This is my fourth installment where I'm trying to define what makes a good VC. I have broken the task into 5 stages or episodes as follows, and I'm tackling each stage in turn.
- Finding Deals
- Evaluating and Picking Deals
- Executing an Investment
- Managing and Growing the Deal After Investment
- Finding a Successful exit
Here I am talking about the time after making a venture investment and building value in the startup, in preparation for an exit. This is the operational part of the job — how do you help a startup succeed? I should disclose in advance that I am a believer in venture capitalists who are actively involved with their companies, who require board of director roles, and who keep in frequent touch with the startup team. There are VC funds that function as silent, hands-off players and follow other investors leads. The following really doesn't apply to them.
In my humble opinion, the best VCs are those that have an operating background. Starting a company presents the entrepreneur with a range of complex problems and decisions that have to be made. The best VCs are ones that have confronted these issues in their own careers. For example, a balance has to be struck between frugality and audacity. A thrifty startup fosters a healthy company culture and focuses the majority of spending on areas that increase the value of the enterprise and the likelihood of success. On the other hand, knowing when to hit the accelerator and spend the money for the greatest effect, that is a challenge that every entrepreneur faces. It really helps to have backers and VCs who've done that before.
And there are a host of seemingly minor administrative decisions a startup needs to address, e.g. payroll, benefits, facilities, accounting, legal, ip protection, capital equipment, hiring… Experienced entrepreneurs have encountered these issues in their past startups. They make the best VCs in my humble opinion during this stage.
One key challenge is transitioning a founding team into a management structure that can grow the business. Frequently, founding team members “get ahead of themselves” and get set on how they are the right people to lead this venture to the promised land. They see themselves as the next Scott McNealy or Steve Jobs, i.e. the founder that took the company all the way to billions in revenue. Or a cofounder has gotten comfortable with a lofty title and responsibility area and doesn't want his role reduced or narrowed. Or the founders have brought along one of their fraternity buddies as a co-founder, mostly because he's a long-time drinking buddy, but who has no qualifications for the job he envisions for himself.
A great stage 4, “operating” VC will be adept at building a sensible and scalable management structure from the founding team, without disrupting the operation or culture of the startup. Almost more importantly, a good operating VC will mentor the founding team members so that they see and buy into the wisdom of this management structure.
This is one of the most challenging aspects of investing in and helping manage a startup: managing individual egos and expectations to maximize the overall value of the enterprise. By definition, to have the courage to start a company from nothing but an idea requires a big ego and almost an irrational determination to succeed. But the VC is investing in the overall enterprise more than the individual egos of the founders. Sensitively managing those egos for the overall benefit of the organization (and everyone's investment or time or money) is a truly important skill for a VC at this stage.
Another key value that an operating VC can and should offer to a post-investment startup is introductions to key contributors, i.e. partners, customers, key hires, etc. That means it is important for the VC to have a full rolodex, which again favors VCs with long operating histories.
Perhaps the hardest to quantify but ultimately most important addition a good operating VC can offer to a startup team is rational and reasoned advice and criticism on strategy. An operating VC in this stage, typically also serving as a board member, is ideally suited to give the entrepreneur advice that is not biased by the day-to-day “drinking of their own Kool-aid” that an aggressive startup team may suffer from. A great operating VC can give the team perspective and balance, at least partly from an outsider's perspective at those monthly or quarterly board meetings, and intervening contacts.
Finally, once a VC is invested in a startup, one of their key tasks is to bring in follow-on financing and new venture capital firms to lead those rounds. That means coaching a startup team to do a great venture presentation. It is ironic that now the VC is coaching the team on how to best sell their deal to other VCs. But it is further ironic that VCs are often particularly good at this coaching. They see lots of deals and they know a good pitch when they see it. They know what sells THEM on a deal. But a great VC can often help an entrepreneur position their deal relative to all the other competing deals out there that a follow-on VC might be seeing.
So to summarize, in this stage a good VC is bringing operating experience, mentoring, a good rolodex of contacts, team-building and human resource skills, strategic thinking, a balanced “semi-outsider's” perspective, and coaching on how to best raise more money.