Ed Zimmerman wrote a nice article in the WSJ about the value of VC Associates. It’s a great read, and as a former VC associate, I agree with many of his points. But VC associates continue to get a bad reputation, and I totally understand why. It’s not that VC associates are bad or ineffective. But some are. And almost all are prone to some bad behavior at least sometimes. Partners are prone to bad behavior too, but because they are the “decision makers”, founders are more likely to just shrug their shoulders and move on (although everyone has their limits). Here’s my 2 cents on what VC associates should do (or not do) to avoid being annoying and unhelpful to founders.
1. Be authentic and transparent. Every entrepreneur can look on LinkedIN and see that the amazing operating experience you claim to have was acquired in 1 summer internship 2 years ago. Don’t feel like you need to be different or more than you are. Do be honest about why you are or aren’t interested in a company. Do be honest about what your firm’s process looks like, whether you have air cover from the partners at your firm, and what to expect next. Also, be honest about how interested you really are in a company. If you are just trying to build a relationship over time, but your typical goal is to invest after a company has achieved significantly more, say that.
2. Pre-wire the entrepreneur and your partners. I’ve seen this many times, where an entrepreneur goes into a meeting with one or more partners at the firm, but their expectations for the meeting are completely different from what actually transpired. I think it’s just courtesy to do the extra work to pre-wire the entrepreneur so they know what they are getting into, and pre-wire your partners so they know what to expect and the entrepreneur doesn’t feel like an idiot.
3. But measured about your enthusiasm. It’s easy as an associate to lead entrepreneurs on with overly optimistic messaging. What happens is that the associate is eager to show productivity and get “credit” for “seeing” a deal early. So they convince the entrepreneur that the firm is excited enough to do a deal quickly, so that the founder is willing to come in to meet the partners. During the meeting, it becomes clear that there is no way that the firm will invest. But from the associate’s point of view, they get credit for surfacing credible deals to their partners, even if it pretty clearly doesn’t fit what the firm is looking for. Ultimately, this will hurt everyone.
4. Be careful about mirroring your partners too much. This is a subtle point. Because VC is an apprenticeship business, it’s easy for an associate to start to mirror the behaviors and style of the partners that they work with. In many cases, this is great, but I’d be careful about taking it too far. First, I really think that one’s best strategy is authenticity, and you need to find your own style and personality. Second, I’d be wary about picking up some behaviors before there is substance to support it. The role of a VC makes it very easy to develop an over-inflated ego, and on top of that, many VC partners have had a ton of success, and have a fair bit of confidence to go along with it. It’s easy to start mirroring the behaviors of a confident (maybe cocky) person, but without as much substance to go along with it, you end up looking pretty lame.
5. Provide real help, not noisy activity. Associates can really help portfolio companies. But it’s also really easy to start wasting their time. Most likely, as an associate, you aren’t going to contribute that much pontificating at board meetings about strategy. You also are probably not going to be the person that brings on the SVP of sales for a series B company, or their next CTO. You probably aren’t going to have all these great ideas and introductions that will prove valuable to the CEO of a company you are shadowing. But you can help. Figure out what the hiring plans are for the companies you are supporting, and start scouring the market for the best people you can find that fits those roles. It’s a great long-term investment, because the mid-level PMs, sales people, and software developers of today may become great founders down the road. Also, get to know the next level of the management team of the companies you support. It’s amazing how VC’s tend to spend a huge % of time with the founders and CEO of a company, but relatively little time with the VP or Director level executives. Get to know them, understand their more tactical needs and try to produce for them. Oh, and bringing in customers is always a good thing.
Overall, I think humility is really important. When I think about many of the former associates I know who are now partners at their respective firms, I find that most of them were surprisingly humble and empathetic towards entrepreneurs, and there wasn’t at all a sense that they needed to justify themselves because they were just lowly associates. Couple that with incredible hunger around helping founders, and strong intuition about how markets are developing, and you have the makings of a really great VC.
Startup founders have so much invested in their company that it can cloud the way they think about competition. Sometimes you can be too paranoid and get way too focused on competitors, to the point that they cause you to take your eye off the ball. In other cases, you can be so focused on what you are doing that you can be blind to your competitors and fail to respond when they start doing things that are pretty smart that you should be learning from.
One of my biggest pet peeves when speaking with entrepreneurs about their business is the way some talk about their competition. Specifically, I get annoyed by entrepreneurs who are overly dismissive of their competitors. You don’t need to go through a laundry list of competitors, but there is almost certainly at least 1 or 2 that are going to pose a formidable threat in some meaningful way. Personally, I appreciate entrepreneurs that are thoughtful about competition, and will speak fairly deeply about the small number of companies (large or small) that are really potential threats to their success. I prefer a vibe that goes something like:
“These guys are good. Here’s how we are different and why we think we will win. But they’ve make some really smart choices too. I look forward to competing against them.”
This is way harder said than done. Responding to competition is highly emotional. Trust me, we experience this too.When a competitor comes onto the scene, or makes an interesting move, it’s easy to experience a wide range of strong emotions:
- Admiration “why didn’t I think of that?”
