Venture Capital: Preliminary Questions for Entrepreneurs
The Venture Capital industry has been a critical component of the high impact business scene in the United States for fifty years. It is hard to imagine a Silicon Valley anything like today’s without recognizing the critical role venture capital and venture capitalists have played in creating and sustaining it – “it” being an innovation engine of unmatched impact anywhere else in the world, and one that, gradually, is infiltrating other parts of the nation and globe. And yet, many entrepreneurs are deeply suspicious of the industry and its practitioners. Many entrepreneurs, including even a few who have, or at least seemed to have, benefited from working with venture capitalists, talk about the industry with terms like “vulture capital” and “vulture capitalist.” What goes on here?
As a serial venture-backed entrepreneur, venture capitalist and counsel to dozens of entrepreneurs and venture capitalists over a twenty-five year career in Silicon Valley, North Carolina and Wisconsin, my own take is that while there are surely bad actors in the venture capital community – as there are in any community, including the entrepreneurial community – most entrepreneurial animus for venture capitalists is based on misconceptions about the role and modus operandi of venture capital in the innovation process. My own experience suggests that many (not all, but many) of the venture capital horror stories told by entrepreneurs involve deals that never should have been made at all: deals made by entrepreneurs who saw the capital but not the strings attached to it when they made their venture capital bargain. In the interest of trying to stop some of those foredoomed venture capital deals that shouldn’t get done from getting done in the future, here are a few things entrepreneurs should think long and hard about before even considering looking for venture capital dollars for their deal.
- Venture capital is expensive. In fact, venture capital is the most expensive form of financing out there, at least on the right side of the law. While an early stage venture capital investor may be seeking a “modest” 3x or 4x cash on cash return on their portfolio, the implications of that kind of portfolio return mean that they are looking for at least a 10x return on any given investment in that portfolio. It takes a couple of such “home runs” to make up for the singles, doubles and strike outs that make up most of the typical venture capital portfolio, so every deal done has to have home run potential. The implication of this, for entrepreneurs, is that the success bar is extremely high: that venture investors will hold them accountable for anything less than stellar results. If you are not ready to be judged by those kinds of standards, don’t enter the arena.
- Venture capitalists are first and foremost accountable to their own investors, not themselves (and of course not their portfolio entrepreneurs). They have legally binding fiduciary obligations to put the interests of their own investors ahead of their own interests and the interests of their portfolio companies and entrepreneurs. Even the most entrepreneur-friendly venture capitalist, when push comes to shove, will look out for the interests of their own investors ahead of the interests of their portfolio entrepreneurs. And they should: that is their job.
- Venture capitalists generally have egos on a par with entrepreneurs, which is to say that, pace entrepreneurs, they may be wrong a fair amount, but they are almost never in doubt. If you are not comfortable working with folks who can be as stubborn and opinionated as you are, don’t expect a cozy relationship with your venture capital investors.
- Venture capitalists work for venture capital funds, and both venture capitalists and their funds are significantly influenced by the dynamics of their own career development path as well as their fund’s evolution – good or bad – over time. Venture capitalists come and go – your great relationship with a venture fund can be recast overnight if your venture capitalist leaves the fund. No matter how supportive and enthused your venture capitalist may be about your deal, if her venture capital fund has limited cash resources (and they all do) your ability to access those resources in a pinch is up to the fund’s management as a whole, not your particular venture professional (and, of course, at some point, there just isn’t any dry powder left for anyone).
- Just about every venture capitalist believes – really – that they and their fund bring more than money to the table. And many of them do. Unless you agree, stay away. Nothing can sour a venture capital relationship quite so fast as an entrepreneur who won’t listen respectively to, if not always take, advice from their venture capital investors. If you want passive investors, don’t look for venture capital funding.
- Pretty much all venture capitalists have big egos (see above). They all have strong and usually in some way unusual personalities (as do most serious entrepreneurs). There are quiet, supportive types (well, a few) and there are folk like Don Valentine, a widely-respected dean of the industry who has been quoted over the years (without ever denying it, to my knowledge) as follows: “I have never fired a CEO too early in my entire career.” The point? However good the fit might otherwise be with a venture capital fund, make sure you can get along and be productive working with the particular venture capitalist who will be working your deal. (And, per 4 above, hope that particular venture capitalist stays with her fund and your deal for the long haul.)
I am sure there are some entrepreneurs reading this who are wondering just why, in light of the above, anyone would want to work with venture capitalists. If you are one of those, well, don’t; seek venture capital, that is. Devise a bootstrapping financing plan, or, if that isn’t practical, think of an idea where that is practical, or find another direction to go with your career. On the other hand, if you can, with your eyes really open to the above rules of the road, think of working with a venture capitalist as just another part of your challenge, something to be relished rather than feared, go for it. But if you end up road kill, well, that happens. Just about every ultimately successful entrepreneur makes big mistakes and has big failures. Just ask Steve Jobs, he of the Newton PDA and NeXT Computer.