A fascinating group of early stage investors participated who seem to have virtually single handedly kept early stage/angel investment alive in the the UK over the past 18 months. One topic of conversation kept coming up, ‘How do you manage relationships with VCs more effectively, and how can early stage investors prevent the venture community from taking advantage of their risk taking?’ (Or slightly more robust language to that effect). This touches on something that Fred Destin at Atlas Venture has been thinking about with respect to entrepreneurs recently but it seems there are other people who have reasons to be wary of some VCs. (And amongst this group, I would point out that Fred was seen as an excellent and honourable investor).
As VCs has grown into larger funds, there has been a gap created at the early stage market which is being increasingly filled by an emerging troupe of highly experienced entrepreneurs who have cashed out of a number of previous ventures and are now making a go of investing time and money into new ventures.
There is a problem that seems to regularly occur when those ventures go for additional rounds of funding and a small, but significant number, of venture investors enter into funding discussions with a company with the intention of screwing earlier investors whenever possible – by adding toxic, unreasonable liquidation preferences, terms and conditions. Often a term sheet is offered that is not actually a term sheet but the start of a longer negotiation that can mean that a company stops running their business and focuses on fund raising and meeting the demands of the VC. All the while the company will be running out of money and have less and less room to manoeuvre until it is forced into a deal that it didn’t want to do.
So what can early stage investors do? How can entrepreneurs, especially first timers, protect themselves?
A few thoughts emerged from this discussion that might be useful to others.
- Raise money much sooner than you need/expect to in order to allow enough room to negotiate.
- Make sure companies are doing well and hitting milestones. Companies that are doing well will have more competition from investors.
- Avoid working with partners and deal makers in firms that are not yet proven. Many of the worst stories that were discussed were perpetrated by firms that didn’t have a significant track record or experience. VCs felt they had to make a name for themselves and to do so they needed to do deals that made them look good. Often, this plus rampant egos, transforms itself into a desire to wash out early investors.
- Spend more time collaborating and co-investing with other early stage investors in order that you can capitalise a company properly and make sure that when you raise further capital, you have other options – extending the involvement of angels for example instead of being reliant on venture.
- Share information about investors that you wish to do business with, and those that you don’t, through informal networks. Reference individuals, not just the firms.
- A number of people stressed that aggressive investment behaviour typically comes from individuals wishing to make a name for themselves, rather than firms.
- Try to work with early stage investors that have experienced the cut and thrust of both fund raising and growing a business multiple times.
Would be interested in hearing any other views/experiences of the early stage/venture investor schism and how it might be solved. (Or is this all imagined by the angel?).