As I was thinking of writing this post, I was sitting in my hotel room at the Nantucket Conference, a gathering of a small group of entrepreneurs, venture capitalists, and industry professionals, all united by the process of value creation. Of course it took me a couple extra days to actually get these thoughts down, but here goes.
What do I mean by “imbalance”? In general, the relationship going in isn’t equally weighted. Why? 1) Venture capitalists go into to deals with their Eyes Wide Open. They have likely studied the space and other companies in the space. They’ve backed companies before. Venture capitalists look at more deals in a month than a typical entrepreneur will work on in a lifetime. 2) It can take an experienced venture capitalist a few minutes to do a first-pass evaluation of a deal (based on team, market, idea, timing, overall opportunity) and get a sense for next steps, but it takes an entrepreneurial team years to build products, hire and shape a company, devise a strategy, and create real sustainable value. 3) Venture capitalists become EXPERT at evaluating deals. Few entrepreneurs are “expert” at raising money. 4) Venture capitalists are experts at negotiating venture financing deals. They’ve seen many different types of deal structures and have experience with what works and what doesn’t work. Entrepreneurs have some experience and if they are lucky they have a sense of what they’d like to see happen. 5) Deals typically have “down-side risk protection” built in to protect the investors’ downside in case things don’t go well. Entrepreneurs’ only downside protection is the fact that it’s usually not all their money at risk 🙂 6) The venture capitalist will likely join your board. The board’s main responsibility will be to fire/hire the CEO. If this position is currently held by you, recognize what you are getting yourself into. So what can you as an entrepreneur do to get the relationship to point where there is more balance? 1) Go in with the proper expectations. You are asking someone else to put up the money for you to pursue your dream. That money isn’t free and it’s not an obligation that you take it; it’s a privilege (as long as you choose the right partner). 2) Build the onion. Get the best advisors to advise you and help you figure things out. 3) Get initial support and be in a strong position to demonstrate progress. Early angel investors can be great for giving you some headroom while you are prototyping or getting initial customer traction. More traction = more leverage = more interest in your deal = more competition for your deal (even in this environment, some deals are getting done) = better deal for your company. 4) Realize that if things go well, everyone will (hopefully) be happy, but if things go badly, everyone will lose out. 5) Understand venture capital deal terms and focus on the totality of the deal, not just the valuation (preference, participation, drag along, board voting, board composition, option pool, etc). 6) Have a great lawyer + advisors who can review all your term sheets and deal terms. 7) If possible, be personal friends with a venture capitalist (who you will never pitch for money) so you can ask for inside tips on the process and on deals etc. 8) Consider yourself fortunate to be in the position you’re in, and know that the VC’s who back you will be lucky to have backed you! 9) Be high-integrity and sincere always. Depending on which type of entrepreneur you are, you’ll likely be seeing these folks again and again. You’ll probably have multiple chances at bat. Entrepreneurs everywhere will be rooting for you! Not sure if this is helpful, but the imbalance in the relationship between entrepreneur and VC is real. If you can go in with your Eyes (not) Wide Shut, you’ll have a better shot at having a good outcome.