On VC Startup Myths
Venture Capital is both a fascinating career path for an individual and an integral part of the capital markets way beyond just technology today. Over the years these are the types of anecdotes and myths that I’ve gotten a kick out of. They are painfully obvious to me now, but once weren’t.
Because of the power-dynamic involved with capital it’s always good to understand how as an industry finance really works. This is my short effort to demystify startup VC inner workings and myths.
- The multiple term sheet myth – Funded companies usually get 1 term sheet, end of story. This is not anecdotal, it’s from primary evidence and VCs agree. The reason I point this out is because people love to talk about capital-availability and I realized at some point that founders / journalists think once a company gets 1 term sheet, it unlocks some magic dust and they get a bunch of others through FOMO. No. Why do only 10-15% of companies (the funded sample of course) get 3 or more term sheets, some 2, but the majority 1? This dynamic is complex. Many times people know when you have a term sheet, not even because you told them, but because the Valley is small (see point 4 below). Other investors are reticent about putting a term sheet out if theirs is going to be rejected. This is very painful for VCs (getting rejected) since they have to advocate then go back to their partnership and tell their peers you chose someone else, and if that happens too many times the partnership loses confidence in the partner. But the main reason may be this: just as every person is a snowflake, every company is too – you may only have one person who falls in loves with you. The good news is that one is enough.
- Your prospective VC is on Twitter myth – I don’t know why this myth perpetuates beyond that marketing for brands is powerful. 80% chance your eventual VC does not tweet. This may be painfully obvious to some but it’s a myth that exists nonetheless. I only point this out because it genuinely seems to me from talking to some founders that they think the people who are active on social networks are their main targets in a financing. Every firm (think about one you have in mind) has 1 or 2 people who are tweeting a lot. This can lead founders to think of that individual when they think of that fund. But there may be 8 or so other partners. Make sure you know that most partners are behind the scenes. A different person may be the right partner for you in the firm, and if you initially reach out to the wrong person because they are on Twitter, you are doing it wrong. Maybe the meta point about twitter is a lot of myths perpetuate because of the medium itself. Worth keeping this in mind.
- Your VC is a contrarian thinker myth – By definition contrarian means contrary to what the group thinks. I think what confuses people around what’s contrarian and what isn’t, is that most funded businesses only get one offer. Because most deals are not competitive, VCs improperly conflate that because they lean in to fund you – that they are ‘contrarian’. No. They were just the only one to give a term sheet for the above mentioned dynamics, or 1 of 2. Really folks, it’s more that the term ‘contrarian’ sounds cool (I love it too!), end of story.
- Your pitch is private myth – Silicon Valley is not a place anymore… it’s a mindset. Every investor is connected around the entire world and everyone seems to know everything. When you email a VC you spoke to here is what happens: their market is always desiring complete information and the partner gets the email/deck etc, then sends it across the firm, into the firm’s CRM, etc. Within 24 hours the VP / associate inside firm A goes to lunch somewhere in South Park / Sand Hill, sees her friend who is an associate at firm B, and he / she learns everything about your deal. Yes – information really does flow like that. So that new firm not only knows what you pitched, the valuation you’re seeking, but also whether the original firm ‘passed’ etc. All because everyone is connected and that’s what happens over lunch. Dynamic for a different post and this has been covered well by others, but that’s why fundraising needs to happen on a tight timescale. The takeaway here is that social norms are much different for what info is shared.. so be careful.
- Investor: “I passed on that deal” myth – This is a funny one. You will often hear investors say in conversation “Yeah, I passed on that deal”. Often this is some virtue-signaling. Not all the time, but often. Here is what I mean. Sometimes someone really did pass… but other times, and in fact almost 80% of the time, they didn’t pass. They just didn’t put an offer in and told the company something like “come back to me when you have x”. Think about it. When was the last time you heard a VC say “Oh I got rejected from that deal”. It’s much easier to say “I passed”. Back to the multiple term sheet thing, say a company talked to 20 investors and found 1 lead. Say 19 passed. But 4 of the 19 were also close to investing. Think through what would have happened if those 4 also gave a term sheet. The company would have 5 offers! This means the founder would reject 80% (4 of 5) and choose just one and sign that term sheet.. So often it’s a weird subtle display of insecurity when an investor brags they passed. Here’s what I often think back when people say that to me: so if you even had an opportunity to invest, would the company have accepted you? Passing often means they heard you have a term sheet and decide not to compete, and this is a virtuous cycle as to why companies receive one offer.
- Your VC will spend tons of time fixing your problems myth – Great VCs are just that, great VCs. They may be involved in key company tasks at a high vantage point or really help with some hard problems (they should if they are good). I once heard a quote that sums it up well from a long-time founder: a good VC is sort of like a Director Level hire within the company in terms of stature, ability to help, etc. Maybe not as influential as a VP / Executive, but a great Director. That seems fair and may be a good way to think about it. Either way, understand that you will sometimes spend 24/7 thinking about your company, but most investors have about 3% of their time, or about an hour a week for you. Unless you are doing really well (or really poorly) expect this to happen in lumps around board meetings. Be really smart around how you are spending money and around being influenced by VCs, since they may not predict Trapdoors as well as you should.
- Your investors are ‘supportive’ myth – Yeah I get it, you have supportive investors, everyone does. Support actually means one thing more than any other: that if you are running out of money, your investors will financially support you. I am not saying they should or that you should expect it. But support really boils down to that. Otherwise, anyone is ‘supportive’ when you have money left in the bank.
- That a deal is done at the term sheet myth – the reality is all kinds of terms get thrown in after a deal. The farther down the growth path (series C and later), the more terms. When financing documents go from term sheet (2 pages) to lawyer-clawed documents that are 25 pages, new terms get added. And they can add percentage points of dilution to the company. I had a frank conversion with a well accomplished VC who admitted many partners / funds add onerous terms that favor them. Why would a VC do this? Because they want to have better looking terms initially to get the founder to sign their term sheet if there are other offers. I have seen a lot of weird stuff fly here. I heard of a Series A investor who after a term sheet was signed added crazy things like the company would pay for a bunch of his first class airfare to fly places to ‘help’ and negotiated this hard. WTF? When lawyers get involved in anything… things can get weird. The back and forth between legal teams in finalizing a deal inserts a palpable tension since the investor has nothing to lose and the entrepreneurs have everything to lose if a deal falls through. This fact is well known—so I am not exposing it as a myth. But I am saying that term sheets can actually change after a deal. Only a completely psychopathic VC would do something like add a liquidation preference into a deal after it’s signed (that’s super unethical) but they are prone to negotiating some terms dramatically in their favor (e.g. a 15% option pool that isn’t necessary, which in the next financing gets added back in a way that increases dilution for the company), unfair stipulations on how or when you can raise other capital, unfair founder stock-option re-vesting arrangements (yes, vested options re-vesting from scratch) and a variety of other things. Look out for this and be prepared going in and reference VCs with other founders before you sign. Leverage is gone afterward.
Overall, venture capital as an industry has changed the world greatly and will continue to do so at an accelerated pace. The ability for companies to use funding for growth has led to magical outcomes for the people involved, both in the US and across the world.
But like all areas of finance, things works differently than they appear on the surface. And just like in any industry, money can make people do and believe crazy things, while the social echo chamber and feedback loop can serve both to perpetuate and to expose industry myths.