Archive for the ‘Leadership Profiles’ Category

Unintended Consequences: When SAFE and Convertible Notes Go Awry

Andrew Krowne and I recently co-wrote an article in Tech Crunch, Why SAFE Notes Are Not Safe for Entrepreneurs. We’ve received numerous constructive comments, both privately and on social media, from attorneys, VCs, and CEOs who are well aware of the problem (including several who are experiencing it in real time).

This is a fundamental issue that does, indeed, boil down to understanding the post-money valuation of a company. But it is also a topic that many find esoteric and difficult to grasp.

To restate two core points of the article:

While there are proper uses of notes (to bridge the company to achieve a major milestone, or driven by insiders’ willingness to extend runway), there also are troubling and frequent improper uses (to postpone pricing equity until valuation is higher or to ignore the implicit message associated with being unable to find a lead investor to price the round on terms that the founders like).

 At its core, this issue points to the lack of understanding about the importance of post-money valuation by both entrepreneurs and investors. While VC deals remain marketed on a pre-money basis, sophisticated investors know that what matters most is the post-money (how much of the company will I own after all of the new shares have been issued). Unfortunately, what the CEO/founder forgets most often is that the notes have a multiplier effect in the post-money calculation; the more notes and the further the cap is from the new priced equity, the greater the variance between actual and nominal pre- and post-money valuations.

There is nothing wrong with using a SAFE or a convertible note in a startup if you know its implications. However, many VCs experience vexing discussions with CEOs, and many CEOs belatedly realize that this is because they made a mistake: issuing multiple series of notes at various valuation caps without actually sitting down and figuring out the pro forma post-conversion equity ownership.

This is not uncommon—and it is a problem precisely because the notes are being used improperly. The most serious unintended consequence occurs from “note waterfalls”— converting multiple notes that have multiple valuation caps.

Many entrepreneurs lose track of what they have been cooking up in the cap table. They do not recognize that they may have already contractually sold a meaningful portion of equity in their company.

When it comes time to convert the notes, these entrepreneurs face ‘sticker shock’ about their post-financing ownership. That’s only one result of mismanaged expectations dating back to when the notes were issued!

The following scenarios represent typical recipes for trouble:

  • Company X is early in business development, has a near-term need for capital to get through the next 3-6 months, and the management team has no understanding of how the equity should be divided up among its various constituencies (this includes option pools and what ownership stakes investors typically require at various development stages).
  • Company Y receives an offer from an angel or ‘unsophisticated’ smaller VC fund that is unwilling to lead and price the equity but wants to ‘invest now’.   The easiest way to do so is via SAFE notes, due to their simplicity, “available online” documentation, no major covenants established to protect the investors, no governance implications at the board level, etc. All of these items are postponed until the elusive priced equity round. “It’s going to be great!”
  • Issuing notes eases the burden of getting several investors to commit simultaneously and solves the ‘chicken-or-the-egg’ issue by creating a rolling close that financially benefits the earliest movers with more attractive financial terms. In contrast, there is limited benefit for being the 2nd investor or the 10th investor joining the syndicate of a priced round, so it is common for investors to wait to see “who else is involved”.
  • The CEO/founder often has leeway to influence or negotiate the cap value (especially when the headline cap is softened by a discount). This is very common when the company is still in its infancy and the valuation goalposts remain distant. A much larger problem arises when subsequent ‘series’ of notes are issued, especially if each successive series has a higher valuation cap. CEOs and unsophisticated investors very often start anchoring the caps to what they think the company could be worth, all without external validation. In these cases the caps can easily diverge from the true number at which a company could raise sufficient equity to provide at least 18 months of runway with no revenue (a normal VC round).

The bottom line: Startup CEOs/Founders need to do the projected capitalization table math on an as-converted, post-money basis from Day 1, before issuing any notes and modeling various possible future scenarios. It will be worth the time and effort.

Make sure you understand what you are doing now so that you are not negatively surprised in the future. Sound simple? Yes, and it’s a lot simpler than making your startup grow into a successful company. Now go do it.

