The Investor Pyramid Is Relevant to All Employees

This is the point in the book when you might say, “Thanks, but no thanks; this investor stuff doesn't apply to me because I never engage with our company's investors.” I would posit that everyone in a business is affected by the relationship a company has with its investors. For example, all of our employees at Costanoa had to suffer through the consequences of a misaligned relationship. Similarly, the principles you will learn in the next three chapters are relevant to whomever in the workplace you are accountable. Many of these themes about alignment and legacy are just as transferable to the relationship between you and your boss as they are between a company and its investor. An employee can think of his or her boss as an investor of sorts: the boss invests time and money in hopes that the return on investment will be a productive employee. These principles are also relevant in a non-profit with the donors or Board being in the role of investors.

Many people think that entrepreneurs or CEOs enjoy life without a boss. That's an illusion. Almost all of us answer to someone in the workplace. An entrepreneur or business leader is accountable to his or her investor or capital source, just like an employee needs to make sure that his or her boss is happy with their performance.

This Investor Pyramid focuses on how you create a strong foundation for this relationship with the person to whom you report. At the base, it is essential that you have what I call transaction alignment. You can't meet investors' expectations if you don't understand their goals. Get this right, and you've created trust, the foundational bricks and mortar that any successful relationship needs. Without trust, the structure of your business relationship may start looking a bit like the Leaning Tower of Pisa. It's amazing how many young tech entrepreneurs wanting to become the next unicorn (private tech start-ups with valuations over $1 billion) don't get this right.

Clearly, based on his quote that opens Part Four of this book, Maslow recognized the importance of entrepreneurs to society. He also acknowledged that entrepreneurs wouldn't be in business without their capital source. So, although we've already explored in detail the first two key constituencies in any business, the employee and the customer, it's now time to turn our attention to the last part of this essential trinity, the investor.

Are Investors Human?

When I speak to business leaders about the Relationship Truths Pyramid, I get a very positive reception when I'm applying the Hierarchy of Needs to the employee or customer relationship. But somehow, when the subject turns to the Investor Pyramid, many businesspeople conveniently forget that investors are human beings with needs, too. The prevailing comment I hear is “Investors don't act like humans. They're purely focused on how to get the highest return on investment (ROI) possible.”

So, are all investors ROI robots? This part of the book will help you understand that you can provide your investors with a high ROI and do it in a way that creates a deep human connection. In fact, I would argue that creating a deep relationship is a helpful step toward achieving a strong ROI because having a poor relationship with your investor distracts you from the proper running of your business. We've all seen companies that went down the tubes because the CEO and executive team were preoccupied by a challenging relationship with their investors.

If you recall the Transformation Pyramid from Chapter Two, you'll recognize that the survival need for investors has similarities to those you'd find for an employee. Employee compensation is a tangible metric, just as investor return is at the base of the Investor Pyramid. The fundamental need for any investor—unless they're purely thinking like a philanthropist—is making sure their transaction goals are being met. The bottom line is the bottom level of the Investor Pyramid. During the next two chapters, we will explore the success and transformation needs of investors. These two levels will make it even clearer that investors are human because many of their decisions are driven by emotional, not utilitarian, needs. For the time being, let's explore what an investor is looking for at the base of this pyramid.

Hundreds of articles and books have been written about the psychology of these particular human beings we call investors. There's even a whole field known as behavioral finance that attempts to better understand and explain how emotions and cognitive errors influence investors and their decision-making processes. Behavioral finance has shown that these ROI robots aren't as rational as we may think. For example, one theory called the Fear of Regret suggests that investors avoid selling stocks that have gone down in order to avoid the pain and regret of having made a bad investment. Anchoring is another psychological concept of investors that is based on the idea that an investor assumes current prices are about right. In a bull market, for example, each new high is anchored by its closeness to the last record, and more distant history increasingly becomes irrelevant. People tend to give too much weight to recent experience, extrapolating recent trends that are often at odds with long-run averages. The result is investment market overreaction or underreaction that can lead to bubbles and crashes, two extreme results from investors who are a little too human.

