Finding Value Beyond the Cash: How to Choose a VC
Clearstone Venture Partners
If you’re an entrepreneur seeking financing, this is for you. For 25 years I was part of entrepreneurial teams pitching for financing in 3 industries, 16 of them in technology sectors relevant to us. Sometimes I pitched to banks, sometimes to individuals and of course to venture firms. Now it’s January 2004 and I am on the other side of the table. It’s easy to see how wide the gulf of understanding is between entrepreneurs and their financiers, but also how true it is we all want the same things: success, significance and wealth. You’re more likely to get them if you choose your funding sources for value after the check clears.
In all the time I spent building companies, the most common sentiment I heard expressed by entrepreneurs about venture capital was succinctly summarized by the observation that, “90% of the value of a VC is delivered the day they hand over the check.” Now, it’s easy to understand why an entrepreneur might feel this way. After all, it is people in the company who actually do the work of transforming financing into value.
But the truth is, the start-up world is chaotic, stormy and unforgiving. Even the best efforts at building a business can end in failure, or what we call “walking dead” companies that are robust enough to live but too weak or irrelevant to accumulate value for an exit. So when raising money from venture capital sources, I always tried to assess the real prospects for added value beyond the money in venture capital firms. Your investors will usually end up serving on the board of your company and their decisions will affect the course of events in your business. Even if as an entrepreneur you believe their value is almost completely delivered in the form of a check, you will live with the people in a VC firm for several years. Their perceptions and behavior will have a profound effect on your company and your life. You might as well leverage their assets for everyone’s benefit. Since all cash is the same, and all terms have to be negotiated, this is my list of qualities I’ve looked for when evaluating which venture capital firms are a good fit for a business:
Real management perspective No founding or hired CEO will have uniform management expertise across all the functional sectors a company must build to scale. As a founder you might be well-rounded, but many executives with good leadership qualities are light on finance and operations, and many operating managers are light on market-making and concept leadership. The board must help to fill in the gaps while the CEO catches up to evolving requirements. You will want a board and associated professionals who have operating and company-building expertise you can tap when you encounter something new in the evolution of your business.
Powerful networks Don’t expect your board to find customers for you, but do expect them to open doors for partnering and grease the route to an alliance, and then use their relationships to help make sure alliances are supported by follow-through. Investors can also be rich sources of talent for referral into your company. Look for venture firms that have networks with reach in your market area, and a proven willingness to access them on behalf of portfolio companies.
Leadership on future rounds Raising a new round of funding taxes a company's management team and operations. Normally, you will seek an outside investor to establish the value of your company, but many factors can complicate this effort. Sometimes your company's progress lags behind plan. Maybe your chip didn't tape-out on schedule or your revenue forecast has slipped. Software has taken an extra quarter to bring to market. Whatever the reason, you have not achieved a critical milestone to win outside financing, though your business fundamentals are still strong. You've got a great management team, you have proven your market is robust and you're clearly positioned to be the market leader. But time is running out. Be ready for such a predicament. Now is the time to seek a venture firm that can actively help you build a syndicate for your next round of money, who can introduce you to the power players in other VC firms, and who will campaign for you behind the scenes. And in a pinch, they should have a track record for financing inside rounds themselves when the situation warrants.
Time and Energy Your business is going to be idiosyncratic and you must require your investors to put the effort into understanding its technical burdens, its market drivers, its revenue drivers, its talent requirements and its day-to-day management challenges. If your board only has the attention span to understand your business via a monthly PowerPoint summary, they are not going to be an asset for you or your management team.
Ambition Companies of lasting value – the market makers and category-creators – don’t get built on a tactical agenda. The trajectory of a company begins with the ambition of its market position and the scope of its solutions. Big companies rocket upward on the fuel of big ideas. Very few little ideas propel big and valuable companies in the technology business. You will want venture investors who are visionary enough to fund a large ambition rooted in near-term products that provide market traction points.
Objectivity This is the flip side of ambition. Every company travels an arc from launch. Along the way there will be a point at which peak value for effort & capital invested will have been attained. Missing exploitation of that window for harvesting value can have dire consequences for everyone involved. This is the most common self-inflicted catastrophic wound suffered by companies in the technology ecosystem. Clearstone works to help its companies become independent, IPO candidates. However, you will want a board that can balance ambition with an ability to objectively analyze and intuitively know if and when it is time to sell. That’s important for keeping the management team honest on the company’s market and prospects, and for making sure the board’s network for M&A assistance kicks in early enough to realize the desired result if an acquisition is needed. Possessing the judgment to not overreach when other people’s time and money are at stake is equally important as ambition.
Sophisticated understanding of the market for liquidity Companies, not products, are the vehicles for value accumulation. Uncertainty about how the public markets will value growth businesses in the technology sector is leading some venture capital firms to try for guiding a higher percentage of their investments to successful liquidity at lower average value. For this to work, businesses will have to be designed to be appealing to acquirers even if they are aiming for an IPO. You will need investors who are attuned to the camps of acquirers that inhabit every technology sector, their product and technology requirements for feeding the hungry beast of growth-driven value, and are willing to come to agreement to operate for liquidity objectives by designing your company for multiple exit options. Many companies aim for an IPO and hope for the best. Companies that assemble teams who understand acquisition dynamics in their markets can maximize the odds of reaching a satisfying exit. Having this kind of strategic sophistication on the board is invaluable for dynamically gaming the company’s course as a vehicle for creating wealth that can be harvested.
Board Savvy The CEO might set the agenda and lead the board, but on most boards a de facto leader emerges from among the investors. Become insightful about the personality factors of your prospective board members and try to anticipate or even select your dominant investor. Be sure that person is going to be an objective thinker and calm in a crisis.
Straightforward Communications If you allow a conflict-averse style of communications to dominate your board and investors discussions, the result is that board concerns about operations, operating style and results are sometimes expressed too late. Companies are hierarchical, action-oriented and decisive. Partnerships are collaborative and deliberative. When venture professionals are at the point of interface with their companies, a cultural chasm must be crossed. Communications are easily distorted and executive management has too little context for accepting direct input or intervention from the board. Things go mysteriously wrong in part because investors have too few contact points with the operators of the company. You need investors who have the courage of their convictions and the tolerance for argument as an instrument for finding answers efficiently, while still preserving relationships. Venture capital partners are busy juggling the intellectual challenges and management demands of several companies simultaneously, not to mention all the companies under evaluation for investment. It’s easy for your latest problem to be one more irritation. No matter how much you need the money, look for investors who communicate freely, have unlimited appetites for the chaos of company-building, who seek and establish relationships with your entire management team, and who embrace rather than postpone the arguments that derive from the circumstances of willing a new business to life.
If you focus your evaluations of venture capital firms on these factors, or similar ones you’ve learned are important to you, the human capital gained by your financing will become instrumental to your success, rather than incidental to it. Clearstone isn’t the only venture capital firm striving to earn your confidence as an entrepreneur’s preferred partner, but we are among the most proactive in building the staff and practices needed to deliver compelling value after the check.