How to Build a Global Center of Innovation Excellence in Salzburg, Austria

Pascal Levensohn Salzburg

 

 

 

 

 

 

 

 (c) Blowup Salzburg / Fachhochschule Salzburg

I recently joined the Advisory Board to Gerhard Blechinger, the Rector of the FachHochschule Salzburg, (the Salzburg University of Applied Sciences) and became a guest lecturer on Entrepreneurship at the University.  My inaugural keynote lecture focused on the challenges and opportunities for Salzburg to become a global center of innovation excellence.  To succeed in this ambitious initiative, the academic, business, and entrepreneur communities will need to collaborate closely.  In my view this commitment to collaborate is in place. I also believe that the greatest challenge for the region will be overcoming cultural biases that punish risk-taking and are intolerant of failure in the process of building new companies…

Below are selections from my formal remarks:

“… While many countries have accelerated their national research and development investments and funded national venture capital ecosystem development programs, there is still no proxy for the scale that has been achieved in the US, particularly in Silicon Valley itself.

The challenge that many regions face in seeking to become innovation centers of excellence can be summed up in one sentence:

Good ideas are generated from all corners of the earth, but few regions offer a complete and cost-effective ecosystem to develop these good ideas into great companies.

Why is this the case?

Silicon Valley has proven its fertility in giving birth to world changing technologies over many decades; its inspiration to the entire world has grown exponentially over the past 20 years because the Internet has empowered millions of previously unconnected individuals to collaborate, enabling information about anything to be shared globally and discussed in real time through audio and video conferencing on an unprecedented scale and at extremely low cost.

But it is not enough to simply have technology tools and risk capital in hand to build a sustainable innovation ecosystem.

For Salzburg to succeed as an innovation hub, it is essential for local private sector business leaders to make a long-term, active, and visible commitment to be active partners in this process.

How can Fachhochshule Salzburg act to further catalyze and contribute to a complete and cost-effective ecosystem for innovation?

How can the Salzburg community come together to nurture ideas into startups and see these startups grow into globally relevant companies?

How can we transform the Salzburg region’s traditional rural economy into a knowledge based, innovative business community?

First, we need to differentiate between whether Salzburg should prioritize the funding of entrepreneurs who are pursuing breakthrough innovation as opposed to incremental innovation. Pursuing breakthrough innovation can lead an emerging company to global scale more quickly, whereas incremental innovation leaves a resource-constrained startup vulnerable to both entrenched and emerging competition, especially in a regional innovation center.

Many entrepreneurs confuse what may be an exciting idea that is only a feature with a truly innovative concept that can become a standalone company. For example, today, designing a smartphone App that alerts you when you have lost your car keys isn’t a viable standalone company; today, a service-based local software solution to manage ecommerce for brick and mortar companies, even if it is profitable, is not an interesting technology investment.

In contrast, consider a patented, proprietary software platform that verifies whether goods are authentic or counterfeit. When that solution combines low-cost, unique labels that are a fraction of the cost of all other solutions, and uses an App on your smartphone to interact with your customers in a manner that has previously been considered impossible, that is an example of an innovative company. Not only does that company exist, it is Salzburg’s own Authentic Vision—and you will hear more from co-founder Thomas Weiss later this evening when he tells you about his journey as a Salzburg entrepreneur.

… Because of Silicon Valley’s large private risk capital pools and attractive startup ecosystem, many startups based on incremental innovation have flourished, but the long-term survivors, now industry leaders, remain few in number—this is a widespread reality in the world of technology: think of the semiconductor industry’s implosion since the 1980’s; the browser, search engine, and ecommerce wars of the late ‘90’s; and the social media wars of the 2000’s—giants have emerged, but many more players have fallen on the battlefield. Let’s not forget that Microsoft had a huge monopoly in operating systems in the 90’s. Apple’s iOS & Google’s Android emerged, challenged, and overtook operating system dominance in the space of a few short years.

In America, Silicon Valley’s cycles of creative destruction and renewal continuously spawn many new challengers– by funding multiple startups that compete relentlessly until they reach dominant self-sustainability, acquisition by a competitor, or bankruptcy. This has not occurred without excess and without some years recording staggering losses.

But the fundamental concept that entrepreneurs have the freedom to fail, and that, if they are worthy, the resources are out there to support them to try again, is at the core of the culture of entrepreneurial success that defines Silicon Valley.

Ideally, innovative startups should be built on ideas that face little or no competition—and this is one of Peter Thiel’s key messages to entrepreneurs who want their startups to be “born global”. Peter Thiel was born in Germany, co-founded PayPal and Palantir, and is one of the most successful venture investors in the world through his Founders Fund. He published the book Zero to One in 2014 . In this book Thiel urges entrepreneurs to pursue only breakthrough innovation: “don’t compete, truly innovate—competition sucks your profits away—find a way to have a monopoly.”

