by Jean-Louis Gassée
With great regularity, entrepreneurs complain about VCs who, in turn, never fail to bemoan the prime donne who think highly — and often too thinly — about the crystalline purity of their technology or business strategy. Today we look at five mistakes entrepreneurs often make.
A recent flurry of meetings with entrepreneurs, both local and from France, reminded me of the enduring ways in which entrepreneurs misunderstand VCs — Venture Capitalists, properly, but often muttered as “Vulture Capitalists” by the disdainful on the supplicant side of the pitch.
I understand. When I started Be almost 30 years ago, upon my desk sat two ceramic pigs dressed as butchers, the perfect avatars of my distaste for the VC profession. Unsubtly, I christened them Victor and Charles:
It amused me at the time, but I’ve since gone over to the Dark Side — I am a VC — and now would rather help entrepreneurs better understand our mores.
an important motive, a negative one: VCs need to avoid big, visible mistakes. This might sound like a contradiction, “venture” is in our name, nothing ventured, nothing gained. But consider our actual function: We are, first and last, a service business. We are fiduciaries, trusted intermediaries for entities or people called Limited Partners (LPs). They have large amounts of money but no competence or appetite for direct investment and shepherding of nascent businesses, the start-ups that are created by hardy inventors, engineers, and business people.
VCs invest money on our LP’s behalf and get paid in two ways. First, there is an up-front management fee, about 2% of the money entrusted to us. If the investment succeeds, we then get a cut, 20% or more, of the investment’s share of the profits that are realized by the “liquidity event” — the start-up goes public, or the little company is acquired by a bigger one. The other 80% is returned, of course, to the LPs.
Needless to say, this is vastly oversimplified. The VC industry has acquired many wrinkles since Général Doriot invented it when investing in Digital Equipment (DEC) 60+ years ago. But the core idea remains: We perform a service, we’re intermediaries between LPs and entrepreneurs…and the object of mixed feelings from both sides.
Just like entrepreneurs, VCs need to raise money. We go to LPs and make a pitch that explains our special skill set in investing in, say, microchips or cybersecurity — a bright but elusive future. LPs are conservative, they need reassurance that we know how to transmute what I’ll politely call their shapeless money into shiny doubloons, into the next Google or Facebook.
For comfort, LPs look at our track record, at the investments we’ve made. This is where an asymmetry comes up. No one will notice that we didn’t invest in Google, but everyone will remark on our digging a big $2B crater when investing in WebVan two bubbles ago, or, more recently, in WeWork. This is what entrepreneurs must keep in mind when pitching us. We like bold ideas, but not so big they’d create a risk for our track record. Even VCs with billion dollar funds worry about their results, they have to think about their next fund-raising campaign and the crisp, tall tales they need to tell cautious LPs.
This leads us to another of the entrepreneurs’ misgivings: They see us as Visionary Sheep, as investors who merely follow trends. Or, turning the metaphor around, they say we hunt in packs. There is some truth in those allegations, as summarized in the following table:
The worst possible outcome is failing all alone, you arrogantly thought you knew better, you didn’t take one of your brothers for the ride, and are getting your just deserts. Barely better is succeeding alone, you selfishly kept all the profits for yourself and your success makes the rest of us look bad.
If you fail with the group, it’s not so bad, there are plenty of excuses to offer one’s LPs. The Greater We thought blah, blah, blah, but the promised technology failed to materialize…
Succeeding with a group, or investment “syndicate”, is the mark of a serious, competent venture investor whose story goes like: We saw the technology/market wave coming over the horizon, we picked the best surfers to join us, and, voilà, a 50x multiple for your investment.
Such is our herd culture.
We now turn to a common optical illusion, that VCs “grant” a meeting to the entrepreneur. No. It’s the other way around. Entrepreneur do us a favor when they knock on our door. In our pitch to LPs, we love to brag about the terrific stream of visionary — but mature — entrepreneurs that have come courting. If entrepreneurs don’t come and pitch us, our joie de vivre disappears and we’re forced to beg a bigger fund to give us a small bite of one of their ventures. So, no favors, just cooperation, each playing their part. Entrepreneurs need VCs and VCs need entrepreneurs.
Another error in perspective is the immediate negative reaction when entrepreneurs are told they’ll see an associate, meaning a junior person, as opposed to a Partner, someone with actual decision power over the future of the start-up. Sometimes this is a test, a way for the VC to gauge the entrepreneur’s ability to handle frustration. If you think that’s the case, my advice is to walk away. VCs aren’t in the business of administering psychology tests, they ought to respect entrepreneurs as they are, as opposed to trying to teach them lessons.
Conversely, a savvy entrepreneur should see an encounter with a more junior person as an opportunity to make the individual a hero, the one who’ll bring a gold nugget to the elders. Treat the individual with respect and lots of good data for them to make your case at the next partnership meeting.
Lastly — and too briefly for such an important and complex subject: VCs are autocrats who want to own a majority of the shares of the entrepreneur’s creation. To some entrepreneurs, this is abhorrent, a loss of control over one’s destiny. And, look, Mark Zuckerberg and a few others before and after him managed to keep the majority of the votes around the boardroom table. Presenting yourself as another Zuckerberg starting the Next Big Thing may work at first, but more often than not, it leads to another WeWork.
VCs want to have control over your company because we promised our LPs that we would stay on top of their investments. Just as entrepreneurs have to keep their VCs happy so they can come back and ask for money when the need arises, VCs, too, have investors that they need to keep happy so they can raise more funds in the future. To keep LPs happy, VCs need to be show that they’re in control of the companies they invest in, as opposed to being passive investors clipping coupons.
There is, of course, more to Venture Investing than the points I make today, it’s not a science codified in a few easily stated laws. If it were, machines, or Machine Learning now, could do our jobs. But how do you codify innovation?