Right around the turn of the millennium, a startup named ArsDigita was born, flourished, and died a horrible death. The entrepreneurs blamed the venture capitalists and circulated their Tale of Woe far and wide.(1) I’m less than sympathetic. If the entrepreneurs had done their homework before eagerly accepting gobs of money, they might have understood the risks of accepting that money.
Having heard a bit from both sides of the ArsDigita story, there seem to be several lessons lurking here for entrepreneurs:
Understand what you’re getting into when you bring in outside money. Read the documents. Choose VCs who know how to run a business. Know how VCs are motivated, and understand that the very nature of VC deals gives the VCs a far better deal than you’re getting.
Read everything you sign. Twice. With lawyers. One ArsDigita founder mentions that the VCs invoked a clause out of the "phonebook" of financing documents. His naivety is touching…Didn’t he notice the quiet guy sitting by VCs? That was their lawyer. It should have tipped him off. They had a lawyer review the thousand-page document. He should have had his own lawyer go over it with a fine-tooth comb.
When you accept money from investors, you’re making a commitment. But you’re not committing to a vision. You’re not committing to a technology. You’re not committing to a dream. You’re committing to providing a certain return on that money to your investors in a certain timeframe. It’s an economic arrangement, and if they disagree with how you’re going about that, they almost certainly structured the deal so they can pull rank.
There’s no reason to believe that any given VC knows anything about running a business, or even choosing managers to run businesses. Some do, but a lot don’t. Many have never held an operational job, and even those who have didn’t necessarily learn from it. And even those who learned didn’t necessarily learn lessons that apply to your business in the current business environment. (Keep in mind that their rule of thumb is 2 home-runs, 2 failures, and a bunch of in-betweens out of a portfolio of 12. That’s called a "normal distribution," ladies and gentlemen, and may mean that most VCs aren’t doing much better than random.)
Furthermore, no matter what a VC thinks about their own motivation, as long as they are investing other people’s money, legally, their first priority must be making money. Their funds have a time horizon, and they own a portfolio of companies. That means when push comes to shove, harvesting your company is more important than your company’s mission or sustainability(2). And if another of their portfolio companies looks more promising than yours (say a 10x return in 2 year versus your 5x return in 7 years), that company will get more time, attention, and subsequent reinvestment. It would be bad business from the perspective of the VCs to spend their resources any other way.
And remember: you have to hit certain targets over several years in order to “earn” your equity in your company. They get all their equity simply by engaging in a one-time financial transaction. Unlike you, they are under no onus to do anything once they’ve put that money in. And if another portfolio company suddenly gives them the needed return on their fund, unlike you, there’s no vesting schedule or performance-based incentives to keep them interested or motivated. I’ve coached a CEO dealing with an outside VC that wanted out of the deal simply to simplify their own portfolio management. The VC was pressing to liquidate the company so they could get cash back out of the investment.
Remember: about 85% of a V’s investments aren’t home runs, and it may be their own fault. We rarely hear much about any except the home runs (“I started and grew a mediocre company” doesn’t make the cover of Fast Company).
That said, the right VC can bring a lot to the table when paired with the right management team. A VC can bring legitimacy, the ability to attract top management, and the connections to bring a company to the next stage of growth. But be very careful about what you’re getting into before you sign on the dotted line.
(1) I will not reprint the stories here. There has been a lot of litigation around the case, and I want to keep my distance. It’s juicy, though. Search for “ArsDigita lawsuit” on the web and you may find something on your own. back
(2) I made the mistake once of thinking that the finance community cared about sustainability. Maybe Warren Buffett and a handful of value investors do. But my experience is that this attitude is the exception rather than the rule. Learning that lesson cost me the chance to make $6.5 million … please learn from my experience! back