving attributions nor accept them at face value, but use industry- and firm-specific information to assess their plausibility,”
“Further analyses reveal that investors’ use of industry peer performance and earnings commonality information appears justified because investors’ perceptions are consistent with the association between the plausibility measures and the ex post actual persistence of earnings surprises.”
In Short, investors have common sense enough to ask “If your performance were low due to extrinsic factors, then how did your peers perform better than you?”. The article goes on to explain the kind of companies that are likely to suspect attribution
“Firms which provide less plausible attributions are larger and have higher likelihood of insider trading around earnings announcements, higher analyst following, higher institutional ownership, higher return volatility, and lower book-to-market ratio. These findings imply that managers with insider trading incentives and those facing greater capital market scrutiny are more likely to offer seemingly self-serving attributions even if they lack plausibility, consistent with the ‘opportunistic behavior’ view of capital markets.”
Given such analysis and trepidations from investors, why would managers continue to make such mistake? The answer is that it’s a matter of their beliefs
“If managers believe there is a chance that investors might be persuaded by their implausible seemingly self-serving attributions, they are more likely to offer them even if ex post it turns out that investors can see through them.”
Managers should focus on being honest with their investors. Sometimes it is better to analyze your organization from an investor’s point of view and measure your performance according to their standards.
You can read the complete article here.