The Prof, the VC, and the CEO: An Open Discussion
On July 6, 2021, the Cambridge University Technology and Enterprise Club (CUTEC) and Oxford Venture Capital Network (OXVC) hosted an open discussion between Luisa Alemany (the Prof - Associate Professor of Management Practice in Strategy and Entrepreneurship at LBS), Francesco Corea (the VC - Research Lead at Balderton Capital), and Ian Chapman-Banks (the CEO - CEO and co-founder of SQREEM). The panelists discussed different aspects of startup funding and venture capital.
One of the focal points of the discussion was the relationship between founders and VCs in the game of raising capital. This publication will summarize and share some thoughts on the subject.
For a CEO, raising capital is one of the most important activities when leading a startup. Ian Chapman-Banks considers it his most important activity and recommends starting each round after closing the previous one. Capital, more often than not, comes from VCs who invest in hundreds of companies a year to increase their probabilities of reaching favorable exits at the end of the lifecycle of the fund.
The panelists used a game analogy to describe raising capital. VCs generally learn the rules of the game early on in their careers, while founders usually focus on building, and when the time comes to raise capital, they enter the game without knowing the rules. As Peter Thiel writes in his book “Zero to One”:
“…In Silicon Valley […] engineers are biased toward building cool stuff rather than selling it.”
As an angel investor and lead of an angel syndicate in LATAM, I typically encounter founders that are so focused on the product they’re building that they forget to think about the interests of the potential investors in the company. Investors, whether angels or VCs, like to think they add value to their portfolio companies more as a personal fulfillment measure than a serious endeavor; in the end, the main goal for any investor is to generate profits, not to add value or befriend founders.
This puts founders at a disadvantage relative to VCs and makes it fundamental for founders to find the right VCs and consider whether their interests are aligned. The aforementioned matter opens another point of discussion regarding smart money and the value-add of VCs. Brad Feld and Jason Mendelson summarize this point in their book “Venture Deals”:
“As a founder, you should do your own due diligence into whom you are speaking to at any given firm.”
Often, this information comes from other founders in later stages who have worked with those firms and even the firm's web page. Twitter is a source of valuable information when used correctly too.
Another factor that founders must consider is the investors’ experience and industry interests. There is still no consensus on the benefit of finding like-minded VCs for a founder, but the fact is, if the VC doesn't understand your product or industry, it’s unlikely that he’ll invest in your startup.
This is the challenge GovTech founders are experiencing in LATAM, where VCs don’t quite understand how to merge new technologies (e.g., blockchain) into governmental services. When this happens, founders have 2 options: (i) try to convince and educate VCs on the product and industry; or (ii) find other sources of capital. The latter has been the best option for LATAM founders, who are now looking for accelerators and angels. This is also convenient for angels who take the time to study and understand new trends where VCs are not getting into yet, to get into interesting deals before anyone else.
Another advantage for considering raising as a game lies in the game-theory perspective where a game is described as a strategic situation, the outcome of which is determined by the decisions of more than one person, exactly what raising capital should be viewed as.
The possible outcomes include the company's valuation, which translates into the amount of control held by each player, the number of board seats that each player retains, the stock options that founders will have to offer to employees, and even the company’s success.
The utilities or payoffs of the players are different between the founders and their investors. Investors’ payoffs depend on their return on investment, which means they’ll seek the success of the company, not the founder, and they’ll try to agree to the lowest valuation possible, which allows them to get a better return for their money in an eventual exit.
Founders need to recognize that in the event of a conflict, or if the company is not generating the expected cash flows projected by investors, VCs and angels will side with the company, which is where their money is invested, and not with the founder, commented Luisa Alemany. This is why founders should not look at VCs as their friends, even when they certainly act like so, but as more experienced players with different interests. By taking this point of view, founders can try to align their investors’ incentives with the founder’s and learn the rules of the game early on.
Ultimately, raising capital should not be viewed as a zero-sum game but as a positive-sum game where, with the right incentives’ alignment, all players can profit and add value to each other. Even if VCs should not be considered friends by founders, they certainly are business partners with an interest to see the company succeed, and I have yet to meet a VC or angel investor who is not interested in helping founders succeed; even just being there for the founder and helping to make tough decisions as a sounding board is a value-add.