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Are Venture Capitalists incompetent or just inconsiderate?

Today’s guest poster is Frank Ronchetti, CFO of a local startup in Boulder. His “ask the vc” question became more of an observation and I thought that I would post in its entirety and then comment below. Frank, you have the floor.

Are VCs incompetent or just inconsiderate? Not all venture capitalists mind you, just the ones who solicit your proposal, read your executive summary, or even meet with you, and then you never hear another word from them. What’s up with that?

There is a subset of the VC community that will just go silent at some point and you never hear from them again. I have raised venture funding for a few companies, and I would estimate this number at around 10-20% of all the funds I have approached. The Berkshire Hathaway annual report’s Acquisition Criteria section always contains the quote, "When the phone don’t ring, you’ll know it’s me." But that only applies where someone looking for funding doesn’t do their homework and sends in a proposal that doesn’t meet their criteria.

The problem in the VC community is broader than that. I have seen potential investors go silent:

  • After researching their investment criteria and seeing that we may be a good fit.
  • After getting an introduction to the fund from a respected referral source.
  • After communicating with a partner who said, “This looks interesting. I will look at your executive summary and get back to you.”
  • And even after having a conference call or face-to-face meeting to go through our business plan in detail.

If silence always meant rejection, then this wouldn’t be such a problem, other than the fact that I waste my time making multiple calls or sending several e-mails to follow up. But silence doesn’t always mean rejection. I have spent literally weeks trying to get a response from a VC, only to hear, “Thank you for being so persistent. We remain interested, but we’ve been swamped / we just closed our new fund / an investment committee member has been on vacation / etc.” The process has then continued. So you can’t just give up.

My strategy when I get the silent treatment has been to leave a series of three to five messages (depending on the quality of the introduction or level of previous engagement) with the last one politely saying, “This is the last time I’m going to call.” But boy, what a waste of time this is. Entrepreneurs bust their butts and spend dozens of hours writing business plans, arranging investor meetings, and preparing and making presentations. Venture capital fund managers owe them the courtesy and respect of making a two-minute phone call to say, “No thank you.”

Thanks Frank, that is indeed frustrating. So what’s the deal? Here is my take:

I’ve always taken the approach (as does my co-author Brad) that you try to keep communication as efficient and responsive as possible. We regularly say that we will return any email that we get, but also caution that phone calls are much harder to return. I think there are two takeaways from this: first, whomever you are dealing with, try to find out their preferred mode of communication and two; I don’t necessarily think that we represent the norm when it comes to responsiveness.

We also try to say “no” as quickly as possible to deals that we are evaluating in our pipeline that aren’t going to be funded by us. There is no use keeping the entrepreneur on the hook if you aren’t going to fund a deal and we try to come to the “no” decision as quickly as possible.

I agree, Frank, there is a lot of bad communication “mojo” in the venture world. In fact, I see it too. I’ve seen countless times where VCs have been unresponsive to entrepreneurs, other VCs, or even their own portfolio companies.

In fairness, keep in mind that most good VCs are reviewing a massive amount of emails, business plans and proposals, so there are times when one can get buried. Take for instance the situation where one of my companies is in the middle of a sale process, while I’m in fundraising mode and moving into a new office. (That actually happened to me last fall). I’m clearly going to get slower in responses, but this normally affects timing by days, not weeks, as you mentioned above.

Okay, I haven’t answered your question: Are VCs incompetent or just inconsiderate? I think it’s more of the latter than the former, but ineffective communication styles, in my opinion, will eventually affect a VCs returns as reputations do matter in this business.

What Is The Effect of the "Pending" Recession on Venture Capital Financings of Private Companies?

Q:  What is the the impact of the U.S. economy going into a (possible) recession on venture funding for new startups?

A:  (Jason).  Somewhere my undergrad economics professors are shuddering as I type this answer.  I won’t hold myself up as an professional economist or fortune teller, but there are some takeaways that have have been learned from prior downturns.

The first takeaway is that a lot of the effects of a recession are dependant upon how deep and long the recession is.  For instance, a longer recession will certainly lessen companies desire for buy advertising, whereas a shorter one may not.  Given advertising’s importance in the revenue models of many vc-backed companies, a protracted downturn will impact their revenue growth and decrease their chances for achieving profitability.  If a VC has a lot of companies in its portfolio that rely on advertising revenues, then it is possible that they’ll have difficulty supporting their companies financially if all of them suddenly experience longer roads to cash flow break even. 

Furthermore, companies will start to conserve cash to maximize earnings and this usually means a reduction in IT expenditures.  Venture companies who rely on enterprise sales will be affected similarly to ones analyzed above.