- Envy “crap, I did think of that, they just beat us to it”
- Dismissiveness “They have no idea what they are doing. What a dumb strategy”
- Denial. “They aren’t really competitors”
- Aggression. “We’re going to crush them”
- on and on and on…
It’s not easy to have a balanced view of competition. But I think it’s pretty critical. You need to be aware of competitors, and have an honest appreciation for that they are doing and what it might mean. Then you have to decide whether it changes your plans or not. Then you have to forget about them for a while, and focus on great execution and playing your own game to the best of your ability. Not as easy as it sounds.
I’m in a reflective mood as Thanksgiving is around the corner, and I’ve been thinking a lot about motivation. If nothing else, entrepreneurs need a LOT of it to push through the valleys between the peaks.
When I think about it, I believe everyone’s motivations are driven by some combination of Love, Greed, and Fear. Some thoughts below on each one.
It’s easy to say that Love ought to be the strongest and most pure motivation. People will go to great lengths for the sake of love. They will suffer hardship and pursue perfection relentlessly because of love. We hope all the founders we back are driven deeply by love. For first time founders, that usually starts with the authentic love of a problem or the love of a product. For repeat founders, some of them just love the process of building and leading companies that make a difference.
Some founders just love to win, or at least to compete. I always remember when Michael Jordan came back to basketball late in his career, he responded to reporters who asked him “why?” and said “for the love of the game”.
We love love. The glorified hero is driven by love, and so is the glorified image of the transformative entrepreneur.
Just as it’s easy to celebrate Love as a wonderful motivation, it’s also easy to dismiss greed as a less-than-ideal one. “It’s not about the money” is something we love to hear. I think it’s common in the current culture to think of greed as leading to short-term thinking. Or a winner-takes-all vs. expand the pie mentality.
But is greed really so bad? Is the desire to want more… maybe more than the next guy or gal really so bad? Maybe it’s just natural.
We love people who exhibit hunger. A relentless drive and desire to keep fighting. A sense that what they have or have accomplished simply isn’t enough – they are hungry for more. Isn’t that just greed in a more positive light?
I love hungry entrepreneurs. One quote I’ve been repeating recently is from my friend Ariel Diaz, the founder and CEO of Boundless. He talked about his frustration with entrepreneurs or tech pundits who talk about working smarter, or life-hacking, or pursuing balance. His view is:
“I was a rower. In rowing, technique matters. But when everyone has good technique, it turns out that if you can find a way to row harder, the boat will move faster”.
I’m greedy for more founders who exhibit that kind of hunger.
Again, being motivated by fear doesn’t seem great. Fear can lead to irrational choices, and fear can make you focus too much on the short term, or what people think of you, or the competition, or a whole host of other unproductive stuff.
But fear is an incredible motivator. So many of us are driven by fear. I know I am.
It’s not the healthiest thing in the world. But if you are honest, aren’t many of us driven deeply be a fear of failure? A fear of letting people down? A fear that in the end, someone looks at your accomplishments and says “myeh, he really didn’t do very much”?
Sounds kind of harsh, but I know so many people for whom this is the internal dialog, whether they are really aware of it or not. As Harold Abrahams said in the classic movie Chariots of Fire about how he feels before a 100-meter race:
“I will raise my eyes and look down that corridor; 4 feet wide, with 10 lonely seconds to justify my whole existence. But WILL I?”
Some of the most accomplished people I know are so insecure. That insecurity drives them to want to prove themselves over and over again. At an extreme, it’s pretty ugly. But it’s powerful, and I think that when in check, it’s a powerful motivator as well. As an investor, we sometimes love people who have “a chip on their shoulder” or “something to prove”. It’s a version of fear that we like quite a bit.
When I reflect on my own motivations, it’s a messy combination of Love, Greed, and Fear. And it’s messy because sometimes, Love makes me foolish, and Greed makes me short-sighted, and Fear makes me panic. But we are not simple creatures, and our motivations are mixed, whether we like it or not.
I gave a quick talk today at the Future Forward conference on “How VC’s Win, and How Things Are Changing”. It’s a topic I’ve been thinking about a lot.
My observation is that the Venture Capital business has changed significantly in the past 10 years because of much greater capital efficiency at the early stages, and much greater transparency around the process of fundraising and the performance and value of investors.
Put another way, the venture capital industry has become more mature, and increasingly, the market for the companies we invest in is more and more efficient. This creates challenges for investors.
When markets become more efficient, a couple things happen. First, it becomes much harder to find “value”. The way I see it, an efficient market means more competition for an investment, which in turn means that pricing will tend to be driven up to the point of discomfort relative to the risk. If you are investing very early, pricing may be good, but the perceived risk will be high (and a lot of smart investors will pass on an opportunity). But if you are investing after product-market fit, the price will be driven up to the point that an investment becomes harder and harder to justify given the remaining risks.
Second, firms in a more efficient market need to find more and better ways to compete. Relying on charm and reputation doesn’t get you very far in a world where entrepreneurs are increasingly less enamored by a VC’s brand or historic legacy, and entrepreneurs are more savvy about asking the question “what do I really get from taking your money vs. someone else’s?”.
