Weekly Briefing Note for Founders 27/6/24

26th June 2024

How VCs Become Assholes

Omri Drory is a GP at leading US VC fund, NfX. In his latest candid essay, 'How VCs Become Assholes', he says of his fund partners: "As founders, each of us had experiences with amazing investors…and some real asshole investors.

"Our biggest fear is waking up one day and realizing that somehow, we became the thing we hated the most. You know the type: late for meetings, always looking at their phone instead of listening, ghosting founders, stressing founders out for no reason, giving unthoughtful, obvious advice."

He then adds: "I truly believe that investors are generally good and mean well. Most, if not all, go [into] investing because they want to create value for all involved and change the world. But even with the best of intentions, it’s easy to become an asshole if you’re not careful."

Drory's forthright post has 2 aims: Firstly, it's intended to help founders understand some of the inner workings - and huge pressures - of the VC world. 

Secondly, it's a manifesto for more productive investor/founder relationships, where the highest behavioural standards are upheld.

This fly-on-the-wall piece describes how this high-stakes game eats away at investors, with invisible forces pushing them down a path of bringing 'negative value-add'. Drory then adds the punchline: "When you see this happening, you should call your investors out on it."

But this rarely happens.

The power dynamic between founder and investor is nearly always highly imbalanced, especially if that investor is on the board. This is accentuated by the 'reality distortion field' that often surrounds investors: When you have money to give out, people stop telling you the truth.

In this week's briefing note we highlight the investor behaviours that receive the most criticism - in the words of investors themselves. On the flip side we highlight the most critical value-add that founders so desperately seek.

Khosla remains a font of wisdom

Vinod Khosla was one of the co-founders of Sun Microsystems. He went on to create Khosla Ventures, one of the most revered and successful global VC funds.

In his now infamous TechCrunch interview, Khosla said that the vast majority of VCs aren’t in a position to offer decent advice to startups. In fact, most of them probably hurt startups, he argued.

TechCrunch founder Michael Arrington asked him to single out VCs that were horrible on boards. “Who is the VC who is the most full of shit that you’ve ever heard?” Arrington asked. “I would be offending too many people,” Khosla retorted. “Maybe some percentage that’s substantially larger than 95 percent of VCs add zero value. I would bet that 70-80 percent add negative value to a startup in their advising.”

Khosla explains that many investors are advising companies when they haven’t earned the right to advise an entrepreneur. He says to junior people at his own firm; "Just because you got an MBA and joined a venture firm doesn’t mean you’re qualified to advise an entrepreneur.

"The biggest piece of it, not the only way, is have you built a large company. Have you gone through how hard it is, how uncertain it is, how traumatic it is to go through?"

He says of his approach to helping entrepreneurs: “I give them advice, but I tell them what I’m uncertain about. I’m confident that I screwed up more often than most people in this room. Hopefully, I can advise entrepreneurs to avoid mistakes. But you can never be sure if you’re trying something new and unreasonable.”

A company becomes the people it hires

By underling that a startup is pursuing something "new and unreasonable" Khosla confirms the very essence of early stage investing. At Seed stage especially, the business is still an experiment. In fact, it's a series of experiments that (hopefully) culminate in a proposition that's scalable. Investment allows these experiments to be undertaken, for mistakes to be made.

Yet too often, when VCs offer term sheets to Seed stage startups, they barely recognise this experimental stage. This is a red flag to any founder looking for an investor that's fully aligned with the current phase of their journey.

Again, investors mean well, but too often they are unwittingly locking startups into behaviours that are more closely associated with established companies. How so?

Take a recent term sheet for a Seed round from a UK VC. Key conditions required a commitment to a 12-month revenue forecast number and a founder warranty on the 'business plan'.

Few Seed stage companies are in a position to commit to a hard revenue forecast in these formative stages. Revenues should not be a stand-alone priority yet. The priority should be finding product/market fit.

The same applies to the so-called 'business plan'. The closest any Seed-stage startup might have to a business plan will be their investor pitch. But pre-product/market fit, what is the purpose in being held accountable to the execution of a business plan that will almost certainly need to change within a few months?

Vinod Khosla, interviewed by Y Combinator several years ago, was scathing of investors expecting business plans - or even significant revenues - to be the focus too early on. His observation was that plans only evolve over time as the founder and their team work together on the problem to be solved.

Again the contrarian, he looks for founders that are able to evolve and change their early plans with speed, rather than fixate on early commercial traction - just for the sake of declaring some early revenues.

