9 Pithy Insights On Venture Capital

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9 Pithy Insights On Venture Capital


The venture capital industry is alive (and doing well).  Despite my ongoing efforts to convince early-stage entrepreneurs (particularly those building software companies) to forego venture capital for as long as possible, it continues to be a popular pursuit.  Guess I’m not yet as convincing as I need to be.

So, assuming that I have not talked you out of deferring the quest for the early-stage VC round, I’d like to share a few insights that I think will help.  You may know most of this already, but chances are there is one item on this list you may not have thought of.

Pithy Insights On Venture Capital

1.  Remember that VCs have a diversified portfolio of investments and can spread their risk.  You can't.  Don’t try to compensate by pursuing a bunch of different ideas simultaneously with the hopes of diversifying your risk.  It doesn’t work that way.

2.  VCs negotiate term sheets and financing deals for a living.  You don't.  Accept this imbalance early and find great advisors and counsel.  VC negotiation, even in early-stage deals is highly nuanced and reasonably complex.  

3.  Partners at VC firms have one big constraint, and it's usually not capital, it's time.  The time it takes to find new deals, explore them and continue to oversee their existing portfolio companies.  Understand where the partner is in terms of their deal flow.  If they have already closed a couple of deals this year, it will impact your chances of getting funding from that partner.  This is not a reflection on you or your idea, but is often purely a function of timing.

4.  Remember that you are being measured on a relative scale.  It's not good enough that you have a great idea and team, it has to be *better* than the other opportunities a VC is considering.  If you’re talking to a top-tier, successful firm, they’re seeing a lot of great ideas and teams.  Most partners in venture firms will do only a few new investments a year, regardless of how many “great idea and great team” opportunities they see.

5.  You raise money from a VC firm, but you work with a specific partner.  Know your partner.  This is the individual that will either bring immense value to your startup or make your life miserable (or both).  Next to your choice of co-founders, this will likely be one of the most significant people decisions you will make.  Don’t take it lightly. 

6..  Transparency is crucial.  Don't try to hide facts about the startup you know are important.  They will come out eventually, and later is rarely better for you.  From a VC’s perspective, the act of hiding unpleasant facts is in many cases a worse signal than the fact itself.  It goes to the integrity and behavior of the founders.  

7.  Time is usually working against you.  You're better off getting a deal done quickly (as long as it's reasonable) than dragging things out for the best possible deal.  If you're looking to raise money, focus on the critical factors and get a deal done.  You are generally better off getting a fair deal done quickly and efficiently vs. seeking the “optimal” deal.  

8. Between the time initial terms are agreed to and when money shows up in your bank, a lot of things can go wrong.  Plan accordingly.  No deal is “done” until the money is in the bank.

9. Never underestimate the intelligence of a general partner at a successful VC firm.  It is a highly competitive industry and though impacted by a “who you know” phenomenon, they don’t suffer fools for very long.  Chances are very high that a partner at a VC firm is highly intelligent.  They have to be.  It’s a tough business.  If you think the VC you are talking to is stupid, you’re talking to the wrong person or the wrong firm (or both).

Bonus Insight (and my favorite one):  Remember that VCs are looking to optimize their “risk/reward” ratio.  As such, it is often to their advantage to get a “costless option” on an investment opportunity.  Said differently, let’s assume they sort of like you and your company.  The deal terms they need to give you today (i.e. the “price”) may not be that different than the deal-terms they’d have to give you 4-6 months from now.  During that time, the risk in your opportunity gets disproportionately lower compared to the “higher price” they’d have to pay later.  The only reason for them to do the deal now is if there is competition for your deal and they may miss out on the opportunity (i.e., a “costless option” is not available).  If, on the other hand, there is no competition, they’re often better off waiting.  If they’ve maintained a good relationship with you in the early days, chances are you’re going to go back to them in a few months anyway (once the business is further along).  Effectively, what they have is an “option to invest later” which didn’t really cost them anything.  At that point, they will have much better insight into you and your idea (and how you deal with the inevitable fact that the business you thought you were building is likely not what you end up building anyways).  All of this is a long-winded way of saying:  “The word maybe is one of the most powerful tools in the VC tool-chest”.
If any of you have experience in the VC industry, please share your personal favorite insights.  I don’t think we as entrepreneurs share enough of this amongst ourselves (most of the information out there comes from VCs themselves or lawyers and advisors).  

