THE DIFFICULT ALIGNMENT OF INTERESTS BETWEEN ENTREPRENEURS AND INVESTORS
Browsing through the websites of startup investors, mainly venture capital investors, is educating. I am stunned by the effort they make to explain to their audience, essentially entrepreneurs seeking funding, how they are completely aligned with founders. Specifically, the killer argument goes like this: “we were entrepreneurs, we know what you are going through, we are in sync with you, not to worry chaps, working together will be like a never-ending honeymoon”. Either they forget who they are, i.e. risk capital investors placing their fund limited partners’ money in fast-growth tech ventures with a precise mandate, or they knowingly lie, just like immature future brides and grooms.
Each side needs the other one to be successful, and a clear understanding of expectations is the rule. Believing that both parties can completely align their interest is a pleasant illusion that will not stand the test of time. It does not imply that the alliance between investors and entrepreneurs is against nature. Entrepreneurs must be ready for the time when misalignment will inevitably occur. Working out expectations on both ends is the best way to avoid nasty surprises. One of my clients is facing a conundrum. Currently invested VCs are trying to dissuade the founders from bringing, in a new financing round with two corporate investors, whose strategic interests are valuable to the venture. It seems obvious VCs estimate that their interests have precedence over those of the investee. Is this thinking conducive to more creation of value? Doubtful.
Entrepreneurs and investors each seek an exceptional return on their human capital investment and their capital investment, respectively. This does not imply in all cases that when a venture capital investor requires an exit, the best exit meeting both entrepreneurs and investors’ expectations will be found. Working early on to define the conditions of the future exit can mitigate the risk of a surprise exit. Yet, it rarely works, as opportunities generally arise unexpectedly.
The biggest misalignment, in growing fashion since unicorns have become the trend for some -or the dream for others-, is between the survival instinct of the entrepreneur and the push for a wreck neck ride (you either fall or you are wildly successful) by VCs. The entrepreneur, fixed on the vision, is ready to navigate with agility, avoid the reefs, and adapt to the terrain. 21st century VCs throw tons of money to build and set the largest sail, surf at record speed with back wind, with high probability of breaking mast and hull, with one goal in mind: to maximize value ASAP and time the day of their exit. It may work in rare cases. The Bill Gates and Jeff Bezos of the world watch this new model with bemusement.
Then come the striking legally crafted clauses. The most puzzling clause in present term sheets is the liquidation clause. I am ready to bet that in more than 80% cases of startup liquidations, there is nothing left to distribute, after paying a few cents on the dollar (or euro) to creditors, except some IP, the value of which dives in the absence of the founding team, unless the IP protects some hard technology.
In general, as no entrepreneur has any leverage to renegotiate a signed deal, my advice is to cautiously select the investors you are going to spend a long journey with. Make time to talk to founders of companies they have invested in, before making any move, and keep looking for investors as long as you have not found the right, ethical investor with the right partnership proposal, a label I find more friendly to qualify a future relationship than term sheet, that sounds like an ultimatum, filled with tricky clauses. After all, investing in technology ventures is not Halloween.