Thiel’s core thesis to get from zero to one is all about breaking through and doing something really new, and he encourages starting on a small scale: “Start small and monopolize.Once you create and dominate a niche market, then you should gradually expand into related and slightly broader markets.”

With this in mind, and of direct relevance to Salzburg’s entrepreneurial initiative, I will now point out several of the most important elements for establishing a successful center for global excellence in innovation and assess their viability in Salzburg:

Defining a Global Center

To be more than moderately successful today, any startup’s potential must be considered on a global scale from its inception. This means that all entrepreneurs must be aware of competing global technologies and try not to step directly in their paths— I have visited entrepreneurs from Finland to Shanghai to Santiago who are simply not doing the work required to be aware of the best in class technologies, of their competitors at other startups, and they don’t really know how to find out what is happening in Silicon Valley.

Silicon Valley Special

In closing, I would like to highlight how we believe that Salzburg can be transformed into a vibrant global center of innovation excellence. Salzburg is blessed with several key elements that are necessary preconditions for a global innovation center of excellence to emerge …

I do see challenges with respect to overcoming some of the cultural barriers to an entrepreneurial culture—specifically in developing and nurturing a cultural understanding and tolerance for entrepreneurial failure. But at the same time I am convinced that there is a real opportunity for global collaboration, supported in partnership with leading international corporations from the Salzburg business community, that can attract the best and the brightest entrepreneurs to FH Salzburg.”

Salzburg Advantages

Governance Models That Don’t Scale: The World According to Charles T. Munger and Jean Jacques Rousseau

JJRMungerCan you name five benign dictators who have ruled successfully for any meaningful period of time (non-fiction)? Can you name five successful, long serving CEO’s (excluding Warren Buffett) whose governance histories are free of the “high-beta” associated with outliers such as Larry Ellison and Steve Jobs?

It’s not easy. Why? Because enlightened dictators and their corporate CEO equivalents are very, very rare; maintaining immunity to the intoxicating effects of power challenges basic human nature.

It is in this context that I found “Corporate Governance According to Charles T. Munger”, a brief article from the Stanford Closer Look Series, thought provoking if not practical. The article was written by David Larker, Director of the Corporate Governance Research Program at the Stanford Graduate School of business, and Brian Tayan, a researcher with Stanford’s Corporate Governance Research Program.

The authors summarize and explain Berkshire Hathaway Vice Chairman Charles T. Munger’s unorthodox view of a model for corporate governance.    According to the article, Munger believes that corporations and their boards should empower their CEO’s more, not less. Munger’s effective CEO, modeled, of course, on Warren Buffet, should be unencumbered by rigid process and freed of unnecessary, excessive checks and balances. Why? So that the CEO can lead effectively. How? In Munger’s construct, CEO’s police themselves, holding themselves accountable to their loosely overseeing directors by binding themselves to a trust based system. And corporate directors should reward these CEO’s for creating shareholder value, while deliberately underpaying them in terms of their annual salary-based cash compensation. According to Munger, and as quoted in the article:

“Good character is very efficient. If you can trust people, your system can be way simpler. There’s enormous efficiency in good character and dis-efficiency in bad character … We want very good leaders who have a lot of power, and we want to delegate a lot of power to those leaders…The highest form that civilization can reach is a seamless web of deserved trust—not much procedure, just totally reliable people correctly trusting one another.”

I agree with Mr. Munger completely, while asking the same questions raised by the authors at the end of this article:

“The trust-based systems that Munger refers to tend to be founder-led organizations. How much of their success is attributed to the managerial and leadership ability of the founder, and how much to the culture that he or she has created? Can these be separated? How can such a company ensure that the culture will continue after the founder’s eventual succession?”

Unfortunately, and founders notwithstanding, the collective global capitalist experience since private property rights were invented and enforced has shown that there aren’t enough of those people on this planet.

kozlowskimug1For a specific cautionary example, I am reminded of Tyco International and its former CEO, Dennis Kozlowski. Kozlowski was recently paroled, almost twelve years after his indictment, ultimate conviction, and after serving over eight years in Attica, for a $134 million corporate fraud (this amount represents a small fraction of the losses suffered by public shareholders). The disgraced former directors of Tyco International (vintage 1999), seemingly highly trustworthy and accomplished men and women, also come to mind. This group, along with the enterprise builders at Enron, Worldcom, and Adelphia, to name just a few, are at the top of my list of examples of poor corporate stewardship and help explain why Mr. Munger’s model for corporate governance is still-born.