So, let's accept that investors are people, too, and that they have a Hierarchy of Needs just like employees and customers do. What's foundational for an investor is the peace of mind that comes with feeling that his or her investment goals are aligned with the company's goals, such that a strong ROI is being created. When this sort of transactional alignment occurs, trust develops. Or as Warren Bennis and Burt Nanus are quoted as saying in Fred Kofman's Conscious Business, trust could be defined as the “lubrication of cooperation” in business.²

Stephen M. R. Covey (son of Stephen R. Covey, the well-known author) has written a book called The Speed of Trust, in which he suggests that companies experience either a trust tax or a trust dividend with respect to the relationships that are created within their organization or with the outside world. He says, “In a company, high trust materially improves communication, collaboration, execution, innovation, strategy, engagement, partnering, and relationships with all stakeholders.”³ He cites a Watson Wyatt study from 2002, which shows that total return to shareholders in high-trust organizations is almost three times higher than that in low-trust organizations. Clearly there is a friction created (the trust tax) when a foundation of trust doesn't exist in a business relationship with investors. That's why trust is at the base of the Investor Pyramid. Without trust, it's almost like the physiological and safety needs of the investor aren't met, which means it's hard to scale the rest of the pyramid.

How do you create a high-trust investor relationship? In a Harvard Business Review article, “The Decision to Trust,” Robert F. Hurley suggests that before a person places his or her trust in someone else, that person carefully weighs the question “How likely is this person to serve my interests?”⁴ When people's interests are completely aligned and an investor believes in the integrity of those he or she has invested with, trust is the natural response.

Attracting an Aligned Investor

No doubt, creating value and a strong return on investment is an essential part of what an investor is looking for, but to talk about the outcome (ROI) without considering the environment (the inputs) that can enhance that ROI seems shortsighted. You can't get milk from a cow that hasn't been fed. In fact, California cheese makers remind us in their ad campaigns that it's the “happy cows” that make great cheese. If it works for the cows, it works for me.

If American business leaders were asked to name the wisest man in the land of investing, Warren Buffett would probably win hands down. I stumbled upon a rare book called The Essays of Warren Buffett: Lessons for Corporate America, which outlines his philosophy of how alignment with investors provides the sustenance for company leaders to create great outcomes. Buffett believes getting that alignment correct on the front end is one of the most important responsibilities of an investor. He writes, “The CEOs at Berkshire's various operating companies enjoy a unique position in corporate America. They are given a simple set of commands: to run their business as if (1) they are its sole owner, (2) it is the only asset they hold, and (3) they can never sell or merge it for a hundred years.”⁵

Imposing this unique set of commands helps Berkshire's various company CEOs have the proper blinders on to focus exclusively on the well-being of their business without the distractions that are typical of most companies. It allows these CEOs to focus on creating enduring value in their businesses, and it helps take away the natural friction (the trust tax) that can occur between a company and its investors.

Buffett is such a believer in aligning the goals of his company and his investors that he even asks his shareholders to designate the charities to which the corporation donates so there's not a risk of misaligned goals even in that arena. He is also insistent that Berkshire's compensation policies are directly correlated with the kind of return it gives its shareholders. He wrote in one of his famous letters to shareholders, “I cannot promise you results. But we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partner.”⁶

Buffett represents a growing set of business leaders who believe that “companies obtain the shareholder constituency that they seek and deserve.” He suggests that if companies “focus their thinking and communications on short-term results or short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors.”⁷ In other words, just understanding your business plan isn't enough for business leaders. You need to also understand the motivations of your investors to ensure they're aligned with your own.

