On the Wrong End: What Venture Capitalists Say and Do Are Often Two Different Things

by Joan Jacobs

If you want to attract a big crowd of technology executives to a presentation, make it a seminar or panel discussion that includes three or four representatives of major venture capital firms. The technology executives will gather in hopes of learning the secret about what it takes to separate venture capitalists from their investment funds.

If you want to learn what it really takes to obtain venture capital funding, though, I would suggest that you come to such functions with a strong pair of glasses, because you’ll have to do a lot of reading between the lines–of massive amounts of feel-good advice. In my capacity as national director of the Technology Executive Roundtable, a national educational and networking organization sponsored by Digital Equipment Corp., with seven chapters nationwide, I have heard several dozen such presentations. I have also spoken with and counseled at least the same number of technology entrepreneurs in search of venture capital funds. And the stories I hear from the two groups bear little resemblance to each other.

Essentially, venture capitalists on the speaking tour make the process of obtaining venture capital sound, while not easy, like an orderly and logical procedure–something like a tennis tournament in which entrants are gradually eliminated, with the best players surviving to the final rounds, and winning their just rewards.

Unlike tennis tournaments, though, when it comes to obtaining venture capital, the rules of the contest seem somehow to not be clear to the entrants. This is not a trivial matter, since venture capitalists invest somewhere between $2 billion and $4 billion annually–much of it in promising technology companies. Consider the following advice that is commonly handed out, and what I know to be the more common reality:

The Advice: Send us your business plan and we’ll review it to see if it turns us on.

The Reality: Business plans that come over the transom are almost never funded. Catch a venture capitalist off guard or in a private moment, and he or she will tell you that. To even have a chance of being considered seriously, business plans had better come in at the suggestion of a top referral source–a known lawyer, accountant, or banker, for example–and even then they are a long shot to be reviewed very deeply.

More commonly than is realized, venture capitalists chase after companies they deem via their own investigating to be “hot.” Perhaps they were started by a previously successful entrepreneur or perhaps they include well-known scientists with proprietary technology. Often, these companies don’t even have a business plan and, not infrequently, prepare them only after the venture capitalists have come to the companies.

One entrepreneur who has successfully raised investment capital says he makes contact with venture capitalists through top referral sources and avoids showing his business plan until he has had at least one or two meetings with the VCs. And even then, he only shows them a plan after they’ve requested it and he’s quizzed them on exactly what they want to examine. In other words, he tries to level the playing field.

The Advice: When we contact you, it means we’re interested in possibly investing

The Reality: Most entrepreneurs are so thrilled to have a follow-up call from a venture capitalist that they quickly open their doors, and files, as widely as possible. These entrepreneurs only discover too late that when venture capitalists follow-up on a business plan, they often have no intention of investing. In many cases, they are “tire kicking”–educating themselves about an industry or technology. Indeed, they may have already committed to a competitor, and want to check the new company out for competitive intelligence purposes.

Some technology entrepreneurs who have been through this process now require venture capitalists to sign non-disclosure agreements before opening the company doors. And even then, they are selective about what they show, allowing the relationship to open up and show signs of seriousness before revealing anything proprietary.

The Advice: The whole financing process can be completed in as little as three or four months.

The Reality: Sure, and that home remodeling project will be ready on schedule, too. I’m not sure why construction projects aren’t completed on time, but I do know that VCs often drag the process out. You’ll never get them to admit it, but my view is that they want to wear the entrepreneurs down, and use up their cash reserves. Then, the technology executives become more amenable to the deal the venture capitalists really want to impose. The negotiation phase is a favorite time for venture capitalists to tighten the screws on technology companies. With the company nearly out of money, the executives will often accept a deal that they would refuse, if only they weren’t on the brink of failure.

The Advice: We want to negotiate “win-win” deals with entrepreneurs. If we can’t do it, we’ll tell you.

The Reality: The line I really enjoy is the one about how the venture capitalists will bend over backwards to help the founding team succeed; after all, the VCs don’t want to run the company. Yet the reality is that the venture capitalists have become increasingly enamored of all kinds of technical language that essentially makes it easy for them to force out the founders and put in their own people–earnings targets, product development benchmarks, marketing goals, and so forth. Some are known to be making their investments contingent on being repaid, even if the company fails. If that sounds more like banking than venture capital to you, join the club.

The Advice:Don’t worry about the fine print in the deal you sign. We want you to grow and will help you all we can.

The Reality: A lawyer who handles lots of financing deals says he can distinguish among them simply by the weight of the documents. The venture capital documents are the ones that strain his back. The fine print increasingly gives the venture capitalists power over the next round of financing–to approve the investors, to avoid experiencing dilution, and even to cash out if they so desire. Thus, entrepreneurs often get a late surprise about leverage, and how little of it they really have.

For entrepreneurs, the message is clear: Scratch that image you have of venture capitalists as Santa Claus in business suits. Approach venture capitalists as you would any financial service people–with a healthy dose of skepticism. Remember, the term “vulture capitalist” didn’t just materialize out of thin air.

Joan Jacobs is national director of the Technology Executive Roundtable, a networking and educational organization of technology executives sponsored nationally by Digital Equipment Corporation.