Posted by admin_onstartups.com admin_onstartups.com on Fri, Nov 03, 2006


Good stuff. I might add (if I may) "Define Victory". Knowing what you want as an outcome is important and often overlooked. In my experience, most entrepreneurs are not great at raising money, and leave it until it is late in the process (guilty as charged). That means that they spend more time trying to understand term sheets, talking to counsel, etc. rather than making sure that the outcome of the VC investment is supportive of what the entrepreneurs wants to do ("victory").

posted on Friday, November 03, 2006 at 1:08 PM by Dave Patrick

Interesting post. Let me ask you a question. I don't see a VC's adding any real value other than money and connections. This runs counter to everything you read - but you shouldn't believe everything you read. Take successful companies like Sun, Yahoo, whoever. Are you going to tell me that the VC's were giving them tangible advice on product development. Were they giving those companies advice that the founders or executives didn't already know. I think for marginal startups that make it to an IPO and then the stock doesnt go anywhere probably would not have made it to an IPO if it wasnt for the VC's. New industries like the internet in the 90's and nanotechnology today are not well understood by the VC's when they arise so where exactly does the VC add value. I understand there are lessons learned that the VC can pass along and that is worth something. Did Google need VC's/ My guess is far less than the vC's think they are needed. Venture Capitalists do not add anywhere near the value they think they add and I am looking to find any study that quantifies exactly what this profession does to earn the perception that people have of them. I sense smoke and mirrors MBA style but I don't know. Any thoughts?

posted on Friday, November 03, 2006 at 1:37 PM by Herman

Damn good post and essential reading for start-up entrepreneurs!

And, early stage startups ought to closely pay attention to your (hard-won) experience "...my ongoing efforts to convince early-stage entrepreneurs (particularly those building software companies) to forego venture capital for as long as possible...".

Dharmesh, I've Dugg this article and I'm going to post to my blog because your observations as expressed within this article are essential reading, especially for software and Web 2.0 entrepreneurs.

posted on Friday, November 03, 2006 at 4:52 PM by Sheamus

Dharmesh, you are right on about the "costless option," where an investor strings you along while you scramble to reduce risk. Many firms will simply never tell you "no," only "maybe." Your only recourse is to get a term sheet from another potential investor.

Herman, Sun Micro absolutely got good advice from their investors about product development. You better believe it! Dharmesh, you're quite right that partners at top-tier VC firms are highly intelligent and accomplished people. Like you said, if the people you are talking to at a VC firm don't seem intelligent to you, it's really a bad idea to take that firm's money. You WILL regret it later on.

posted on Friday, November 03, 2006 at 5:59 PM by Ollie Jones

Some more advice fwiw. Get to know a potential VC's geographic preference. It seems extrememly odd to someone sitting in the middle of a major research university in the Midwest or the UK but VC's are just not interested in investing in any company that involves air flight to visit. You can argue that this has got to be short sighted, that they are going to limit their options, that there are great programmers at lower cost in Ames Iowa, but the VC is only interested in funding companies in their back yard. So be prepared to move. If you need early VC funding go ahead and move *before* seeking money. Borrow office space from some one at 2800 Sand Hill Road. That should be close enough.

posted on Tuesday, November 07, 2006 at 8:26 PM by Stiennon

No, Herman, VCs don't give you product advice. They give you business advice. They know the industry, so their advice is much better than your average MBA, who know how to manage the cost side, but not the upside of businesses.

If you get VC money, you get VC people on your board.

posted on Sunday, November 19, 2006 at 6:33 PM by David Locke

Great blog. I could have made this comment on many of your posts, and the fact it ended on one as far back as November tells you I spent a lot of time here.

I'm a VC and promoting transparency is one of my goals with my blog. This is more difficult than one might think, largely because we are all small partnerships with opaque internal working proactices, but I'm going to use your post here to try and help bring some clarity.

posted on Tuesday, April 17, 2007 at 8:12 AM by Nic Brisbourne

Would looking like your VC help? I am referring to this advice: http://smartstartup.typepad.com/my_weblog/2007/09/secrets-of-rais.html Is this hot on the east coast too?

posted on Wednesday, September 26, 2007 at 3:28 PM by Capital Seeker

I recently returned to the uk after 30 years in Hollywood. I have been in showbiz since 57 and want to make great low budget movies here. I need a successful broker to raise the £££.

posted on Wednesday, March 26, 2008 at 9:19 AM by PAUL MARTIN

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