Bill George, who presided as CEO over Medtronic's 10-year meteoric rise in market capitalization from $1 billion to $60 billion, says in Authentic Leadership that we should be wary of the “shareholder of the last five minutes.” Being loyal to the short-term investor doesn't help you as a company in the long term. George says, “Do your shareholders choose you or do you choose them? Sophisticated CEOs choose their investors by defining their particular business approach and strategy and assuring that their investors are aligned with that program.”⁸

Apple's chair Arthur Levinson concurred with George in Fortune magazine when talking about his time as CEO of Genentech, “There is so much pressure to hit your numbers. I've been very clear with Wall Street since 1995 that if we see an opportunity to make better drugs and more money down the road at a short-term cost, we will do that every time. And you need to know that's the kind of company we are.”⁹

Creating Transactional Alignment

How do you ensure that you are on the same page as your investors? Well, if you're a public company, much of it has to do with what George and Levinson suggested. Most public company CEOs think part of their job is selling their company to Wall Street analysts; yet, more and more are realizing that it's really about attracting the right investors who truly get who you are as a company and where you're going. The era of Sarbanes–Oxley transparency means that investors have a clearer sense of all facets of a company, which suggests that stock market investors will increasingly be able to align themselves with companies that fit their goals.

When it comes to investors in private companies, it's a little like dating. You don't rush into a marriage until you've made certain that you're compatible on some of the key basics. The reason many company–investor relationships don't work out is that the two parties didn't communicate their individual intent to see if they had the same goals. So, let's discuss some of the key utilitarian elements that any private investor is looking for. Ask yourself the questions that are listed under each of the five points, but more importantly, consider the nuances and subtleties that might exist between how you would answer these questions and how your primary investors would:

1. Rate of return: What's the minimum rate of return they are expecting from the investment, how is that being calculated, and what kind of extra incentives do you and the company receive if you hit some of their return thresholds?
2. Liquidity timing and strategy: What is the time horizon for their investment, to whom would they sell their investment, and how does that sale affect your control of the company? (Often, the liquidity plan for a business requires a sale to another entity, which means you and your management team may no longer be involved, as was the case for us with Costanoa.)
3. Definition of the market and the company's approach to differentiation: Do you concur on the size of the market, the composition of your management team, and their fundamental business strategy for maximizing the opportunity? In other words, do you agree on the basic business plan?
4. Cash needs to execute on the business strategy: Based on how you are going to grow the business and what key strategic investments need to be made to allow this scalability, are there expected cash-call requirements from these existing investors, or are you going to bring in another round of financing from other investors, and what's the approach to valuing the new and the old money?
5. A single metric that defines effectiveness: Do you concur on what metric is the leading indicator of whether you are effectively managing the business?

The Definition of Effective Performance

As for that last point, few subjects create more animated discussions between companies and their investors. Quite often, discord on point 5 means there wasn't concurrence on point 3. Every company faces conflicting objectives: Profitability or growth? Short-term perspective or long-term? The benefits of organizational synergy or the analysis of stand-alone unit performance? Dominic Dodd and Ken Favaro have written a terrific book, The Three Tensions, which outlines ways for a company and its investors to create a dialogue on how to deal with these potentially conflicting objectives.

Similarly, Jim Collins in Good to Great showed that even companies in unspectacular industries could post impressive financial performance if they were able to see clearly what one “economic denominator” drove effective performance in their business. Walgreen's switched from profit per store to profit per customer visit because it found that profit per store inhibited its ability to create the convenience of multiple stores within a particular community, which is what the consumer is looking for from Walgreen's. Collins points out that a company can have multiple economic denominators, but focusing on just one helps provide the insight that can come from that singular metric.

We were faced with an enormous challenge during the Bay Area's sharp hotel downturn in 2001, because the primary metrics that had defined Joie de Vivre's effectiveness in the previous half decade were year-over-year revenue, or net income growth, both of which had shown phenomenal results for our investors and owners. But we began to realize that an annualized growth metric was really a lagging indicator of our efforts in terms of creating a great product or building customer loyalty. In addition, annualized revenue or net income growth didn't give us a relative standard to judge each hotel's performance because it was more of a broad barometer of the success the Bay Area was experiencing during the dot-com boom. We were faced with having to refocus our investors on a new, more meaningful metric.

