The Entrepreneur/VC Dynamic
This strikes me as one of those really important topics that doesn’t get nearly enough airplay. I neither hear this freely discussed among industry participants nor among lead investors and the founders they are backing. Building a company is really tough, requiring incomprehensible amounts of effort, stress and personal sacrifice. Added drama is certainly not desirable, yet this happens all too frequently when mismatched utility functions cause disputes among owners at precisely the worst time - around a potential exit. The punch line is, as it is in every aspect of life: good, honest communication, trust and respect is absolutely critical. Without these essential relationship elements not only will outcomes likely be sub-optimized, but the pain and suffering along the way will make the journey far less enjoyable for all.
Many entrepreneurs want to build companies with the assistance of venture capital. VCs bring cash, experience and often valuable connections to the table. They can help mitigate financing risk and provide the resources necessary for the founders to execute their plan. It might also be that the founders don’t have the resources necessary to bootstrap or that the nature of their problem or target market has a higher bar for what constitutes the “minimum viable product” (as is the case with many enterprise-facing applications). Bottom line, the entrepreneurs have made the decision that either a bootstrapped or purely angel-financed enterprise is not the way to go, and open themselves up to taking venture money.
Venture capitalists want to help entrepreneurs build great companies. In the best case, they want to help entrepreneurs build great - and great big - companies. VCs have Limited Partners (LP), and the way venture math works is that achieving cash returns of 3x, 4x, 5x or more on LP capital necessarily requires “hits.” While one can certainly debate both the magnitude (“singles and doubles” versus “home runs”) and frequency (“Can I achieve a better mortality rate than the historical norm?”) of hits required to achieve LP return objectives, the real deal is that VCs need and want hits, and they want to be as heavily invested in the hits as possible. And the fervent hope of VCs is that the entrepreneurs with possible hits on their hands want to shoot for the home run and eschew the chance to stop at first or second base (to continue to torture the baseball metaphor). The alignment of entrepreneur/VC motives around exit potential - the Holy Grail.
As fortune would have it, while I actively seek The Grail, it is hard to find. And it is a holy mission, to be sure. Just why is this happy place of overlapping spaces in entrepreneur/VC Venn diagram so hard to find? And why don’t entrepreneurs and VCs always see eye-to-eye on the exit? So, let’s say you’ve got a super founding team with a great idea. Let’s also suppose that this team, while awesome, hasn’t had a big win yet. Most great teams are like this. You read about the unicorns in the paper, but there a lots and lots of other winners out there who are building great things and solving huge problems but toil in relative obscurity. And this might be their second, third or fourth try at greatness. Read: they don’t have tons of coin. Sure, they might have a nice life, but they haven’t taken millions out of a deal. So personal money matters - potentially a lot.
In the early days things are great. Company is doing well, growing, building great stuff, and the entrepreneur and the VC are in La La Land. Happy Happy Joy Joy. Everyone is working hard and working together to make the company a smashing success. Then it happens. The unsolicited offer from you-know-who. Distraction. Chaos. More distraction. More chaos. And let’s say the offer is low, way lower than the entrepreneur and the VC ever contemplated as being in the ballpark, but it is still a shitload of money. VC is thinking “In the nicest of ways, tell them to f*&k off. This offer is grossly inadequate. Why would we ever give up the future growth potential of this rocket ship for such a pittance?” Entrepreneur is thinking “Uh, uh, uh, what is my spouse going to say if I walk away from ($5, 6, $10) million dollars? What happens if something goes wrong, the business fails and I was the dumbass that walked away from ($5, $6, $10) million dollars?” BOOM! Misaligned motives 101. La La Land? No more.
This happens all the time. It is part of life. And I don’t want to hear about protective provisions, veto rights, etc. If the basis for decision-making is the legal hammer that the VC has over the founders, then you’ve got a big, big problem. Trust is lost - likely for good. Board dynamics will never be the same. I believe that there is one feeling that each party needs to have, and it is the only way to effectively navigate this emotional and financial minefield: empathy. Regardless of where the entrepreneurs got their money, IT IS THEIR COMPANY. And while they, as does the VC, have fiduciary obligations to all shareholders, it doesn’t mean having to say no to a bona fide acquisition offer simply because the VC thinks selling is a mistake. The entrepreneur needs to understand the VCs goals and the implicit covenant that was entered into upon taking venture funding, that building a big company was the shared objective. Now things can change in the stark light of day. The VC needs to understand that this deal could be a life-changing event for the entrepreneur, and while they might think the exit is dumb and can and should make the case as to why it is, they shouldn’t take a scorched-earth approach and burn the relationship with the entrepreneur - because THAT is dumb.
At this point the possibility of a little founder liquidity and other creative problem-solving approaches can be explored, but it can only happen in an environment of trust and respect. Both parties need to recognize that no matter what happens, the utility functions of the VC and the entrepreneur simply do not match in an early-stage exit scenario. They just don’t. And this has to be ok. Because if it’s not, the chance for establishing healthy long-term relationships between VCs and entrepreneurs goes way, way down. Investing in an early-stage company isn’t merely investing in a product, technology or service, it is investing in a person (or people) and a relationship. Building companies is necessarily a people business. And approaching these relationships from the perspective that “life is a marathon; not a sprint” is, in my opinion, essential to building a healthy venture firm for the long haul, and will ultimately optimize long-term returns as well.
