Today’s Venture Capitalists (VCs) have often qualified innovation as a buyer’s or a seller’s market (in publicly discussing valuation trends), and that communicates so well how they view innovation; as a commodity.
No wonder they fail miserably in generating meaningful alpha (portfolio returns for Limited Partners, or LPs). It is impossible to find and attract the outliers of innovation by comparing and compressing valuations. And commodities never outgrow their peers.
Disruptive innovation is never a commodity and is always a seller’s market (with the company selling its stock to investors). So, the minute innovation becomes a buyer’s market, that innovation has just been “crowned” a sub-prime entity and so are equally crowned both buyer and seller.
Finding the perfect date
As a VC, finding the right type of innovation to monetize is like finding the perfect date, they are few and far between. And to a founder of a startup finding the right General Partner (at a VC firm) is similarly daunting.
A unique match between two people (the General Partner and the CEO) is something that takes more than glowing at the prospect of having a baby together (i.e., build a new prosperous company) and discussing the financial projections and terms of the deal.
Most of us can dream, but can we make it happen together is the real question.
The reason why many people are such bad daters is that they do not hold on to their standards, those that make them happy and those that make them healthy. They confuse money, power, and perks with merit and hope sheer proximity will someday rub some off to them. But it never does, you need to do the hard work yourself to reap its precious reward. You get what you put in.
I do not consider myself a pretty boy, yet I never had a problem dating because I know what I want and especially stand firm on what I do not. Standing firm allows you to stay true to yourself and often has the added benefit of weeding out sub-prime parties quickly and thus avoid unmanageable disaster further down the road. (That is my happy date-turned-wife in the picture.)
I cannot tell you how many times I have spoken to entrepreneurs that have banged their heads against the doors of VCs and selectively served as their dutiful psychologist to help them not to bow down to sub-prime standards.
Most entrepreneurs become nervous and afraid to negotiate because this VC may just be the only interested party they have, and if you are a tough negotiator, those investors may frighten others that you are “hard to work with.” But a choice of one investor is not a choice.
Even before any commitment to invest is reached, entrepreneurs frequently let VC change their business model, use-of-proceeds, valuation, and everything else, in the hopes of landing a round of funding. Not realizing that this VC can have whatever opinions it wants, but as an entrepreneur, you are the only one responsible for making it happen. Do not accept an infinite monkey theorem, that you then need to turn into a work of Shakespeare in your startup.
So, don’t be afraid to lose. Because losing from a sub-prime VC is a win.
Marriage does not make a person
Getting laid is not a recipe to produce a happy child; a healthy marriage is. So, even if an entrepreneur lands an investment, raising Venture Capital alone does not make a successful company. With so many sub-prime VCs, statistically and empirically, the odds are still not in your favor.
Success, in the latter case, is defined by the company’s ability to produce public value, either by serving the public directly or indirectly by getting them to invest by way of IPO (or acquisition).
So, both parties need to demonstrate that they are experienced, skilled, agree, and contribute to achieving that (initial) public value for the company. In other words, a marriage needs to be consummated in which the assets, principles, and goals of raising a happy child (the company) are shared. And that means that while both parties supply different assets, one cannot overpower the other (like Pimps and Hoes) and force its agenda.
A priori, an equilibrium needs to be established that is healthy and promises minimal friction down the road.
Bad starts make for bad endings
Without an organic fit and chemistry, a venture deal that starts off wrong usually ends wrong. For the VC that damage is diversified, for the entrepreneur, it is often crushing. So, the dating process is not just a way for the VC to check the entrepreneur out, but for the entrepreneur to gauge if the proposed equilibrium (mentality, experience, skills, term-sheet, vision) is authentic, attainable and healthy.
Here is how many VCs set themselves up wrong for the dating game and why entrepreneurs deserve better (in this context “the date” is the VC, and “you” is the entrepreneur):
The date wants to know everything about you but won’t tell much about himself.
VCs demand to know a lot about the entrepreneur, but what does an entrepreneur know about the VC’s merit? GP merit hides behind ten levels of diversification and a fuzzy Private Placement Memorandum (PPM, the business plan for LPs) that leaves plenty of room for “creative” post-close re-interpretation. Whether the GP is a great gambler or skillful is virtually impossible to assert. What we do know is that many GPs have never themselves crossed the chasm, a trait that makes them almost certain a lousy dating partner.
