Value Add Posts

More wisdom from Randy Komisar‘s The Monk and the Riddle (emphasis added):

Passion

“So why were they doing this? Why was it worth their time? I am always amazed that venture capitalists don’t ask that question. Perhaps at this point everyone assumes it’s obvious: to get rich.

“Passion and drive are not the same at all. Passion pulls you toward something you cannot resist. Drive pushes you toward something you feel compelled or obligated to do. If you know nothing about yourself, you can’t tell the difference. Once you gain a modicum of self-knowledge, you can express your passion…

[Passion] is the sense of connection you feel when the work you do expresses who you are. Only passion will get you through the tough times… It’s the romance, not the finance that makes business worth pursuing.

“I can’t get excited by a business whose biggest idea is making money.”

Venture Capital

“Most VCs (even if they insist otherwise) simply don’t have the time to give close management attention to the companies they’ve funded. In addition, in contrast to the original VCs, who often gathered years of operating experience prior to becoming venture capitalists, many partners in today’s firms have no executive management experience. They could be working on Wall Street as easily as on Sand Hill Road.”

“I have never seen a company fail for having too much money. Dilution is nominal, but running out of money is terminal.”

Excellence

[Mediocrity is] the biggest risk of all in Silicon Valley… Instead of managing business risk to minimize or avoid failure, the focus here is on maximizing success. The Valley recognizes that failure is an unavoidable part of the search for success.

“[Excellence] should be your primary measure of success… not simply the spoils that come with good fortune. You don’t want to entrust your satisfaction and sense of fulfillment to circumstances outside your control. Instead, base them on the quality of what you do and who you are, not the success of your business per se.”

Leadership

“Management is a methodical process; its purpose is to produce the desired results on time and on budget. It complements and supports but cannot do without leadership, in which character and vision combine to empower someone to venture into uncertainty. Leaders must suspend the disbelief of the constituents and move ahead even with very incomplete information.

Many ideas in this Valley happen against all common sense. It’s good when entrepreneurs are a little bit deaf and blind, but if they’re completely deaf and complete blind—and many are—they’re unlikely to learn enough from the market and their advisors to make their vision a reality.”

“Nearly 100% of the investors interviewed believe that they add value to their portfolio companies. Unfortunately… only 45% of the entrepreneurs interviewed indicated that they believe that was the case.”

Matthew Louie and Cali Tran,
Harvard M.B.A. Students

Every investor claims to add value. But how much value do they really add? In particular, how well do they help with recruiting?

18% of executive hires come from investors, says one study.

Noam Wasserman, from the Harvard Business School, presents some interesting data in Investors (and Managers) as Headhunters:

“Investors provide leads to a significant subset of hired executives (an average of 18% of executive hires). However, they trail both the non-CEO members of the management team (who referred, on average, 29% of executive hires) and CEOs (36%).

“The major exceptions were for the CEO and CFO positions, for which the percentages [for investor leads] jumped to 28% and 30%.”

Translation: investors refer 18% of hired executives, employees refers 65%, and “other sources” refer the remaining 17%.

Hire investors for money-add and employees for value-add.

This data is consistent with our advice: hire investors for their money-add. Investors do add value, but you should assume their primary contribution will be money. Most of your value-add will come from employees, not investors.

Find an investor who will make an investment decision quickly, who is humble and trustworthy, who will treat you like a peer, who shares your vision, and is betting on you, not the market. If you’re lucky enough to find more than one of these investors, you can start thinking about which one will add the most value.

Ignore the averages: How will your investors help you?

Finally, this survey is really interesting, but it measures averages. You don’t care how the average investor helps the average entrepreneur. You care about how your investor will help you. And the only way to figure that out is by referencing your investors.

Related: Investor/Entrepreneur Value Expectation Gap.

Q: Everybody is telling us to raise smart money. What’s the difference between smart money and dumb money?

“The best assumption to make is that your VC’s primary value add is the cash they are investing. Then you’ll always be surprised on the upside.”

Marc Andreessen

Summary: Smart money is money plus the promise of help that’s worth paying for, dumb money is money plus hidden harm, and mostly money is mostly money. Weed out the dumb money with diligence. Evaluate supposedly smart money with the smart money test. Finally, assume your investors are mostly money: unbundle money and value-add to get money on the best terms possible and value-add on the best terms possible.

smartmoney.png

If smart money is money plus the promise of help that’s worth paying for, then dumb money is money plus hidden harm, and mostly money is mostly money. All three provide what entrepreneurs primarily want from investors: money.

  1. Avoid dumb money: you don’t hire harmful people—so don’t marry them for the life of the company either.
  2. Most investors are mostly money but very few of them act like their primary contribution is capital. They spend too much time selling you on their value-add and not enough time getting you a quick yes or no.
  3. Smart money is rare—after all, would you work with most investors if they didn’t bring a piggy bank? Also, too many investors think the “smart” in smart money means “we know how to run your business better than you.”

Weed out the dumb money with diligence.

