Blue Dots Partners

Entrepreneurs and VCs live on different planets and sometimes seem to be subject to different laws of physics. This “impedance mismatch” creates misalignments that, at a minimum, distract CEOs and their board from their focus on building the business. Ultimately, distraction can lead to disaster.

Different time scales

VCs raise money from LPs (Limited Partners) via a partnership agreement that typically lasts 8 years with a one-year extension that can be applied twice. So, the life of a fund is 10 years, which is the time given to a Venture Capitalist firm to find, invest, nurture and drive to a profitable exit a portfolio of promising companies. Early-stage investors put money in a young company and expect a liquidity event that will return as many times as possible the amount they invested with a time horizon of 5 to 7 years, while the natural frequency of raising a round of financing is often between 12 and 24 months. Great entrepreneurs are driven by a great and uncompromised sense of urgency: “I need to ship this product on Friday”, “I want 1 million users in 90 days”, “I need to hire an incredible VP of Engineering now” and “I want to close my round of financing yesterday”.

Different motivations

By design, VCs are driven by multiples and timing. It’s the combination of both that determines the IRR (Internal Rate of Return) that is used by LPs to rank VC firms and allocate a portion of the money they manage. Interim valuations, typically determined when the company raises additional capital but before there is a liquidity event, are important for cosmetic and marketing reasons and are particularly useful if the VC firm is in the process of raising its next fund from LPs. This is why having one or several of the current 145 unicorns in the portfolio is such a big deal. It grants bragging rights, and lets the fund mark up its total portfolio value on their books (until the unicorn sees a down round). Great entrepreneurs are not driven by theoretical valuation, money or ephemeral glory. They are driven by the urge to make a significant and lasting impact in the world, typically measured by the size of the impact on the audience they reach and by how much they changed them for a better life. Think for example, in the consumer space: 23andMe, Airbnb, Amazon, Facebook, Google, Twitter, Tesla, Uber, Snapchat, etc. Of course, there is no dislike of making a lot of money and fame, but this is rarely the primary driver.

Different worlds

In my VC career, I looked at 1,400 companies and with very few exceptions asked the CEO who their competitors were. I have never heard the correct contextual answer. The CEOs would say “Amazon” or “Microsoft Sharepoint” or “Business Objects”. In the context of raising money, their true competitor is in fact the company that presented just before them at our Monday partnership meeting. That company may have been selling shoes over the Internet. We will decide to invest either in them or in the company that the CEO is presenting. This is why it is so critical for the CEO to understand what business VCs are in. They invest in companies that give them the most hope to create tremendous and sustainable shareholder value (by growing revenue much faster that the market in which they operate). Fear of “losing the deal” and missing out the next big thing is a great motivator for most VC firms to write a check.

Selling something I don’t want to buy

Entrepreneurs get excited, take pride and get carried away by the marvel of their product. They want to convince me, the VC that this is the best product on the planet. In pretty much all the cases, the VC will actually never buy the product. When did you see a VC buy a Denial Of Services Attack on-promise security product that sells for $125,000 per server? What they truly want to buy is the belief that the company will be the next billion-dollar valued business in 5 years. They also want to make sure other VC firms are seeing the same opportunity and are not totally alone: this is why VC often ask: “What other VCs are you talking to?” “Did you get a term sheet?” “How far are you in your fund raising process?” “Did you talk to Sequoia?”

Different strategy, different exit

It is not rare that boards and entrepreneurs are not aligned on exit. Some VC investors will have a “spend a lot to grow fast” approach, while entrepreneurs might be more concerned with building a solid and repeatable business model. This misalignment tends to create tension at the Board level and some times, even between investors, who came different times and who are at different cycles in their own fund raising.

When things go wrong

Many VCs have an itching finger on the trigger to fire the CEO when revenue growth does not meet their expectations. At Blue Dots, we often hear the following statement from VCs: “If the company is not growing as it should, we just fire the CEO and recruit a new one.” While that is a legitimate course of action in some cases, we do not believe that it is wise to do so until the root cause of the slowing growth is fully understood. Sometimes, the market is shifting or a new competitor is coming from nowhere or the new product that took a long time to build is no longer relevant to the market. In these cases, firing the CEO may cause more problems than solutions.

While the relationship between entrepreneurs and investors does not always present itself as a natural alignment, it can certainly work when expectations are clearly identified. Reciprocal due diligence and deep discussion is always advised before cashing that multi-million dollar check and inviting new members to one’s board and face some misalignment challenges.

Aligning for success™