When to pull the Katana

A good friend of mine is fond of saying "I don't pull out the Katana unless I am going to use it". Now I have gotten used to Japanese idiomatic slang over the years (it's endemic in investment banking) - I have "opened the Kimono", "pulled water to my own rice paddy" and learned that "even monkeys fall from trees". But this saying got me thinking - when is it time to pull the Katana, and what happens if you put it back without slaking its thirst?

I am not one of those people who believes that you should never pull the Katana (both metaphorically and actually). There is a time to fight. In my role as advisor to investors and founders however I have spent a lot of time convincing my clients that now is not that time. But how do you know when it has arrived?

My litigator friends tell me that the Katana only gets pulled when one or both sides have unrealistic points of view. So the trigger for conflict is always a dysfunctional behaviour or belief. The ability to recognise this is a key characteristic of winners when the swords start swinging. Draw first and strike a fatal blow is the credo. Reasonable or hopeful people draw second and this results in death.

So if you are going to carry a Katana, you need to be prepared to draw it first and go for the jugular.

Recognising dysfunctional behaviour is not as easy as it sounds. For example imagine that you are the founder of a company and you receive a buy out offer from a large industry player after five years of back breaking work. The price is 2x the invested capital with a royalty for future sales. For the management team its a nice payday and for the investor its 15% IRR. The founder takes the offer to the board and it is declined - as the investor feels bullish about the company. However, three months later the investor runs into liquidity issues and when the founder seeks top up funding he is informed that new money is 3x more expensive than the last round. The founder asks to seek funding externally this request is refused. The investor does not want dilution and an up-round isn't happening. The founder will just have to take his current investors' money at their price. This set of circumstances feels like injustice and the founder reach for his Katana...

The investor sees things differently. They backed an entrepreneur and invested a significant amount of money into the business. It turns out however that the capital investment required to drive the company growth was much greater than they had first imagined. But this is their first fund and they cannot have a loss so they followed-on until the investment was 30% of their capital. At this point they were offered a 2x return to exit and an uncertain Royalty. Their view at this point is that they need to be compensated for taking such a huge risk (albeit by mistake) so they reject the offer. Unfortunately later in the year they have some liquidity issues in other portfolio companies and when the founder comes for money they have to choose between competing interests in the fund. This pushes up the cost of capital due to opportunity costs. The investor's tolerance for push back on this issue is minimal as they have demonstrated their commitment fulsomely and believe that the founder is irrational to expect limitless capital at the same price. They reach for their Katana....

My grandfather told me that there are three truths, "your truth, my truth and the actual truth". This is often the reality at Katana-time. So in my role as advisor I seek compromise wherever possible - to preserve as much value for both sides - as their hands hover over their blades.

But then someone acts in bad faith. A sneaky move to dilute the founders. A hostile takeover bid against the investor. Its a small world and word gets out fast. At that point there is no going back. There can be only one winner. Katana's are drawn. The general rule is that he who draws first kills his opponent. There is room for no mercy.

LinkedIn and HBR and every other management journal is full of stories about "win win" and compromise solutions. It is a beautiful concept that we strive for. But as anyone who has invested or been invested-in knows, the world is a harsh place and not everyone is Baloo the bear. When the bad thing happens you need people around you who know how to fight and are not squeamish about doing so.

Take home message #1: try not to pull the Katana. Its not true to say that no one wins in a fight. In fact it is completely wrong. By definition someone always wins. But the fall out for both parties is long term reputitional damage. No one wants drama.

Take home message #2: if you pull the Katana, use it.

Take home message #3: have people around you to speak the truth, provide a back channel and find ways to seek an end to hostilities at every juncture. My litigator friends tell me that 90% of their cases settle out of court. There is a reason for this. War is expensive.

Finally, think very carefully before you accept money or invest money. There should always be a pre-nup and make sure that the board has people on it who can help manage conflicts : good Non Execs can save the day. Money is not money. It comes with people, personalities, track records, dry powder, short fund lives, ego, control issues, philosophical issues and different perspectives on the same data set. So be highly discriminating about who you work with. Once you do decide to get engaged, go all in. Nothing works without trust or the benefit of the doubt. Keep talking. Socialise, exchange views and challenge each other. If you do this chances are everything will work out fine.

But keep your Katana sharp.