What a lot of people don't realize is that entrepreneurs pick their VC's as much as we pick the deals we invest in. With so much ink (bits) devoted to covering the VC side of things, I thought it would be helpful to look at the process through the eyes of the startup.
We've done 57 equity deals over the last 7 years, a middle range number but enough experience to identify some common pitfalls, tips-and-tricks, and success factors. I can also say with dead-on seriousness that we look long and hard at the complete investor syndicate and have to like it as much as the deal in order to invest. In other words, I may be white hot about the deal, but if the investors give me the chills I will walk. The reason for this is simple, just like good companies require strong leadership teams, they also need strong investor teams, the operative word being "team".
There are several kinds of investors in the private equity world. The obvious starting point is the A-list investors with big names, their track records are typically enviable and the partners often have some star power associated with them. The brand name itself is an attractor for both qualified and capable employees, and also some public relations boost. The downside is that the egos can be pretty large, resulting in the potential for disruption through board members acting more as sole operators than complimentary team players.
I have also noticed a disturbing behavior pattern among these A-list groups that is a function of the tension between acting in the best interest of their limited partners, their co-investors, and the investment as a whole. In other words, if the deal goes bad they shift into a zero sum mode where in order for their firm to win, everyone else has to lose. Through bare-knuckle tactics and a lack of concern for the fallout, these firms use the resources at their disposal to leverage every possible nickle on the table. Some of you reading this will say "well Jeff, what do you expect, they are playing to win", and I actually agree with you, but that doesn't mean I have to like or respect it. But in the end, maybe I'm just naive to think that over the long haul the team approach with shared gains and shared losses is the winning strategy.
The next group of investors is what some would call the middle market, but I prefer to call them specialists. Some of these funds are in fact very large funds that have been around for a long time, but their approach is to not seek a lot of publicity, and they tend to be specialists in a number of technology areas. I like this group of investors alot, simply because the partners tend to be better team players with real operational experience. The downside to this group of investors is that the younger funds may not have the broad network of contacts that inevitably come in really handy for future financings.
Financial and institutional investors are the next group, they are funds that eminate largely from banks and insurance companies, but also entities like pension funds. We don't do a lot of work with these groups, which is more to say that they don't seem to be in the kinds of deals that we like. However, I do want to say that these investors have some unique strengths that should not be overlooked. Financial services as a vertical tends to be a robust adopter of new technologies and if your startup is looking at these markets, well having a major player as an investor is a tremendous door opener.
Corporate VC's, like myself, are the last category of investor that I'll cover (although there are more). Corporates offer big opportunities and big risks that have to be measured and strategized for. My fund is financially motivated meaning that we do this for money and not strategic value (well at least to the extent that making money is a strategic objective). Many corporate venture funds do not have this focus, their motivations have many facets, from investments in key manufacturing technology to investing in companies that allow them to sample a market with limted downside. It's important, as entrepreneurs and as investors, to know what their motivations are. Corporate groups can also experience turnover among their people, something that needs to be calculated upfront if you are going to depend on that investor to deliver something for the company in terms of partnership.
The sum total of advice that I have in this post is that it comes down to the people and their ability to contribute to a team. Startup execs who are inclined to take an investment from an A-list fund but don't like the partner are setting themselves up for conflict that will result in long term harm. Investors that enter into deals without looking at the dynamics of the investor syndicate and board dynamics are neglecting an important area of due diligence.
I'm always surprised that maybe 1 in 10 deals I look at seriously will call MY references. We make a big deal about calling the company's references and indeed, the personal references of the executives, why not for the investors as well? The truth is that they will Google you, but that is not going to be a good substitute for picking up the phone and calling someone. I get asked the question "what do you think about so-and-so at abc fund?" all the time, but again that just isn't as good as a reference call where you can ask questions like this:
- do they show up for regularly scheduled board meetings?
- what operational areas are their contributions most valuable in?
- would you invest with them again?
- have they introduced you to other interesting deals?
- does the fund make an effort to bring together executives from their portfolio?
- are they good at following through on tasks?
- how do they build interpersonal relationships with the team and the other investors?
For startup executives, the management of board meetings is critical. Investors left to their own devices will simply not be a productive and action-oriented board. It takes the CEO and the Chairman to control and drive the board meeting with the end result being that all of the relevant information about the company's performance and objectives/tactics is delivered, AND that board members are tasked with specific follow up actions that are important to the company and it's growth. This is why you need to really think about the investors that you let into the company.
Also, startup executives need to understand the dynamics of venture partnerships. A young partner in a firm is not going to have the latitude that a senior partner is, while a senior partner may not have the drive of the other. As shocking as this may seem, not all the partners in a venture firm will get along with each other all the time, so if you can, understand what those relationships are and evaluate whether or not you have the right partner in a firm working with you. Know where your venture investor is with regard to committed capital in their funds and their prospects for fundraising; the last situation you want to be in is raising follow on capital without bringing all of your existing investors forward with you. Know what the firms entire portfolio is, and get to know them when it makes sense.
A productive and value-creating investors syndicate is one where the players get along well together and respect each others contributions, the leadership team is strengthened with a good backstop provided by the board, and ultimately that the company performs to expectations because all of the parts mesh well together and deliver the right product to the right market at the right unit economics. As investors and management, it is prudent to consider all the things that can go wrong and then consider each investors ability to manage through those obstacles, before committing on a syndicate makeup. If the VC can't be a team player, it's not likely they will create significant value. There are no king makers in this business, building a successful company takes some luck, but a lot more hard work from everyone, including the board of directors.