Don’t assume any investor won’t be harmful. Do the diligence to prove otherwise:

  • Do you trust him?
  • Will he provide his pro rata in the next round? (Not so important for seed funds and angels.)
  • Will he support you if the company is going sideways?
  • Does he have impeccable references?
  • Does he want control?
  • When it comes time to sell the company, will he let you?
  • Will he let you expand the option pool to hire someone great?
  • Does he want to replace you as CEO?
  • Will he try to merge you with a dying company from his portfolio?
  • Do you want to marry him for the life of the company?
  • Is he committed to investing in startups and does he have a reputation to protect in the startup world?
  • et cetera

Evaluate supposedly smart money with the smart money test.

After you’ve weeded out the dumb money, do the smart money test on everybody else:

Would you add the investor to your board of directors (or advisors) if he didn’t come with money?

If the answer is no, he is mostly money (see below). If the answer is yes, subtract some dilution from his investment since he’s eliminating the cost of a value-add director or advisor. You’re paying for the smart money investor—with his own money!

A smart money investor can be very valuable because he is good enough to be an advisor or board member and he owns enough to really care about the company in good times and bad times. An advisor or independent director won’t own enough of the company to really care if the company is in trouble—his career isn’t on the line like an investor’s.

But! If the investor you thought was smart doesn’t add value, you can’t fire him like an advisor or director and get your money back. You can only hope to ignore him. Which is why it is safer to…

Assume your investors are mostly money.

Whether you raise smart money or mostly money, you should raise money as if your investors were mostly money. In other words, unbundle money and value-add. Get money on the best terms possible and get value-add on the best terms possible.

You can buy advice and introductions for 1/10th of the price that most investors charge. An investor will buy 15–30% of your company. An advisor or independent director will require 0.25–2.5% of your company with a vesting schedule of 2–4 years.

An advisor or independent director will be hand-picked from the population of planet Earth. He should be more effective than someone picked from the vast pool of investors who want to invest in your company.

He will own common stock, unlike an investor who owns preferred stock with additional rights.

And he won’t have conflicting responsibilities to his venture firm, other venture firms, or limited partners.

Money-add first, value-add second.

Value-add is great but it comes after money-add. First, find a money-add investor who will make an investment decision quickly, who is humble and trustworthy, who will treat you like a peer, who shares your vision, and is betting on you, not the market.

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Sorry we haven’t posted for a few days—we’ll get back to venture hacking this week. In the meantime, here are some hacks from the deep recesses of our personal blogs…

Naval

VC Bundling

Microsoft bundles its Office applications. Record Labels and Game Publishers bundle cash and distribution. Silicon Valley Venture Capital bundles Advice, Control, and Money. In lean times, you, the entrepreneur, have to buy the bundled good.

Want Cash? It comes bundled with an Advisor on your Board of Directors, like it or not. And they take Control.

Want Advice? VCs won’t take Board seats without putting in Cash – it’s the only way to get enough leverage. And they take Control. Always the Control.

Smart entrepreneurs in times of plenty (like our current financing bubblet), serial entrepreneurs, and those with profitable businesses break apart these bundles. To un-bundle, you must have multiple bidders (that’s a longer entry), and you must have the ability to refuse capital (on Sand Hill Road, collusion is just a lunch away).

Lawyers or Insurance Salesmen?

Watch out for the bait-and-switch – this is when you interview the gregarious, smart senior partner, who then swaps in the less popular, less experienced partner once you’ve signed them up. And the new person might be cheaper, but not much cheaper.

Put them on fixed-fee per job, especially for closing a financing, and especially for lawyers for the other side (one of the old great VC tricks is that startups pay for the VC’s attorneys in closings! A ridiculous practice justified as being “standard”)

The 80-hour Myth

Let’s get serious. Nobody works eighty hours a week. Not eighty real, productive hours. Look closely at workaholics (and I’ve been one, and worked with ones), and a lot of the time is spent idling, re-charging, cycling, switching gears, etc. In the old days this was water-cooler talk. In Silicon Valley, it’s gaming, email, IM, lunches, and idle meetings. Let’s drop the farce, ok?

Nivi

Don’t target large and obvious markets?

“Because the process of securing funding forces many potentially disruptive ideas to get shaped instead as sustaining innovations that target large and obvious markets, the very process of getting the money to start a venture actually sends many of them on a march toward failure.”

Womb-to-tomb Investing

“… failure to execute operationally is not the only source of risk [in startups]; every venture is also subject to volatility in the price and availability of capital due to the volatility of the stock market. After the collapse of the Internet Bubble, many promising companies foundered because their funding dried up.

… [Warburg Pincus has] supported the multi-year process of building a sustainable business by underwriting all of the capital needed to reach positive cash flow, thereby not only enabling management to focus full-time on the business but also insuring against the risks generated by a volatile stock market.”

Dear M.B.A.,

“Morons! I know there’s nothing out there. That’s why I want to build the railroad!”