But I did say the article was thought provoking, as Charles Munger’s corporate governance philosophy, in my view, evokes Jean Jacques Rousseau’s concept of the Lawgiver.  Author Alex Scott summarizes Rousseau’s core thesis from the Social contract succinctly in this excerpt from his book, The Conditions of Knowledge: Reviews of 100 Great Works of Philosophy :

“The general will always desires the common good, says Rousseau, but it may not always choose correctly between what is advantageous or disadvantageous for promoting social harmony and cooperation, because it may be influenced by particular groups of individuals who are concerned with promoting their own private interests. Thus, the general will may need to be guided by the judgment of an individual who is concerned only with the public interest and who can explain to the body politic how to promote justice and equal citizenship. This individual is the “lawgiver” (le législateur). The lawgiver is guided by sublime reason and by a concern for the common good, and he is an individual whose enlightened judgment can determine the principles of justice and utility which are best suited to society.”

I agree! Let’s find that individual and give him (or her) the keys to the public policy car! Munger’s corporate lawgiver, the enlightened CEO, is also an admirable model worth aspiring to emulate.

As with Rousseau’s 1762 treatise, history has sadly shown us that we lack sufficient incorruptible raw material across the entire history of mankind to render the “lawgiver” experiment successfully scalable, be it in public government or corporate governance.

The unbridled exercise of power is the ultimate intoxicant, and very few humans can responsibly limit the flow of that drug, especially not when they have are given the opportunity to administer it to themselves.

 

 

I’m Back!

DSCN2594After a one-year hiatus, I am back.  Stay tuned for new posts on venture capital, corporate governance trends, and current public policy issues that impact investors and entrepreneurs. I have also done a lot of hiking throughout America and Europe in the last year and will share highlights from my hiking experiences as a new topic.

Over the past year I’ve made meaningful personal and professional changes. Today I am healthier, happier, and more energized than ever. I look forward to sharing my thoughts with readers and welcome all constructive comments.

Equity Traders Acknowledge that Structural Issues Are Crippling U.S. IPO’s

globe in handsIncreasing numbers of professionals in a position to foment meaningful change in the capital markets are recognizing that structural issues underlie the IPO drought for emerging companies with market capitalizations below $1 billion.  This must become a widely held point of view before any meaningful structural reform can take place, setting aside the legislative delays we can continue to expect from the partisan divisions that have rendered our elected leaders ineffective.

I’ve made this structural argument for over three years on this blog and in public speeches.  Again, I urge readers to make their voices heard on this topic.  On November 24, 2008 I wrote A Case Study in the Unintended Consequences of Financial Regulation:  The Death of the U.S. Small Cap IPO? and invited anyone with constructive, practical ideas on how to revitalize IPO’s in the United States to contact me so that I could pass along their ideas to my colleagues at the National Venture Capital Association. In this post, I made a strong argument that structural market issues were the root cause of the death of the small capitalization IPO:

The lack of IPO’s in the U.S. has broad, negative implications for continued risk taking by U.S. venture capitalists. If we have no public market liquidity for emerging growth companies, there will be no next generation of American technology giants. The demise of the technology IPO has also contributed to the structural breakdown in the broader cycle of research and development that underlies the American innovation crisis…

This post followed my exposition of the argument that America would face an overall crisis in innovation, drawing on work by Judy Estrin and others, in September 2008: The Innovation Crisis Is Coming- Let’s Do Something About it Now!

Sadly, the veracity of these arguments is being proven over and over again, as the venture capital industry continues to shrink and the fallacy of an American jobless recovery becomes apparent.  Pointing to the success of several handfuls of social media companies as an index for the general health of innovation in the U.S. in 2011 is not statistically meaningful and irrelevant to the thousands of startups that are finding it impossible to reach the much greater critical mass necessary to access the public equity capital markets today.  To be clear, publicly traded household names that would not be able to go public today based on current IPO requirements include Dell, Intel, EMC, Yahoo!, Intuit, EA Sports, and many others.

access deniedIn an article published on October 6, 2011 in Traders Magazine.Com, conference remarks by several leading international stock exchange professionals show that they are coming around to understanding the downside to small companies of a trading market infrastructure that treats unknown emerging public companies the same way as multi-billion dollar liquid securities:

“Though trading costs have gone down, that isn’t necessarily a good thing, according to Steve Wunsch, head of corporate initiatives at the ISE Stock Exchange. He said low trading costs have made it difficult for anyone to make money trading smaller names, thus drying up markets for smaller companies.”