So, this is forcing VC’s to seriously rethink the way they compete in the market. Those that don’t evolve will have a pretty tough time, I think. Specifically, I’ve seen innovations in the following areas:
- Sourcing in new, less competitive geographies (for example: US firms focusing on Europe, Brazil, etc)
- Finding leveraged ways to tap into different founder communities (for example: General Catalyst’s Rough Draft initiative, or FRC’s Dorm Room Fund)
- Using data and technology to identify talent
Winning (systematically finding ways to help companies be more successful and also win competitive deals)
- Using AUM to “productize” value-add. (for example: OpenView on the growth equity side and A16Z on venture)
- Leveraging the human capital of the portfolio to give value to the “platform” (for example: the FRC community)
- Tuning investment models to specific kinds of investing (for example: seed funds, sector focused funds, etc)
But by far, I think the single more important thing a fund can do is to improve their selection. I’ve blogged about this before, and I continue to think that there is a big opportunity here and we just don’t know what the answer is just yet. Getting better at sourcing and winning is important. But I actually think that the biggest difference will be the ability to look at an opportunity, and say “yes” when others say “no”… and be non-consensus “right”.
** One fun thing about this conference is that there was someone from Collective Next who was creating a mini illustration/idea map of the talk in real-time. Pretty cool – see below!
Nearly all VC investors have an ownership percentage they are shooting for. For most large funds, it’s 20%. I’ve blogged about the mysterious 20% ownership threshold before.
If it seems arbitrary, that’s because it is. Usually, this ownership number is justified based on what would be considered an ownership that is “meaningful” for a fund. But that logic kind of falls apart when you consider that “meaningful” should be totally relative to fund size.
Here’s what I mean. Take an example of a company that exits for $400M (which is relatively heroic when you consider the vast majority of successful exits are far below this level). If a $200M VC fund has 20% ownership, this exit returns 40% of that VC’s fund. That’s pretty meaningful! If that same VC were able to produce 5 exits of this scale, that would return 2X on the fund. Pretty good (but funny enough, still not spectacular considering that that is $2B in enterprise value).
But if that same VC is operating out of a $400M fund, those exits are HALF as meaningful. Each $400M exit returns 20% of the fund, and the 5 combined only return a 1X. Obviously, it gets worse or better as the fund size increases or decreases. You would think then that this would necessitate that larger funds target more ownership, but that ends up not really being the case. Instead, those funds try to invest in companies that can be “bigger”, but at the early stage, it’s hard to differentiate companies that could be $400M exits vs. $1B exits.
The reason that larger funds can’t consistently target more ownership (say, 30%+) is because of competition in the market. There are enough players out there that ownership tends to settle at the 20% range for new series A investors (and often series B investors).
One weapon that large funds do have is more capital. This can be leveraged in a couple ways. First, a larger fund is more able to wait. The thinking goes “if I’m going to only get 20% ownership anyway, why don’t I wait until the next round, and then invest. I might have to invest more ($10-15M instead of $5) but I still get similar ownership and presumably a lot less risk.
The other thing larger funds are able to do is compete more aggressively on the series A by expanding round size. The large fund may say to the founder,” wouldn’t you rather just raise $8M instead of $5M for the same (or marginally more) dilution?” It ends up being a pretty compelling argument. Although cost basis does matter to all investors, in a world where you are probably only going to get 20% ownership, the difference between investing $4, $5, or $6M to get there isn’t that meaningful.
Investors also talk about the concept of “buying up”. This means increasing ownership in a company over time. Again, larger funds are able to do this better by using their capital as a weapon and leading or co-leading later rounds, trying to do super-pro rata in the next round, or buying secondaries. But these situations are pretty hard to predict, so it’s tough for funds to try to do this systematically.
Where “buying up” gets a bit hairy is in the seed to series A rounds. This is why investor signaling is an issue. Almost all large funds are trying to get to 20% ownership, and in truth, they are expecting (hoping) for more than 20% ownership for a company that they seed. But for funds that make smaller, passive bets at the seed stage (eg <$500K) they are likely to have much less ownership than their target. Thus, these funds will need to try to increase ownership significantly to hit their 20% bogey.
For example, if a seed round happens at $5M post money, and the VC invested $500K, that VC owns 10% of the company. This VC now needs to buy an additional 10% at least at the next round to hit their target ownership. This implies:
- If the big VC isn’t trying to buy up, there is a risk that new investors will wonder if there is something about the company that makes it less attractive (negative signaling)
- If you want a new outside VC investor, you will end up with an additional 10% dilution if you are trying to keep everyone happy (assuming other seed investors just want to take their pro-rata or less).
And most VC’s that employ a high-velocity seed strategy invest less than $500K, which amplifies the problem.
Ultimately, companies raise capital from good investors if they are working on a big problem and are showing exceptional progress. The dynamics around VC ownership come into play once a few different investors are interested in a company’s round. But in the final innings of discussions with investors and deal negotiations, I find many entrepreneurs to be pretty surprised at how ownership targets drive the dynamics of the deal. It’s a little arbitrary, but it pays to be thoughtful about this stuff because it can have meaningful downstream implications.