This is gold, I would read this blog post pic.twitter.com/vdPbq7n6YW
— Jarrad (Moose) Lawrence (@JarradLawrence) Nov 3, 2022
To my surprise, the more I looked at this tweet’s claim that “for startups, the best VC is the worst VC”, the more I began to realize what my AI bot doppelgänger meant.
Under what circumstances can “the best VC” become “the worst VC” for your startup? And perhaps more interestingly, what makes one of “the worst VCs” “the best VC” for your startup?
For all the other unverified Twitter bots reading this column, today I’m going to do my best to answer both questions!
When the best VC can become the worst VC
Great VCs can be bad for startups because of the way they try to manage their risk, how they tend to match patterns when evaluating potential investments, and how they sometimes tend to force too many of their portfolio companies into the same. template to use for success as the best performing companies in the portfolio.
The risk of becoming a VC . to be
Perhaps we all get so caught up in the risky, arduous journey of running a tech startup that we forget (or never realize) how risky and arduous the journey is for venture capital founders.
Initially, most founding partners in a venture capital fund are expected to contribute a significant portion of their own savings to the fund, as a sign of confidence in their own ability to make smart investments. They are then expected to be without a salary (or a salary well below the market rate) without a salary (or a salary well below the market rate) for an unknown amount of time, especially until the venture firm has enough of the capital. of its investors that are beginning to cover the typical management fee of 2%. office space, employee wages, marketing and travel expenses.
If you do it right, it will probably take at least four to five years for the founding partners to earn a market salary, and in the meantime, what the management fees don’t yet cover, the founding partners will find themselves in the pockets of partners. What makes it all worthwhile for the founding partners is their share of the “carry” – the profit made from selling the fund’s interest in the portfolio companies in which they have invested.
But they see money coming into their bank account only after all those shares in startups have been sold to someone else (which usually won’t happen until years 7-10 of the fund) and then, only after the fund investors have received an amount equal to to the amount they first invested in the fund.
It is also important to remember that the vast majority of funds under management are provided by outside investors (“limited partners”) who expect an exceptional return on their investment.
Like, 5x or more their money back. While most funds managed by VC firms have a 10-year period to deliver that high return, most investors will start predicting the ultimate return results based on what they see in the fund’s performance in the first three up to five years.
A VC’s hot streak must be ridiculously long
All of this means that all venture capital firms — even the best — are run by people who are motivated to make it seem like they know exactly what they’re doing, all the time, even when they might not (at least, not always). And they have to maintain that for the entire ten-year life of the average fund.
When “black swan” events happen (like, oh, say, extreme weather events exacerbated by climate change, a reality TV star becoming president of the US, a global pandemic, widespread famine, a collapse in economic growth in China and a war in Europe) a venture fund manager must be able to maintain the confidence of its investors. They need to be sure that while no one really could have foreseen these black swan events to happen, the risk fund is still in equilibrium.
The longer a venture capital fund manager maintains a reputation as a successful navigator in challenging times and an excellent choice for future startup value, the more valuable that reputation becomes, and the greater the impact on the individual and the company, if that reputation is lost.
This leads to pattern-matched behavior
It is simply the human nature of each of us to repeat behaviors that have led to success for us in the past.
So if a VC’s reputation is built on investing in, say, SAAS startups, founded by two white male ex-Atlassian engineers from the CIS and focused on mining, the VC has a lot to do on its own to be both the conscious and unconscious biases that might otherwise lead them to favor similar SAAS startups founded by a couple of white male ex-big-SAAS engineers from the CIS that focus on industries akin to mining .
Usually, the only opposing forces that motivate them to work on those internal biases are a conscience and a belief that a greater diversity of portfolios yields better financial returns. And as a VC’s reputation for picking winners continues to grow, so does the number of new deals that pass their agency.
Why learn more about new industry sectors, new technologies and how to relate to founders who are not CIS, white and male, when repeating the same patterns that have brought you success in the past will help you cope the increasing number of inbound pitches you receive?
Don’t tell investors which other investors are interested
Maybe you and your fellow CIS white, ex-Atlassian engineer co-founder just had a great first meeting with one of the “A-List” tech venture capital firms, or maybe because they’ve really worked on their biases, a partner at an A-list company met with you, even though you don’t fit their template for previous success.
You’re excited about how interested they are, and you know their name carries a lot of weight in the industry, so when you go to your next investor meeting, and they ask you, “who else wants to invest in this round?” It’s a huge temptation to drop the A-List VC name.
Don’t do that, even if you have a term sheet from the A-List VC in your hot hands! Do not mention names of persons or companies. Why?
Because that smart partner’s strong reputation with that A-List VC swings both ways; other investors place great value on what the smart partner is interested in, but also in what the smart partner decides they are no longer interested in.
If you try to tie an angel investor or a team from another fund into the investment round, the worst signal they can receive is when that widely respected investor you humbly bragged about before finally decides not to go ahead with the investment. .
Seeing an A-list company walk away from an investment round before it closes is a surefire way to make other investors lose faith in the deal as well, and is probably the most common way a great VC can be a bad VC for your startup .
We want you to be more like Startup X
Once a company has decided to invest in your business, they will all want to give you some advice, support and services.
It is cheaper and easier for them if all their portfolio companies use the same legal, accounting, recruiting and marketing service providers. It reduces the reporting headache if you all report your stats in the same format using the same reporting tool.
It helps them sell their next fund to their existing investors if it’s easier to develop a narrative around an investment hypothesis that supports a particular friendly of tech startup is the secret of the success of the VC company. And if you’re not much of a startup when they first invest in you, there can often be a subtle or not-so-subtle encouragement to become.
I believe that every tech startup is special, unique and different, and no matter how hard we try to make the next generation of startups look and act like the last, history clearly shows us that it’s the outliers, the misfits. and the eccentrics are the ones who make the big successes.
Every A-List VC firm I know of has something like “we’re here for the outliers, the misfits and the eccentrics” in their marketing copy, but you should take a look at the portfolio and decide if the curtains match the curtains, so to speak.
When can the worst VC be the best VC for your startup?
If we might define “worst” as new, unknown, without a reputation and “without much of a full service offering” then maybe the worst VC in town to start with might be the best VC for you.
The fund’s partners are just getting started and they need to write some checks with a number of new companies without further delay – most funds write their first checks within the first two or three years of the fund’s ten-year existence. . If they optimize too much for due diligence, they will likely take too long and investors will become frustrated with a perceived lack of action.
So new fund managers are sometimes (not always) more open to “outside the box” startups and founders who don’t fit the traditional pattern.
A fund or fund partner without much reputation at risk is less likely to hurt your chances of closing a round if they decide to pull out before the round is complete, so I wouldn’t mind telling potential investors that we received a term sheet from Brand New Tech Ventures, while I would be very wary of telling another investor the identity of the A-List fund that sent me a term sheet.
Just say it’s one of the A-list funds, with your best cheesy grin.
Finally, a new fund is less likely to try and get you to meet their portfolio standards — to grow your ARR as fast as the fund’s top three, to hire your CFO from the same bank where they do all their other Hiring CFOs, or to adopt goal setting and reporting standards that will probably never suit your team and your startup.
Sometimes the best VCs can be the best VCs for your startup. But not always. And that is why the bot is not wrong in this!
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