Joseph Hall, a partner with the law firm of Davis Polk & Wardell, said the government could have caused part of the problem by repealing the Glass-Steagall Act’s separation of investment banks and commercial banks. That allowed a lot of small brokers to be bought up by big banks, reducing niche trading, he said.

Grant Thornton’s [David] Weild placed more of the blame on Reg NMS, which he said homogenized the markets to the detriment of new issuers. He said a one-size-fits-all market structure does not support smaller, newer companies.

The good news, Weild said, is that Washington seems to be paying attention. …

In my view, the bad news is that it’s taken three years since the global financial crisis erupted for us to get an increasing number of influential people to pay attention.  Meanwhile, millions of jobs have been lost, and innovation in America continues to suffer.

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New Book by Professor Mannie Manhong Liu and Pascal Levensohn– Venture Capital: Theory and Practice, published by the University of International Business and Economics Press, Beijing

I never expected to have my first book published in China, much less in Mandarin, but that goes to show how much the world continues to change.  My contributions to this undergraduate textbook, Venture Capital: Theory & Practice, are the result of two important collaborations.  First, the body of collaborative work on corporate governance best practices that I have developed since 1999 with other venture capitalists and professional service providers to the venture industry; and, second, the direct collaboration on venture capital that resulted from meeting Professor Mannie Manhong Liu in the summer of 2007 at the  Symposium on Building the Financial System of the 21st Century between China and the US, sponsored by the Harvard Law School together with the CDRF (China Development Research Foundation) and PIFS (the Program on International Financial Systems).

Venture Capital started in China in 1985, when the first government-sponsored venture capital firm was established. The industry built slowly until a few years into the new century. In 2006, China’s total venture capital investment reached $1.78 B, becoming number two globally, next to the US; the US venture capital investment was $25.6B that year, accounting for 67.9% of the world total ($37.7b).  While China was far behind, accounting for about 4.7% of the total, nevertheless, China became number two and has kept that status ever since.

Venture Capital is a popular buzzword in China. Renmin University was among the first universities to create a venture capital major in the School of Finance and teach venture capital for undergraduates.  In recent years, many universities have followed, teaching venture capital as an elective course. In October 2010, our new textbook will become available.

Mannie and I share a strong interest in research in the field of venture capital and private equity. Mannie was working for Professor Josh Lerner at Harvard Business School before she returned to China to teach these subjects. The backbone for my contribution to our effort is the best practices work “for practitioners by practitioners” that I have developed in the area of venture capital through the multiple articles and three white papers that I’ve written.

Mannie was invited by a publisher in Beijing to write a textbook for undergraduate students in China; she in turn invited me to join her as the book’s co-author. Writing the book was a very intensive task, and both of us have worked on it for many months, with Mannie and her team translating my work and both of us discussing the context of the content for the Chinese audience.

Venture Capital: Theory and Practice, is in Chinese and is categorized as one of  “China’s National College Major Investment Textbook Series for the ‘Twelfth Five-Year Plan.’” The book has three parts and a total of 12 chapters. The Theory includes chapters on the venture capital concept, entrepreneurship, and a simple history; The Practice covers fundraising, business plan construction and analysis, investment due diligence, post investment monitoring and exit; and The Future emphasizes early stage investment, especially angel investment, as well as Cleantech VCs and socially responsible investment.  In the last chapter, Venture Capital in China, we explore the amazing development of China’s unique venture capital industry.

This textbook combines the strength of my Silicon Valley experiences as a venture capitalist and Mannie’s research as a professor, and it will help strengthen Chinese college-education programs in this particular field.  The book draws on and acknowledges important contributions from the members of the Working Group on Director Accountability and other experts in the field of venture capital.  I’ve donated all of my royalties from the book to the Society of Kauffman Fellows, which reported on the publication of this book in their July report.

VC Governance FAQ: (10) Are limited partner defaults on capital commitments triggering a wave of lawsuits in the venture industry?

images-11This is the last in our series of 10 frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: I’ve read that some GPs are suing LPs for not making capital calls. The LPs claim that they are cash constrained and/or the VC fund has not performed. Why throw more money their way? Do you see a trend here of broken contracts?