Along with companies trying to conserve cash, they will tend to acquire less companies and the ones they do will be for lower prices.  IPOs will not be possible in the choppy markets that are common during a recession.

All of the above will cause a lot of noise, grumbling and folks on MSNBC talking about how the sky is falling. 

Now how does this all affect VC financings?  Well, history would tell us that VCs will put less money into funding companies, converse cash and wait until the acquisition and public markets open up a bit.  With a lack of good exits, why would a VC want to invest in a company?  However, that’s never made much sense to me, especially if we limit investments to early-staged companies.  I’ve always thought the best time to invest in young startups is when things are choppy.  You usually can invest at lower prices, hire folks for less than you normally would, etc.  Also, I’d never expect an investment to exit in the near future (1-3 years, for sure) and therefore the company will be well positioned to exit at the end of the recession.  If you wait until the recession is over, you are already paying too much.

So bottom line is "we’ll see."  The last go around saw a tremendous drop in venture investing during hard economic times.  If i was a betting man, I’d probably still expect the same, but I can see a strong argument for continuing to invest regularly through the cycle.

SEC Announces Rule Change for Private Companies

One company that draws a lot of questions is Google.  Specifically, folks have questions regarding the fact pattern of their initial public offering.  We weren’t investors in the company, so we generally don’t get involved answering these, but today my friends Mike Sullivan and Julia Vax from Howard Rice sent me this nugget: 

“Google’s IPO in 2004 shed some light on a little-known federal securities law – the one that requires that companies with more than 500 securityholders (including holders of stock options) to “go public”. The SEC has long required companies with 500+ securityholders and at least $10 million in assets to publicly file detailed information that is the equivalent of an IPO prospectus. That’s what forced Google to do its IPO – they realized they could no longer shield their confidential financial information as a private company.

On November 15, the SEC announced a rule change to create an exception for stock options – so that companies will be able to have an unlimited number of optionholders without having to register as a public company. Some have speculated that Facebook might soon be facing the same 500+ optionholder issue that Google faced – but now Facebook (and other rapidly growing companies with lots of optionees) will be able to remain a private company without compulsion from SEC rules.”

All in all, the SEC has their head on straight here.  Thanks Mike and Julia for imparting some knowledge.

Book Review: Venture Capital and the Finance of Innovation

I read a lot.  I often review books on my Feld Thoughts site but Venture Capital and the Finance of Innovation by Andrew Metrick seemed more appropriate for AsktheVC. 

If you are interested in how venture capital works, this is a superb book.  It’s broken into four parts – the first two are invaluable, the third is ok, and the fourth will only be interesting if you are working on your MBA and want to do some theoretical stuff that you’ll never use in the real world. 

Part 1 is titled VC Basics and covers the VC Industry, VC Players, VC Returns, The Cost of Venture Capital, The Best VCs, and VC around the world.  It’s a solid introduction to how the VC industry works.

Part 2 is titled Total Valuation.  This part has a bunch of juicy meat in it that is relevant to all entrepreneurs raising venture capital (as well as any new venture capitalist.)  It delves deep into the financial structuring of deals in sections titled The Analysis of VC Investments, Term Sheets, Preferred Stock, The VC Method, Discounted-Cash-Flow Analysis of Growth Companies, and Comparables Analysis.  The examples are extensive, build on themselves, and create a solid foundation for anyone that wants to understand the economics of venture capital.

Part 3 – titled Partial Valuation – is the section where it becomes apparent that Metrick is a professor at a business school.  While intellectually (and mathematically) interesting, most of this section is a departure from the practical reality of how most VCs think about deals.  While I’m sure the theory and examples will arm some eager new VCs with exciting justification for complex spreadsheet models to determine valuation, I’d suggest that there’s little practical value in this section.

Part 4 – titled The Finance of Innovation – is all business school stuff.  R&D Finance, Monte Carlo Simulation, Real Options, Binomal Trees, Game Theory, and R&D Valuation.  If you are an entrepreneur, give the following line a try at your next board meeting: “Mr. VC, can you share with me the binomial tree model that you used to come up with the current option price?”  That’ll get a laugh – at multiple levels.

Several of the appendicies are excellent, including Information Sources for Venture Capital and Sample Term Sheets.

Overall, Venture Capital and the Finance of Innovation is worth the price for simply the first two parts and the appendicies.  Unless you want to exercise your high school and college math skills, skim parts 3 and 4 and realize that most of the theory is just that.

If you are curious about other books we recommend on this site, take a look at the books tab for some of our other favorites.