by David Holtzman
Like virginity, Venture Capitalists are better appreciated as a concept than a reality. Knowledgable tech executives privately hate them, although they're afraid to show it publicly. Lawyers and investment bankers work with them and see them socially, but mumble under their breath, complaining about hubris. The press loves them and politicians put them up on pedestals. They control truly vast amounts of wealth; none of it theirs and can wave their hand and turn a punk into a philanthropist.
How do they work?
VCs have partnerships that manage multiple funds. Each fund is invested in by Limited Partners, who are usually institutions, sometimes high net-worth individuals. They can range from 30 million to a billion dollars. Some firms manage 10 funds simultaneously by the same small group of partners. They invest in companies, usually at an early, risky stage, and take a sizable percentage of the company in return; ideally around 40%.
What's a VC like?
They used to be senior executives in related industries. They would bring a wealth of operational experience, connections and mature decision-making to the young companies in addition to money. It's different today. Most VCs are young, ivy-league graduates with MBAs. Some of them also have a short stint in technical companies and engineering degrees. Most of them dress the same, high end polo shirts, khakis, comfortable shoes and maybe custom blue blazers.
What's good about them?
As individuals, they're intelligent, social and upstanding members of their business community. As an industry, they inject badly needed capital into the areas of our economy that would most benefit from innovation. As an investment, they're superb, often returning 2 or 3 times the original amount to their LPs, many of whom are pension funds.
What's bad about them?
It's a myth that they offer a lot of value to the fledgling company. They could, but only as long as they're actively engaged. Most of them are involved in half a dozen businesses at a time and it's too easy of them to lose touch. The biggest problem is that they don't really understand business as a seat-of-your-pants visceral pursuit. Business is about integrity. VCs are not. That makes all the difference. True entrepreneurs create their companies one relationship at a time and need to be able to count on their partners to watch their backs.
VCs have their own agenda at three levels in addition to helping to build the business that they've just invested in. One is to get the highest return for their LPs. The second is to make their firm look good, regardless of which fund is involved. The third is to win their internal power struggles with their partners. When you're seated across the table from a VC, remember that you're dealing with a cast of dozens of people, many of whom you will never meet, all of whom will soon have vocal opinions about your business.
VCs take board seats. As Hamlet said, "Aye, there's the rub." They can kill a company through bad actions, through inactivity or most commonly, by maneuvering the fundraising process so that the company is critically dependent upon them for follow-on funding, then like a street dealer, withholding the fix until the price sensitivity disappears in a wave of shakes.
Yet, they're the only game in town. VCs are the only source of the early stage funding that are the life blood of rapidly growing tech companies.
I offer three rules for dealing with VCs
1. Don't take money from someone that you wouldn't comfortable socialize with. If you don't like them now, you'll despise them later.
2. Read the term sheet. Know what you're getting into now, so you're not surprised later. There are no "standard clauses". Every word may be important to you someday when you're getting sued or thinking about it yourself.
3. Stack the board with people that have stature and that you trust. It may not make a difference, but if the board turns against you, too, you will be a miserable human being.
Posted on January 12, 2006