Answer: First, it would appear that the reports of numerous LP  defaults exceed the reality. Based upon discussions with industry  participants, most institutional LPs have, in fact, met their  obligations to make capital calls. Second,  the decision of a GP to sue an LP over a default is most often the absolute  last resort. The GPs are not in business to institute litigation — this a  distraction for the GP and added publicity that neither GPs nor LPs desire.  When the LP Agreement is executed, all of the parties enter into a contract  with the expectation that both LPs and GPs will honor their respective  commitments. The GPs have committed their time, and have built an organization  to implement an investment strategy and program for the fund. They should be  entitled to rely on the contractual obligations of those sophisticated  investors who agreed to support this program over the long  term.

VC Governance FAQ: (6) Are contract terms in partnership agreements shifting in favor of institutional Limited Partners?

images-10This is the sixth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: You had some thoughts about contract terms. Do you think the trend is shifting in favor of institutional LPs to receive better terms?

Answer: Certainly as the sources of capital have become more  selective and scarce, the GPs have had to become more aware of LP concerns over terms. While  the GPs in top tier funds will still be able to maintain favorable terms (and  LPs will always want to get into their funds), even these GPs have made some  concessions to maintain a supportive investor base. For example, recent press  reports have indicated that at least two prominent funds had lowered their  “premium” carry structures, and made the payment of a 30% carry rate subject  to the return of a multiple of the investors’ capital. For those other funds  that are not oversubscribed, there will undoubtedly be some pressure on  terms. Though there has been a lot of talk about the terms suggested in the  recent guidelines published by the ILPA, these guidelines have not fully  caught hold (and some proposed terms –like joint and several liability  on clawbacks — may be seen as too extreme). Still, in the current fundraising  environment, there will certainly be some movement to provide an  alignment of interests between LPs and GPs, while trying to maintain the  appropriate incentives for the GPs.

VC Governance FAQ: (5) How are VC funds governed differently from the governance standards applied to their portfolio companies?

images-8This is the fifth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: Please differentiate between the governance of a VC fund versus the governance of companies in a VC fund’s portfolio? Is one more important than the other?

Answer: This is a very important question, and it starts with recognizing that VC funds, as partnerships, are governed very differently from portfolio companies, which are corporations.  The VC fund may have one managing partner that sets the tone and controls the entire firm, or it may have a collegial distribution of governance among several senior partners.  The best way to understand how a VC fund is governed begins with an analysis of the fund’s investment committee, its deal due diligence process, and the specific allocation of the fund’s investment capital among the individual partners.  An important question to ask is, do the partners evaluate themselves and each other on an annual basis or at all? You might be surprised to learn that many VC funds lack an internal feedback loop, that the partners may not communicate openly among each other, and that the partners themselves may lack a formal measure of accountability among each other, even though the economics are divided formally in the management company agreement.images-9

Turning to portfolio companies, the board of directors is responsible for the governance of the company, and here we have a very interesting dynamic which often leads to board dysfunction—the VC directors have inherent conflicts of interest as representatives of their funds and as fiduciaries who must act in the best interests of all of the shareholders.  In addition there is a major tension and conflict between the management team and the VC directors—the management wants more share ownership, and the common equity is at the bottom of the seniority stack behind the various series of preferred equity rounds.  The VCs want capital efficiency, which means they want management to do more with less.  Compounding the complexity is the fact that most VC-backed companies replace their CEOs twice between the founding and the liquidity event.  So you can imagine that the VC boardroom governance equation is very complex and rife with opportunities for problems.

VC Governance FAQ: (4) How do you manage risk when backing serial entrepreneurs?

images-7This is the fourth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: Are there ways to mitigate the team risk when in fact VC funds often back a particular team or particular CEO?

Answer: When we back serial entrepreneurs, it is critical to assess where they are today in their lifetime achievement and performance potential curve.  By that, I am reminded of the fundamental risk in looking at track records—“past performance is not indicative of future returns.”  It amazes me how many investors chase performance and don’t pay attention to the current team composition at the VC manager, to the current dynamics of the partnership.  Ideally you want to back a proven winner who is still hungry enough to deserve a seat at the table.  Venture capital is totally a hits- driven business, but there are very few hitters, either VCs or entrepreneurs– who are able to hit multiple home runs.  When you look at VC’s, you want to find VC’s who are magnets for great entrepreneurs, whether they are first timers or veterans, and rely on the VCs’ pattern recognition ability to make that judgment call in picking a winner.  One way to mitigate risk is to assess how deep the team is in the VC organization—remember that you are making a 10 year bet on a team, and few teams stay together through an entire cycle.questionnaire