His often-quoted thesis on this: "A company becomes the people it hires not the plan it makes." This doesn't mean that you are wavering on the vision, but you are incredibly flexible about the journey to get there. As he says, "This is the journey to conquer Mount Everest, not just to get to base camp." Good investors understand the longer-term objective and the trade-offs.

Don't sit on your founders' boards

In a subsequent interview, Khosla gave some other contrarian advice to the VC industry: Don’t sit on your founders’ boards. “I’m not a big fan of governance; I think if you engage as a team member with a founder, you have much more influence than if you’re sitting on a board and voting,” he said.

While Khosla’s anti-board perspective may upset plenty of other VCs, LPs don’t appear to be pushing back against it. Khosla and his firm, founded in 2004, is raising $2.5B across 2 new funds according to regulatory filings, having recently closed a new $400M Seed fund.

In the US, it’s interesting to note that Seed stage boards are often sparsely populated, generally just the founders plus the Seed investor. It's not until the early growth rounds, e.g. Series A or B, that the structure of a chair and additional non-execs begins to take shape.

Yet in Europe and especially the UK, there is often a strong desire by Seed investors to create structure. As we said in our earlier piece, How effective is your Board?, this rapid insertion of structure can have a debilitating effect on how founders operate. In the term sheet example quoted above, a condition of investment was the appointment of a non-executive chair. Why?

When asked, investors often say it's to provide governance, plus support and guidance for the Founder/CEO. But there’s many a finance director - even part time - that could easily provide the governance framework required at this early stage.

And on support and guidance, more and more first-time founders are following the lead of experienced founders who simply appoint independent advisors to help with various aspects of the startup to scaleup journey, as and when required.

This is not to say that many first-time founders wouldn't benefit from the wisdom and experience of a seasoned 'non-exec'. But in the very formative stages, such people don’t need to be on the board to deliver this value.

Experienced early-stage investors have a key role to play in encouraging founders to seek out specialist advice. This is a muscle that founders must develop as they build their network over time. It becomes a defining capability of great founders.

Founders face a myriad of tough decisions as they build. But as Khosla observes, "The single hardest decision you'll make is whose advice to trust on what topic." It's where the right investors can really help you.

More than money

It seems as though investors themselves are more critical of their own performance than founders are. But maybe this reflects the asymmetric relationship mentioned above.

For a better understanding on what founders are looking for, Atomico's State of European Tech 2023 provides insight. Founders were asked, "What are the most important considerations when selecting an investor to lead your next round?"

Founders said it was finding a VC that truly ‘gets them’ - a shared alignment of vision/purpose was by far the most cited response (36%). Access to relevant networks, as well the importance of having chemistry with the investor partner, were the next most-often cited (28% of founders).

Yet VCs cited 'the strength of reputation of an investor' as their top ranked answer (selected by 31% of VC respondents). This features way down the list of priorities for founders (13% of founder respondents). In fact, none of the founders' top 3 value-add requirements overlapped with the investors' top 3.

In terms of UK specific data, the More Than Money report, undertaken by early-stage VC firm Forward Partners in 2021, was the first report of its kind to investigate ‘value add’ for UK startups. It brought together insights from over 500 founders and investors to uncover what works, what doesn’t, and crucially, what great ‘value add' services could look like.

A key takeaway from this analysis was that even though the majority of founders said they wanted more than money (61%) and the vast majority of investors said they offered it (92%), "3 in 5 founders feel duped: 59% of founders report a negative experience with value-add compared to what they were promised."

In the heady days of 2021 when too much money was chasing too few deals, many VCs considered value add as critical to compete in that ecosystem. Now the tables have turned, perhaps the pressure to deliver that value add has diminished.

Honest reality

And maybe this is the honest reality of the VC/Founder relationship. As one well-known VC said in the Forward Partners report, “We find it quite puzzling that many UK venture funds are designing themselves to be the support person. We are doing the opposite in designing ourselves to never be the support person.

"I think you can also run the risk of adverse selection because the founders that require the help and extra services will come and seek you out. The people that can do all that stuff and figure it out for themselves don’t come and seek you out because the value add they really want from their investors is someone that is going to turn up for board meetings and be really productive.”

And as another US VC that invests in Europe added, “I would admit that we have tried to offer value add services that we have ended up shuttering because the standard we were able to reach was not comparable to what was available out there on the open market. If you can’t move the needle in the right way, then why bother?"

It's a Partnership

Drory concludes that the VC/Founder relationship is a high stakes partnership. He compares it to sailing across the world into unknown territories with that person. Unexpected things are going to happen no matter what. If you can’t be straightforward with your crew, you’re lost.

He concludes: "We owe it to one another to uphold the highest behavioural standards during the journey." 

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