The Financing Conversation
I was at a meeting of venture fund managers last week where a panel of venture backed CEOs discussed the topic of “bad vc behavior.” It was a fascinating discussion, and, because of the quality of the entrepreneurs, a very frank one.
One scenario that was discussed at length, was when investors and founders do not agree on the merit of a liquidity opportunity. It was raised in the context of a transaction that is attractive to the founders, but not attractive to the investors — either as a result of fund dynamics or other return expectations. Almost all of the founders listed this type of scenario as one of their top concerns with accepting venture financing.
It is easy to see how a liquidity event can be viewed differently by a venture investor and a founder (particularly a first-time founder). What may look like a moderate return for a vc, could be life-changing for a founder. A venture investor is managing an entire portfolio — attempting to achieve an overall good return for his limited partners. A founder is singularly focused on his company, on creating a decent return for his investors, and on his personal return. Based on these, and several other dynamics, it is inevitable that the parties will have different objectives.
The way I have always tried to minimize these issues is to have the conversation about goals, objectives, return parameters, etc… early and often. The goal for investors and founders should not be to stay aligned, but to stay informed. To that end, the conversation should start before the first dollar is ever invested. The founder should ask potential investors direct questions relating to where they are in their fund, what type of return they are expecting, how much capital they have allocated to the investment, and what are their return objectives. Conversely, the investor should take the time to understand what the founder is trying to achieve. Is he trying to make enough to send his children to college, to retire in three years, or does he want to build a large company that he leads for several years to come?
The initial conversation helps each side pick their partners, but, as we all know, things change. Market dynamics, family dynamics, and life situations are constantly in flux. As a result, this conversation should be re-visited on a regular basis to make sure the parties stay in tune with one another. At a minimum, every subsequent financing event should be proceeded with a frank and candid conversation. For example, if a new investor is being brought in, does the founder understand the return implications and the new time horizon? If there is a valuation step-up, do both parties understand the how it affects return expectations? In my experience, it is often mid to late stage financing events, where new investors are being brought to the table, where investors and founders lose touch.
It is impossible to keep investors and founders in sync. What is possible, is to make sure each understands what the other is trying to get accomplished, and that financing strategy is created within that context. Anything else is likely to lead to a disconnect, frustration, and more panels about “bad vc behavior.”