As I mentioned in Chapter Three, explaining who my boss is complicated: a large patchwork quilt of various investors that we own hotels with and an even larger number of owners whose hotels we manage. Fortunately, I had no boss at Joie de Vivre per se because I owned the management company and brand outright. Yet, because the hotels we operated are owned by others or in partnership with others, I still answered to more than 100 individuals or entities, representing 22 different owner groups, who were all shocked by the 2001 downturn after six consecutive years of record revenue growth.

Actually, I had to start delivering bad news even before the 9/11 tragedies. Bay Area hotel revenues began a quick decline in the winter of 2001, about a year after the stock market started punishing the high-tech industry for the silly bubble that had been created. After years of receiving healthy investor distribution checks from Joie de Vivre, our investors and owners reverted back to the bottom of the Hierarchy of Needs Pyramid, as they were worried whether their base ROI needs were going to be met. In other words, they wondered if they would still be receiving checks or if they were going to have to start writing them to cover the hotels' growing negative cash flows.

It was clear we needed our investors and owners to rethink how they defined Joie de Vivre's effectiveness. I remember the conversation I had with one of our long-term investors who was disgruntled with how far our monthly revenue and net income numbers had fallen in 2001. I asked him whether effectiveness is meant to be a relative term. He acknowledged that it was, so we started brainstorming about the ways Joie de Vivre could show its relative effectiveness to our competition during a time when every hotel in our region was experiencing declining revenues and net income. While I showed the investor that our employee and customer satisfaction scores continued to be a good bit higher than the hospitality industry averages, he repeated a well-known phrase from the film Jerry Maguire: “Show me the money!” He didn't want to be convinced that there was a direct line from happy employees or customers to profitability. Since our hotels are privately owned and we can't compare exact profitability with our directly competitive hotels, we needed to look for another metric that had a profound impact on a hotel's relative success in the marketplace: market share.

Each of our hotels receives competitive market share data on a weekly basis from a third-party source, Smith Travel Research, which the hotel industry uses religiously. This confidential data allows us to review whether we are gaining or losing market share at each hotel, and we can break it down by day of the week and whether the week-to-week variance is due to occupancy or average room rate changes. Fortunately, more than 80 percent of our hotels were growing market share during the downturn versus their competition. So, while the proverbial pie was shrinking in our marketplace, our slice of the pie was growing quickly.

I still had to sell the rest of our investors and owners on why this market share metric should be their primary means of determining whether we were performing effectively. Some investors concurred immediately while others took more time. I was able to give to some of them (especially those who took a little longer to come around) studies that showed the link between market share and profitability. I showed a few of them former Medtronic's CEO Bill George's book Authentic Leadership, in which he wrote, “Market share is the best measure of how well a company is serving its customers.…Market share gains create higher levels of profitability…increases in share are highly motivating to employees, making the best people want to work for you and giving them incentive to reach higher levels of performance…market share gains create a positively reinforcing cycle.”¹⁰

Some of these doubting investors were able to see that these small wins in market share were helping our frustrated, yet resilient, hotel general managers and sales staff continue their enthusiastic leadership during a truly depressing time. As I used to say to our management team, “When you're running a marathon in the mud, any small win helps give you that little boost of energy to keep you moving forward.” Karlene Holloman, our former vice president of operations, told me that shifting this most-watched metric from something that was unattainable (growing revenues in a market that was seeing 35 to 50 percent revenue declines over a three-year period) to something that was attainable (growing market share) completely changed the mood at the monthly investor meetings she led at each hotel.

Maximizing profits for investors is a legitimate and essential part of running a business. Assuring that you have transactional alignment in terms of the key elements of the business will create more harmony in your company–investor relationship. But this chapter has focused purely on the transactional nature of this relationship. The deal is the glue that keeps the company and investor together on this level of the pyramid. The investor on a path toward self-actualization realizes that the scarce commodity in the investment world isn't necessarily a good deal but a good partner relationship. The deal is the milk; the relationship is the cow. We will now shift our focus from the tangible elements of transaction alignment to how investors create long-term relationships with companies or entrepreneurs who provide them a lifetime of opportunities and oodles of moolah.