Loco Motive

Why Venture Capitalists Get on a Train Leaving the Station

Scott Lenet
Risky Business


“A woman walks into a train station… and sees an engineer with tools and parts all over the platform — it’s a train engine under construction. She thinks to herself, ‘Cool, that engineer is building a train. It looks like he’s going to be here a while.’ The woman is busy, so she moves on to another train, even though the tracks head in the direction where she would like to go.

The woman comes back another time, and the same engineer has finished building the engine, and is now in the conductor booth. The parts are all off the platform, there is a number 9 painted on the side of the train, which is slowly chug-chug-chugging out of the station. The woman, seeing that the train is leaving the station, rushes to get on board.”

The woman is a venture capitalist and the man is an entrepreneur, and this interaction illustrates a principle called “fear of loss” that explains investor behavior. Entrepreneurs often wonder what it takes to get VCs to fund their companies, and the answer is that — most of the time — we must believe you will succeed without us. Part of the thought process is that if an entrepreneur “can do all this without my money and help, just imagine what can be accomplished if we contribute.” At an even simpler level, VCs will often simply chase after a good deal that appears to be getting away.

So long as the investor can come back tomorrow, or next week, or next year, and the train is still under construction, there is no need to get on board. But if the train is leaving, there is often a pressure to get on now, or lose the opportunity forever. It is this latter pressure that often forces investors to act.

So if you have ever told a venture capitalist that you can’t move your business forward without their capital, you are putting a tremendous amount of power in the hands of your potential investor, and removing the pressure to invest. It’s a little unfair, but it’s how venture capital usually works.

Does your business still require some assembly?

What constitutes a “train leaving the station”? Well, of course, a competitive term sheet from another investor can provide that impression, but this can be easy to fake and may not always convince sophisticated investors. Even better is a business that is simply progressing on its own. Tangible milestones including product releases, new customer wins, customer renewals, and productive distribution relationships provide compelling evidence. What about at the seed stage? Early evidence of progress can include completed beta products, customer LOIs that demonstrate product/market fit, and key hires (including to the company’s advisory board).

To reinforce this insight into investors’ mental models, it helps to continue the metaphor and project how VCs typically look at our own role, compared to that of entrepreneurs and other ecosystem stakeholders. The better analogy is that investors do not actually want to ride the train. We provide fuel.

The entrepreneur’s role: build the train, drive the train, attract the people who ride on the train.

The venture capitalist’s role: provide the fuel to operate the train, until there are enough customers for the operation to support itself — we may also have good perspective on successful railway operations.

Customers’ role: ride the train, pay for the ride.

Partners’ role: there are multiple types of partner transactions including licensing (provide know-how to help you build the engine), supply chain (help you source parts for your train), distribution (help make sure that there are platforms available for your train to pick up and drop off passengers), and co-marketing (advertise your train service).

Corporate VCs’ role: CVCs can contribute a combination of what VCs, customer, and commercial partners provide: investment (fuel), a customer relationship (customers riding the train), or a commercial partnership (help with the train itself or the business of running the train service).

Not all investors think this way. Some venture capitalists will ask themselves, “can we anoint this company as the winner in the market?” While VCs can have extraordinary influence over the direction and destination of a startup (and CVCs potentially more so, since we can be customers and business development partners), we don’t build the train, nor do we drive the train. Our main job as investors is to supply the fuel. It is much easier to help a train go from 10 miles per hour to 500 mph, than it is to go from zero to 10 mph. VCs who prefer to drive the train should incubate businesses instead, or simply become entrepreneurs themselves.

This realization is especially relevant for corporate venture capitalists, who often invest too early and find themselves deeply involved in the operations of their portfolio companies. It’s important to maintain perspective about what entrepreneurs are good at compared to what big companies do well, as noted by Wolcott & Lippitz in their corporate innovation book Grow From Within. Entrepreneurs are good at recognizing non-obvious opportunities, creating something new, and doing it quickly. Corporations are good at repeatable processes, ensuring innovations work successfully as a business, and doing it at scale. It’s the combination of these skills that can make corporate investment such a powerful combination for both parties.

“Are we there yet?”

What do the train tracks represent in this analogy? The direction of the market and the long-term potential of the business — is this train headed to an attractive destination?

∙ Some trains get to a destination and stop (M&A).

∙ Some trains stop at multiple destinations and then keep running with customers getting on and off (independent private companies or IPOs).

∙ Some trains run out of fuel and don’t make it far out of the station (these companies are the “walking dead” or the companies that go out of business).

Many venture capitalists invest according to Newton’s first law, the law of inertia: a body in motion tends to stay in motion and a body at rest tends to stay at rest. Remember this, so you don’t get railroaded.

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Scott Lenet is President of Touchdown Ventures, a Registered Investment Adviser that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs.

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Scott Lenet
Risky Business

Founder of Touchdown Ventures & DFJ Frontier, USC & UCLA adjunct professor, father of twins, Philly sports Phan, Forbes & TechCrunch contributor