The date wants to date other people at the same time.
VCs diversify their risk by investing in other (hopefully not competitive) companies at the same time and hedge their bets, they do not often hedge their often ill-informed opinions upon the entrepreneur. Expect many to do a John Edwards on you when your future suddenly looks like cancer.
The date does not want you to date someone else too.
VCs diversify their risk but watch their reactions when you do the same. They’ll get mad because you have just told them that VC money is a commodity (and disruptive innovation is not), and now they need to step it up and prove their value-add. Right, where you want them.
The date wants to have a threesome and takes his pick.
VCs are more worried about downside risk than upside risk and try to find an accomplice, and syndicate early to avoid risk. They often finagle a sweet syndication deal with a partner under the table that is unlikely to be to your advantage. VC is a demi-cartel.
The date thinks that his money compensates for lack of empathy.
Many VCs lack entrepreneurial experience, which, according to a Dutch saying, means “they’ve heard the church bell ring, but they don’t know where the sound came from.” Money does not make up for in-experience and lack of skills, especially not in the boardroom of an early-stage company.
The date wants you to tell him exactly what you are bringing to the table, without him doing the same.
Entrepreneurs are asked to make elaborate predictions about growth trajectories and stick to them. But have you asked the VC to provide full runway support in return?
The date discusses divorce before you even start dating.
You want to change the world, and the VC wants to target exits. Foolishly the sub-prime VC does not realize that changing the world creates a much more reliable exit than an early “delivery” could ever promise.
The date wants to know whether you want children but withholds his wishes.
Real entrepreneurs want to change the world, not just to exit. VCs, however, will change their mind depending on how the rest of their portfolio is doing and whether at that time, they can get themselves in the top quartile. I know many companies that have been pushed to early “delivery,” to the chagrin of their founders.
The date never really commits and keep all options open.
Entrepreneurs are forced to submit to funding rounds that are designed purely to minimize downside risk for VCs. While you commit to the marriage all the way, a VC can decide to bail out at any time, leaving you hanging (with a strategy that may not be yours, a cap-table that is destroyed, and a runway that may no longer be viable).
The date needs the approval of all his cousins before he can get married.
Seldom can the opinion of one GP secure the deal. He has to push an outlier proposition through an elaborate socialist process with other GPs in the firm to close. An incompatible process that should be banned.
The date requires a prenuptial to engage.
VCs structure elaborate ownership agreements, by way of voting rights, valuations, bylaws – you name it. Forgetting that rudimentary control, plus the ability of the company to develop itself, gives it the highest probability of succeeding. If, as a VC, you don’t believe that, you should not engage in the deal, to begin with. Elaborate downside protection means you just do not believe in the upside.
The date wants full control over your purse.
Excessive controls on money mean there is no trust between VC and entrepreneur. It is necessary to verify trust, but not giving it in advance means the entrepreneur is not giving the VC his confidence either. A CEO needs to be able to run the company and not be bogged down by distracting and bureaucratic spending rules as long as he stays within the use-of-proceeds.
The VC institution needs to be fixed first
Now, I can make a similar list about people who chase sub-prime investments. More than ten years of sub-prime investments have attracted a lot of people to that sub-prime thesis, the majority without the attributes needed to become a successful entrepreneur. With a still-growing number of sub-prime VCs at play, certain corporations have become better custodians of disruptive innovation, able to stimulate entrepreneurs more effectively.
The only way, in my view, we can fix Venture is to change the model by which we deploy the matchmaking services between the assets of the LPs (money) and the assets of the entrepreneurs (ideas). With a more discretionary VC intermediary, we will automatically attract more disruptive ideas (by stimulating entrepreneurs to look at Venture as a prime venue for innovation again) and create more meaningful value.
By the way, I do not dislike many VCs; I despise the institution they represent – because they perform so poorly. That hurts LPs, and their dissatisfaction will have a devastating effect on the innovation in this country.
I am working feverishly on getting VC fixed by changing the economic model that allows LPs to be taken for a ride. Disruptive innovation can wait until they start implementing my economic system. And in the meantime, dear entrepreneur, if you think you have what it takes now, keep your foot down and your head up and keep looking for that discretionary VC in the haystack.
Happy dating! Je maintiendrai!