November 8, 2013
I caught up the other day with a friend (I’ll call him Rob, to protect the innocent) and successful West Coast founder who recently sold his first company. It was a good outcome, though not spectacular. He got a taste of success, made a few bucks, learned a boatload, and like any great entrepreneur, that was enough to leave him desperately hungry to go out and win big the next time. When he does, I hope I’ll have a chance to back him.
This was the first time we’ve had a chance to speak in detail about the transaction, and also the first time he’d been able to really stop and take a long view back at what the prior few years had meant and what he’d learned from them. In the course of our discussion, I asked him how his VC syndicate had worked out for him.
His only financing came from two large firms and a batch of angels. The angels were pretty insignificant and not involved in the business. The two VCs were on his board of directors and more involved.
In general, he was happy enough with his investors and the way they treated him through the process. However, he also said very clearly that he did not get anything close to what he hoped from his board, and the whole experience has taught him a lot about how to construct an investor syndicate for his next company. With the benefit of his less than satisfying experience, he had developed a very simple framework that we discussed and which I found pretty compelling.
He said, simply, that there were three things you needed to get from your investors. After some debate, we finally landed on the following prioritized order for them:
- Domain expertise
- Comfort with your investment stage
- Operating experience
- Domain expertise can mean both relationships and experience in the vertical sector in which you operate, or experience with and knowledge of the business model which you apply. We debated which of the two is more important, but ultimately decided that it’s an interplay of the two that matters, and it’s impossible to pick one over the other.
- Stage expertise is one that entrepreneurs frequently fail to focus on. This is about the alignment of your investors with the level of entropy and chaos that will exist in your company given its stage.
- Operating experience is what it sounds like, and it doesn’t matter all that much in his mind where it comes from, as long as it is a vaguely similar tech sector and, most importantly, the investor has experience operating in a random, chaotic environment where managers are hiring and firing at a rapid pace and key decisions are made before the first cup of coffee and then changed three times by lunch.
As Rob reflected on his experience, he understood that the investor and board struggles he’d had were a result of holes on his board vis a vis this framework. He had raised money from terrific, brand name firms, for sure. But for his seed stage, two-sided marketplace business, he ended up with partners on the board who had between them zero marketplace experience, zero operating experience, and only one of whom was truly comfortable with the vagaries and uncertainties of seed stage deals. So while his initial fundraising press release looked sexy, and his cap table was impressive, his board ended up decidedly ill-equipped to satisfy Rob’s hopes and needs.
I’ve thought a lot about board and syndicate construction in the past, but I think Rob’s framework brings a really simple, elegant view to this incredibly important area that I will actively apply in the future. I’ve been on some 30 boards in my career as a VC, and I’ve seen really functional ones and desperately dysfunctional ones. And when I think back through them all using this framework, it proves a remarkably effective predictor of board performance.
The only overlay I would add is that the framework is also dependent on the relative strength of personalities. If the loudest voice and otherwise most influential board member (this might be a result of experience, dollars invested in the company, or just sheer force of personality) is critically off the mark on any of the above, that can bring a board down on its own.
Rob & I discussed a bit how to practically apply this to future syndicates. While we agreed that it’s of course ideal to have a board full of individuals who are a match on each of the three dimensions, that’s rarely going to be possible. We agreed on two more practical rules of thumb. First, it is absolutely essential that a board, in aggregate, checks each of the three boxes. And second, it is by far preferable to get two of those boxes checked by each member of your board – folks who check only one of the three are just going to miss the point too often.
Of course, sometimes companies don’t have the luxury of a range of options. Sometimes you take the money you can get. However, I would suggest that if you are sophisticated enough to apply this framework to your discussions with each and every prospective investor, asking questions to qualify them on each of the three dimensions, you’ll end up impressing investors with your diligence and on the margin attracting a better group.