22/09/2014

BLOG: Love Can Fade

There’s something very seductive about venture capitalist investment. Ready money, no guarantees, no loan to pay off; and all you have to do in return is share your profits by handing over a reasonable stake of your company. At least that’s what the brochure might say.

This is the story of a 12-year relationship I had with a London venture capital (VC) business when they invested £1.25m in Sift in 1999. As a CEO and business founder, the experience offers lessons which might be valuable to other budding entrepreneurs considering taking money from investors.

It may sound obvious, but names, funds and partners change. You do the deal with one set of people, but they can easily leave or be replaced. In my case, one of the initial investors was a fund that subsequently changed its manager (and thus my board member) twice, each with 

their own agendas and ambitions.

It is vital to cut deals right for the business, not those which impress the venture capitalists. For example, in November 2000, a month after our second round funding, we acquired CRM Forum Limited for approximately £500,000 and three per cent of Sift, but the day before we formally signed, we sat in a room and wondered if we should pull out of the deal. We felt it was wrong, but it was our first acquisition and, in our naivety, went ahead on the basis that we’d talked up the deal during the second round negotiations and wanted to impress. With more experience we’d have walked away.

Obviously taking investment means your stake will be diluted, but things get unbalanced when venture capitals have more than 50 per cent. It can encourage behaviour that is too fast and loose for a growing business. This can be exacerbated if VCs have invested at high values and your performance isn’t stellar; they can take risks betting on achieving a much quicker return than is in any way realistic for the company’s situation.

Depending on how desperate you are for investment, you may or may not be able to be fussy about who invests in the business. But don’t forget to keep your investor under scrutiny. This means comparing stories with their other investees. Look up the carrying value of their investment in you and find out about the constitution of the fund; for instance who invested in it and what they were promised.

Knowledge is power in all negotiation situations. This also extends to VC representatives who sit on your board. They will have personal incentives and you need to understand what deal they have struck with the investment fund they represent. For example, they might just need to prove themselves by doing deals (any deal), but they might also have an incentive to exit by a fixed date.

VCs are not like Angels. Your VC rep is not protecting and discussing his own money. He only cares about your business in the sense that he’s playing a squash match he wants to win. On the other hand, as a founder you care because usually it’s your money, and your life!

Investment should bring growth and the next challenge is to reinvent yourself as a CEO. The skills needed to found, grow and run a start-up are utterly different to those needed for a larger company and most founders can’t make the transition. They generally get kicked out if the company misses a step, particularly if by then they’ve lost equity control. The reality is that founder-thinking can easily kill a growing business and if you want to stay involved, you’ve got to reinvent yourself.

Apart from additional leadership and general business acumen, the key skill that professional CEOs bring to the role is a much harder-headed approach to decisions; in particular they’re prepared to call time on sacred cows! However, what a hired gun can never match is the passion and bloody mindedness of a founder. If you can marry the two skills by reinventing yourself as a CEO-founder, then it can be a powerful combination. But of course, get ‘founder’ off your business card pretty quickly.

This is not intended to antagonise venture capitalists, but I stand by my basic point that most VC investment structures establish an unbalanced relationship with a management team. There are obvious benefits to the entrepreneur as he gets money to spend growing his business, but the trade-off is always significant. Tread carefully!


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