Venture Capitalists Need To Stay Within Their Remit After Investing
18 June 2020
Kjartan Rist for Forbes Magazine
With billions of VC dollars currently invested in startups across the globe, it’s encouraging to see recent reports suggesting that the vast majority of VC-backed startups look to be capable of surviving the ongoing pandemic.
But while VCs have rightly stepped up their efforts to support portfolio companies through the crisis, it’s important that investors don’t overstep their remit and, in doing so, damage the value-add relationships they’ve nurtured with their founders.
The purpose of venture capital
People often refer to venture capital as a young industry, a product of the business world’s recent fixation on delivering hyper-fast growth above all else. Actually, modern venture capital began in post-World War II America and has developed steadily over the past seven decades to become what we know and recognize as today’s venture funding.
In fact, the principle of ‘carried interest’ – the share of profits returned to investment managers such as VCs in return for their endeavor – dates back several hundreds of years. On 16th-century sea voyages between Europe, Asia, and the Americas, it was normal practice for the captain of the ship to take a 2% fee for running the cargo and a 20 percent share of the profit from the goods being transported, to cover the risk of sailing across the ocean.
Today venture capital is typically used either by companies that cannot access other types of finance (banks, traditional debt, etc.) by companies whose rapid growth ambitions cannot be supported purely by cashflow alone, or by ‘Blitzscaling’, Silicon Valley’s growth strategy of choice: “Scaling up at a dizzying pace that blows competitors out of the water.”
Venture capital 2.0
As such, we need to move away from the mindset of venture capital as a pure investment vehicle and restore the concept of mutually-beneficial partnerships with entrepreneurs and their young businesses.
VC/startup partnerships should be driven by early conviction and relationship-building, rather than determined simply by potential addressable market forecasts or five-year growth predictions. Jamie Ward, CEO, and co-founder of flexible gym membership platform Hussle, points out that, “Once an entrepreneur understands investors are not some higher power and, in the vast majority of cases, are essentially entrepreneurs themselves, then they can build a productive relationship that is based on honesty, openness, and collaboration. Founders and investors need to take the time to get to know another as people, without being guarded when talking about the business challenges.”
After forming these partnerships, VCs need to demonstrate proactive management of their investments and remain in continuous dialogue with founders. They need to take a solutions-focused approach, working with portfolio companies to address any issues and shortcomings instead of working “against” the company with a stick. And they need to deploy all of their experience, best-practice, portfolio learnings, and understanding of macro trends, to guide, manage, and support each business on its journey.
This approach is becoming known as ‘activist venture investment’, but in truth, it’s what modern venture capitalism should always have been about.
After all, there are plenty of well-lubricated private individuals and institutions out there for companies that simply require a cash-injection. The entrepreneurs that stand to benefit most from venture capital require more than this – where it’s business development, improved corporate governance, network building, or identifying strategic senior hires. The VC’s remit, beyond the investment itself, is to recognize these needs as they emerge and work proactively to address them.
Defining value-add investing
Due to the complexity of building a valuable company, it is key that investors prioritize support towards their founders and build a network around each entrepreneur to advise and mentor them along the way. Different founders need different types of support depending on their skills, experience, co-founders, geography, sector, or even their personality type.
Crucially, investors should provide input that is operationally relevant for the company and makes a tangible difference to performance without compromising the underlying founder/investor relationship. This is the definition of value-add investing and, contrary to popular misconceptions of our industry, this often means the investor acting as a ‘foe’ during good times and a ‘friend’ during tricky periods. The best VCs rely upon intuitions stemming from years of investing in and building businesses, giving them the ability to pattern-match what they’ve observed across these companies and yield important insights that can be shared with founders and actioned in partnership together.
Often, the most useful input comes in identifying where a company may have gaps in its understanding. As Cameron Shearer, co-founder of digital business insurance challenger brand Digital Risks, explains, “Cash aside, having an investor that understands your market is critical, Our VCs have been highly active, able to feedback insights around the SME space based on their extensive network, and have supported numerous introductions, one of which ultimately led to our Series A lead investor.”
When things go sour
However, there is a fine line between being supportive versus interference. No doubt the COVID-19 crisis has exasperated many founders whose investors have suddenly become a constant and vocal presence within their day-to-day operational lives.
A good VC invests in good founders, and good founders also have good intuitions that they must be allowed to follow. Similarly, founders do not like being dictated to. VCs must know their place, respect each entrepreneurs’ skill-set and domain knowledge, and recognize where it’s necessary and appropriate to contribute.
Overstepping the mark will damage the trust and mutual understanding between investor and founder, to the detriment of the long-term partnership. As investors, we are entitled to ask questions of our founders. But usually, the most helpful two questions we can ask are: where can we assist you beyond capital, and where do you need help?
The perfect balance of activist venture investing
An investor/founder relationship in the venture capital space typically lasts at least four to eight years. To make this a productive relationship, an investor needs to quickly analyze the company and its situation at the outset to define what their own remit should look like.
Remember, there’s a big difference between sharing knowledge and being a know-it-all. It is vital that the investor enters into the company with a humble attitude, both regarding sectoral knowledge as well as the progress the founder has made in building their business to date. Just as the captain of a cargo ship has no enterprise without their cargo, so too must venture capitalists recognize that the investor stands to gain little without the founder.
Of course, over the years, VC/founder relationships will inevitably need to change and evolve, with the investor able to identify what type of support is needed at each point along the way. It’s a balancing act – listening, learning, and facilitating, without intruding, obstructing, or dictating the terms of the relationship.
No investor will make the perfect contribution 100% of the time – we are human, as are our founders. But as a general principle, striking the right balance as an activist VC involves being astute enough to define an appropriate remit and being self-aware enough to stay with it.