Nivi · October 27th, 2008
In Be Careful Who You Deal With, Matt McCall, a Managing Director at DFJ Portage, has great advice for entrepreneurs who are dealing with “slimy bottom sucker” investors:
“As these markets continue their chaotic path downward, people’s true colors come out. Some people show increasing amounts of fairness and consideration. Others will self-optimize and use every bit of leverage that they can get their hands on.
“Two entrepreneur friends of mine recently had a very negative experience with an investor who has a reputation for being Machiavellian and it really, really has incensed me. These slimy bottom suckers use the changing market conditions to test how low they can retrade an existing deal. Here is the standard game plan for these kinds of assholes. When they sense a dramatic change in the market, they pull away their term sheet siting “policy” changes. However, instead of walking away from the deal, they mention in passing that they might reconsider under “different terms”. If the entrepreneur bites, they know that they have leverage and they proceed to throw down absolutely egregious terms (multiple liquidation preference, half the original price, etc). If the entrepreneur bites on this, they know they really have them and continue to ratchet down the terms until things break and they back off.”
Read the rest of Matt’s post to learn how you can counter this investor’s game with your own game theory.
Machiavellian investors will try this trick in good markets too (I’ve seen it happen). Once you sign a term sheet, the investor will try to retrade terms. By then, you’ve told other prospective investors that you’ve signed a term sheet. It’s hard to go back to them and explain what’s happening. And if you walk away from the signed term sheet, it’s hard to talk to new investors with a blown-up term sheet on your hands.
Of course, Machiavellian entrepreneurs exist too. And VCs have enough “institutional knowledge” to know that. Unfortunately, most entrepreneurs don’t have commensurate knowledge about their counterparts.
(Via Ask the VC.)