I was driving along the Oregon coast when the phone call in from the founder of an erstwhile competitor. He and I had met as we were both focusing on building solutions for the emerging enterprise mobility space, and had competed for some funding from a well-known VC firm. He ultimately won the funding battle as this VC and another firm backed his company to the tune of 2.3M dollars in seed funding . We continued to self-fund and scrape by on savings … more on that in another story.
I had not spoken to him in almost 2 years, yet here he was on the phone. After exchanging pleasantries, and him congratulating us on the sale of our company, we got down to brass tacks. I asked him how it was going, he said, “not well”, the VC’s had decided that they would not lead the next round of funding. As we spoke more about this, I could hear the frustration and resignation in his voice. He said customer’s they had won loved their approach, but that they had been struggling to get repeatability. That they had some revenue, but that they really had not seen how to scale. I probed some more, and it seemed that every two months he and his team had been trying to follow sales/scaling plans that the VC’s suggested. They had asked him to contact me and see if anyone in my network would see a fit for their solution in the portfolio. WTF? I wanted to help him, cuz he’s a hell of a nice guy, but helping VC’s to recover their money did not feel like a great use of my network or time.
Not two weeks later I got a call from a separate CEO. Similar situation, in that VC’s who had not funded us at Nukona had seed- invested in his company. The VC’s were declining to lead the A-round, but said they might throw some in if he could get a lead investor. Talk about the “Kiss of Death”. He was frustrated because he thought they could build a company. They had great reference customers and were slowly building value amongst their customer sets. However, his company was running out of money, and they were still running negative cash flow. He was stuck, as there was no way to raise money (see Kiss of Death above)… The lead partner suggested that he reach out to me to see if I could hook them up with someone in my network who might want to acquire the company assets. I hate to see folks jammed up, but the VC’s lack of faith in team and technology already pretty much dictates what I do, or not do.
There were several similarities in these tales of woe, I have captured them below, so you can recognize the patterns here.
Both founders and CEO’s were non-technical. They were business folks who had come in with the money. They both had operated as EIR’s within firms before getting paired with money to go after a problem. In many ways, the role that they had taken was that of professional management, rather than deeply passionate technology evangelists. It didn’t feel personal to them.
They both raised allot of money in convertible notes ($2M+) from institutional investors. With that raise, they paid themselves, their co-founders and the additional staff real salaries, embarked on crazy marketing spends and hired several folks more than needed. They spent money to try to define the problem while wandering in the desert, rather than wandering through the desert before they spent money. In any technology start-up, there’s a natural progression from the theory of the problem space and solution, to the creation of a proposed solution, and then a period of wandering in the desert before finally honing the value proposition. Preservation of assets to get through the desert is critical.
In each case, the biggest problem was that their seed investment came from institutional investors. This is not to say that institutional investors are a problem, but rather that this money came in before the company had any IP or traction…It’s a “too much money” problem, as they raised too much, too early before they were in a repeatable biz model.
My conclusions here are my own, and I encourage you to draw your own, but they are as follows:
- Early stage companies need to be lead by technologists, who are deeply passionate about the problem they are solving. A team formed of some techies and some EIR’s brought together by a 3rd party may become passionate about their problem space, but its not the same team dynamics.
- VC’s are right to walk away from seed investments that have not gained traction. In fact, this is the point of seed money — to test a hypothesis and problem solution. If you are taking seed from a VC, remember that it does not guarantee follow-on funding, but it can prevent follow-on funding from other VC investors. Take ONLY what you need to test your hypothesis.
- I question the value of the “pairing” services that some VC’s propose as a condition of investing. I have not done the detailed analysis, but anecdotally the pattern does not seem to work.
I see the pairing effect happen quite a bit as I read stories in TechCrunch. Everytime I see what is clearly a pairing of money, business leadership and an untried technical team, my current expectation is that an asset sale is 18 months away. Make sure you are not in that boat. Know your problem space, be passionate about the solution, and ensure that you are a team, not a group with shifting alliances. The start-up journey is a hard one, set yourself up to get to the other side of the desert from day one.