The harsh truths of venture capital funding for start-ups
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A start-up that takes its fundraising seriously has to allow its CEO to tackle the project full-time for up to a year. The founders have studied the due diligence requirements ahead of the process, and they approach the investment community in an orderly and structured fashion. The founders and CEO work hard to listen to the needs of the investors and respond with the same enthusiasm as they provide to the customers of their product or service.
An investment in a company isn’t any different. It, too, is a product. It’s an investment sold by a company to a customer, the investor. The entrepreneur finds a venture capitalist with whom an immediate bond is formed. They instantly click and are energized by the ideas of the other. The investment is made and there is usually a truly spectacular dinner.
The closing dinner is an intoxicating experience. The hard work has paid off, and your vision has been validated by the entrustment of substantial capital. The months and sometimes years of previous work lead up to this momentous occasion, which puts an exclamation point on the effort.
Maybe you’ve always felt like the only thing between you and success is capital. And now here it is.
How could it be anything but miraculous from here forward? You might have been munching through lunch on submarine sandwiches and the cheapest Asian noodle packs you could find, and suddenly, you’re comparing the scallop appetizer to the thing you didn’t previously know was food. There’s white linen on the table and you’re thinking that maybe tomorrow you’d buy a suit jacket.
There’s an endless supply of liquor, and later that same night, when you’ve reconnected with your co-founders back at your kind of bar, you get all retrospective on the meaning of it all. You feel like you are about to change the world and there is a special kind of joy in feeling like you know it before anyone else.
That feeling carries over into the following days and months. You’re as committed as ever, and it’s great. Social life? That’s for the weak. You are building something here that changes everything. You’re on your way. The venture capitalist has introduced you to several dream candidates to fill previously vacant leadership and advisory roles. The venture capitalist has provided access to several market partners and helped in ways you never imagined.
Then trouble looms. Maybe it comes slowly and grows over time, or maybe it comes all at once, but even if your venture capitalist is strong, it comes all the same.
Over the course of the last couple of years and successive rounds of financings, you’ve become friends. After the second drink, he laments about the investment decisions of his other partners. Of course, they had decided on unanimous investment decisions at the outset but hey, don’t rock the boat, right? He starts to tell you about the term of the fund and how it’s all getting weird. You listen with a distracted but sympathetic ear.
Sounds like he’s partnered with the wrong guys, and that’s too bad, but you’ve got too much to do to be at this 90-minute lunch. Turns out that the fund has a 10-year term, and they’ve even surpassed their extensions. Again, that’s too bad, but it doesn’t really involve you, so … Two drinks become three, and now you’re leaning forward, listening intently and thinking of slipping out to call your co-founders.
It turns out that they’ve already started looking at offers for their portfolio. Liquidate the portfolio? Hey, you’re in their portfolio! Their Limited Partners (their funders) have decided to liquidate and won’t accept any further extension requests from the VCs. There’s going to be a fire sale. You are the fire sale. The partners of the venture capital firm have been forced to liquidate the holdings of the portfolio. The buyer could be anyone.
Will they care about your vision? You’ve seen headlines about distressed capital funds that take out the portfolios of VCs but haven’t paid a lot of attention. A few weeks later, they own you and take the seats on the board previously held by that great VC and his connections to the industry.
Control now lies in their hands. Your great VC buddy who helped you through so much is gone. He didn’t want to leave, but such was the circumstance. What will become of you? Will they continue to support the company or close your doors and auction the intellectual property?
Be aware. This is happening right now.
Warren Bergen is the author of Swagger & Sweat, A Start-up Capital Boot Camp.
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