At Tau Ventures we advise all entrepreneurs to look upon the diligence process during a fundraising round as a two-way street. We believe it is not only an opportunity but a duty of the CEO to develop conviction that the VC they are bringing on board will indeed be the right partner moving forward. A wrong choice is akin to a bad marriage — terrible for all parties. In fact we subscribe to the maxim that hiring and firing your employees is hard, hiring and firing your investors is harder.
That said, there are many situations in which a startup will have to invariably reconfigure a relationship with a VC. It matters significantly because your champion within the firm is the one who will work the hardest for you, including advocating for funding in future rounds and being your ambassador with other investors. Here are five key situations to keep in mind.
1) Transition: VC Who Championed You Is Changing Firms — This is probably the most common case of having to change an investor relationship. If there is advance knowledge another investor in the partnership usually starts attending board meetings a few months in advance. Some funds will have a board seat and observership and may elevate the observer to the seat. Note a new deal owner will typically have less incentive to manage the investment and do follow-on rounds because they will receive less credit for having sourced the deal initially. As an entrepreneur you should ensure enough rapport with your key investors to be aware of such developments in enough time and voice an opinion as makes sense. After all, a transition of ownership is much more impactful for the startup than the investor who is typically managing multiple companies.
2) Retirement: VC Who Championed You Is Leaving Venture Capital Indefinitely — It’s a common practice for the fund to request the exiting VC to continue with a board seat, oftentimes compensating them. Once again it’s in your interest as an entrepreneur to read the situation correctly and apply the same principles from #1 Transition in terms of getting a successor. You essentially want someone who is good to work with and carries respect within the firm — both things are important. If your champion is leaving for personal or professional reasons that would reflect on the startup then obviously it’s a different matter. But if your champion is exiting voluntarily then it’s convenient to maintain the relationship, with an eye towards finding the best possible successor.
3) Outspent: VC Fund Is Out Of Money — This is perhaps the toughest of situations. In some rare cases funds have been known to default on their capital commitments but more often they simply don’t have unallocated funds to support you in future rounds. Remember most VCs do not have their full fund available to them upfront, they call it incrementally from their LPs over time. Most firms do leave a significant portion in reserve, often close to 50%, but cultures vary enormously on how they deploy this capital and having a champion who both understands and influences the internal decision-making process is key.
How to avoid a surprise? In this day and age it’s very easy to spend a few minutes on the web to check upon a fund’s size, estimate the average check size, and typical follow-on strategy. In the US SEC filings, TechCrunch, Crunchbase and Pitchbook are some of the tools startups can use to triangulate towards those answers. And then obviously ask the major investors themselves during the diligence process. If you do run into an unexpected situation then brainstorm with your champion whether syndicating with their LPs, reaching out to other VCs, or doing a SPV with third parties are options.
4) Conflict: There Are Opposing Interests — Most VCs will not invest in competing companies, at least to start with. But it sometimes happens anyways when different companies in a portfolio start overlapping too much. The typical practice is for different partners to then take each board seat to minimize cross-information. Some firms will go as far as recusing themselves from the seat or even actively selling their position to another investor. Strategic VCs will typically abstain from those specific discussions where they will be inherently conflicted, such as the startup considering competing acquisitions including from the corporate. At the end of the day, the key thing for a CEO is to develop enough trust with the investors because no amount of language in a term sheet can address all possible conflicts.
5) Clash: You And The Investor Are Fighting — Some investors will work on replacing the exact person on the board. Others will advocate for doing a secondary i.e., selling the ownership to another investor. In either case ultimately it’s the CEO’s responsibility to try to manage a conflict, including leveraging the rest of the board as needed. Oftentimes a CEO is also the Chairman of the Board which should help in setting an agenda towards a resolution. Disagreements getting out of hand is actually rarer than it seems from our experience at Tau Ventures. But when it happens it causes tremendous damage — look no further than Uber or WeWork as recent high-profile examples.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.