Wednesday, October 19, 2005

Badly behaved VC - Volume number 1

As an M & A guy and a former employee of one of the largest 1999 era technology venture capitalists, i was perplexed (to say the least) at the actions of a certain East coast based (small) wireless focused venture firm yesterday. I have been lucky enough in my career to have participated in the founding of several companies. As a supporting COO/CFO type in the founding process , i have witnessed the activities and efforts of several entrepreneurs from a truly fascinating viewpoint. I have also been privy to several instances where the behaviour of the financing party (the VC) has been a true dis-service to the entrepreneur. One such instance occured yesterday and has caused me to write about it. Before I do, i would like to stress that competitive, disruptive and sometime unethical practices are more commonplace in the M & A world, in our most recent transaction where we sold a $180m business, several private equity firms were engaged in 'questionable' practices in attempts to secure leading positions. These actions - at least in my view - seem more acceptable than those which i will explain in the Venture world The company in question is a very promising wireless start-up that was seeking a series A funding round of several million. (we were not acting as agent BTW, co-founder and advisor - word to entrpreneurs - if you are raising less than $10m dont get an agent (bank etc) VCs don't like this at all) Several indications from prominent firms were received, and after much deliberation with advisors, angels and the like, the company chose the firm in question primarily on various compatability leverage points (geography, domain expertise, portfolio synergy etc) and most importantly on a stated eagerness to, likelyhood of, and time required for close. The term sheet was thus signed in July. As a start up, it is extremely difficult to keep options open once this occurs - resource deficiencies, no shop clauses, and so on prevent such - nearly every entrepreneur essentially puts all eggs in the basket of the firm that it chooses - and this is the first point of unspoken accountability that a VC must recognise when securing a start-ups comittment. The next 45 days were an intense period of due diligence, document exchanges, employee agreements etc etc etc followed by a closing period of about 2 weeks. The very day before the money was escrowed, the VC took an abrupt U-turn on several issues that it claimed it was not aware of - and that were fully disclosed in the private placement memorandum issued to them prior to signing the term sheet. We were then forced in to a day and night scramble to meet their new requirements - ones that we would have dealt with months before if we would have known that they were to become an issue. For instance - they required that we permanently hire a consultant that was working on the development of a new product for us. Whatsmore the shares were not to come from the post funding option pool. Suffice-it to say, $100k in legal fees later the deal imploded. Now i don't wish to finger point at this funds actions - this may well be how they operate and without breaking any laws per se, this wont be a fund i would ever choose to approach, reccomend or deal with again. But the real fallout is the entrepreneur. This CEO lost about 4 months in a redundant, distracting, and ultimately highly frustrating practice. a major impact on chances of success given the precious resources available to a company of this type, and at this stage. Far more impact than that suffered by the firm. The only plus from this, is that the company is prepared, bound, and VC quality transparent. In conclusion, the position a VC holds when engaging with an entrepreneur is by its nature one sided. Sure, there can be some back and fourth on pre-money, option pool allocations, non-competes, and so on - but the tip of the spear is the fuel needed to create the opportunity. As holders of that spear, it is encumbent upon VC's to be good, really good in their deal assesments - because while you might view 20 companies a year and think nothing of it, it might be that entrepreneurs opportunity of a lifetime. Its ofcourse ok to pass - happens all the time, everyday - i've learnt that entrepreneurs are big 'boys' they can take bad news - what they, we and the industry cant continue to tolerate is bad work resulting in loss of opportunity. my 2 cents - would welcome feedback

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