VC Binds that Tie

This past Thursday I had breakfast with an entrepreneur whom I met about six months ago.  He was raising his Series A round.  We met him back then, but decided not to pursue the opportunity.   He is a first class guy and understood our reasons for declining.  Nevertheless, since then he has referred other entrepreneurs to us. He contacted me this past week to talk about a dilemma he was facing and get another perspective on his situation.

After six months he has finally connected with a VC who gave him a term sheet.  He likes this guy a lot.  But he has a problem.  The lead VC is with a firm based out of the Valley and they are trying to build a syndicate.  In the process, he was connected to another VC in Silicon Valley at so-called ‘top tier’ firm with whom the lead VC would like to work.  While he likes VC #1, he doesn’t feel VC #2 really clicks with him, despite the overt feedback he is getting to the contrary.  In particular, VC#2 is trying to suggest business models and go-to-market approaches that seem rather cookbook.

He needs the money but doesn’t feel good about the conversations. What should he do?

The easy advice (and the advice I gave him) was not to jump into this relationship.  It is obvious that he will be tethered with VC#2 for a long time.  So chemistry matters.  More importantly, what is being signaled in the conversation is that VC#2 isn’t committed to the approach. Nor is it likely that VC#2 is committed to the entrepreneur as leader if the default approach doesn’t work.  This is the larger red flag.   So my advice to him was to (1) have a frank conversation with #1 and then #2 about his sense the #2 isn’t really committed to him, but rather the “opportunity,” and (2) work other connections from #1 to find an alternative #2.

The real point here isn’t the lack of chemistry. It is the VC-to-VC dynamic that underlies the issue.  Co-investments are unique points of VC intersection for an entrepreneur, but they are just points on a line for VCs.  We may co-invest in several deals together.  In fact, ‘showing another VC a deal’ is the currency of dating in the VC business.  It is the method by which VCs socially level themselves or raise themselves in the economic-social strata of VC-dom.   So VC#1 has not yet worked with VC#2, but wants to; hence the introduction.   VC#1 is less sensitized to the ‘fit’ issues because this is the beginning of getting into VC#2’s deal flow. 

This quid pro quo is part of the VC ecosystem and a binding tie for which entrepreneurs need to be vigilant.  Everyone wants to be or be in an “A” firm deal.  It signals status and selection survival, like being admitted to an Ivy League school. Brand association is valuable for the VC#1.  Even if this deal doesn’t work, the association will enhance his deal network and will give his a good co-investor logo to show his limited partners.  But the brand inheritance effect is ephemeral for the company.   It is there for the start-up as long as no one knows how the company is doing, usually around round B. But the individual VC is there long after the brand effect has dissipated.  The  question is whether the entrepreneur still is, too.

Comments

[jim Forbes]

He should get a picture of VC #2 at an anti-Bush ally and send it to Karl Rove.
This is the type of stuff I was alluding to in my piece in this week's online edition of DemoLtter. Your advise to the entrepreneur is great.
wonderful posts, Peter.

Best
Jim Forbes

[Megan Cunningham]

This revealing tale of ulterior motives should be #10 on Guy Kawasaki's The Top Ten Lies of Venture Capitalists:

http://blog.guykawasaki.com/2006/01/the_top_ten_lie.html

Not to presume VC #2 is sinister in his motives, but it's hard not to feel paranoid and cynical about the potential for unanticipated entanglements when reading stories like this. Then again, in my opinion most entrepreneurs should be a lot more cynical --or at least paranoid. What was that andy grove book called again? "Only the Paranoid Survive," right?

[RYK]

This is a great post, shedding much insight.

[Kempton]

Peter,

Thanks for sharing your insight here and I am sure the entrepreneur in question must have really appreciated your help. I am miles behind you in terms of experience or knowledge (probably not even in the same continent as you (smile)) but I am also trying to help some entrepreneurs (some are real green) up here in Canada.

These entrepreneurs are trying to get onto a new TV show (Dragons' Den) where they will be pitching their ideas to five rich VC type investors for real investment dollars (as oppose to a prize). And for many of them, this will quite a learning experience too.

Cheers,
Kempton
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P.S. Here is a link to some info on Dragon's Den and the pitchers. It may remind you and your readers what it is like to meet entrepreneurs in the really early stage of the game.

http://seanwise.typepad.com

Then click on the left side for:
Inside the Dragons' Den