I am Third
Placing yourself behind your investors.
I made partner at one of the largest law firms in the world, Dentons (at the time Sonnesnchein, Nath & Rosenthal), practicing finance and putting deals together. I really thought I had ventures figured out. Of course I was too chicken to fully make a run at it alone, so now at a smaller firm I started doing deals on the side. For the past four years I have sponsored deals, funded a few deals and failed a ton of times.
In the beginning, I had absolutely zero understanding of how hard it was to put a deal together, much less raise the capital to get it up and running. For me, raising capital was really…really hard.
Honestly, I was not use to rejection and it took me a good while to turn around and start viewing myself through the lens of the investor. Why should this person trust me with their money? What makes me a better investment than other opportunities?
I learned that receiving an investment is as much about the relationship, trust and other intangible factors as it is about the opportunity presented.
Trust is not something that can be explained by one definition. It is a feeling, a feeling that each partner works to the benefit of the other and will not work against the common interest of the collective partnership. It is the “I’ve got your back” nod between friends. There is no one particular thing that creates trust (although there are several “one things” that can destroy trust), but adopting an “I am Third” philosophy is a method by which you can objectively exhibit trust in your partnership from the beginning.
By changing my emphasis from return on investment to flow of money, I adopted the “I am Third” motto.
By changing the focus of my economic discussion with potential investors from return on investment or exit strategy to distribution of funds, I started gaining trust. Simply placing myself third in the distribution waterfall had a profound impact on my relationship going forward with potential investors.
Quick reset. A waterfall is a distribution of funds hierarchy which Investopedia.com defines as:
“A distribution waterfall is a hierarchy delineating the order in which funds will be distributed, and may ensure that different types of investors have priority of payment compared to others within the same fund.”
A distribution waterfall is typically laid out fairly clearly in the operating agreement (or other applicable agreement) of a company. Using the “I am Third” motto, my waterfalls look something like:
First, for the payment of operational expenses of the Company, as approved by the Members and consistent with the Budget.
Second, for the payment of the Preferred Return.
Third, for the payment of all remaining Funds Available for Distribution to the Members in accordance with their Membership Percentage.
The idea of course is that as the sponsor, you pay yourself third after you pay expenses and take care of your investor. This exact cash waterfall is not applicable for all deals naturally. However, the concept should be and is applicable to all deals. Take care of your expenses and then your investors before you take care of yourself.
The main thing I learned since adopting the I am Third approach? People tend to invest in you again if you return their money.
The inspiration for this article is the great blog post by Hunter Walk emphasizing the importance of the investor getting paid fairly, but last. I encourage you to go read his article here. Also, I will say Mr. Walk is one of my favorite twitter streams.
