Coming clean

31 October 2006

Every investor has a cautionary tale about deals that went badly wrong - and occasionally they get together in Silicon Valley to share them. So what can entrepreneurs learn from their peers' mistakes?

There's no more entertaining way to pass half an hour with a group of investors than to get them telling war stories. Whether it's a CEO who can't manage, another investor screwing up a deal, or the founders of a company deliberately pulling the plug on their own venture, it's always comforting to hear that other start-ups have made far more spectacular cock-ups than any of us ever will.

Last week's Early Stage Venture Investing event, organized by IBF Conferences in San Jose, didn't disappoint. In a session focusing on something called 'vharmony' - more easily explained as getting the right match between entrepreneur and venture investor - half a dozen investors spilled the beans on some of their biggest investing woes.

They included David Aslin, general partner at 3i Technology Partners, who told the tale of one early investment where things started out well with the CEO. It was only when he was deeply involved that he learned two important things about the man in charge - firstly, his prior experiences of the venture industry had made him highly suspicious of VCs, and secondly, he was used to passive investors. Neither was particularly conducive to good investor relations. 'I wanted information,' said Aslin. 'The CEO's view was that it's none of your damned business.' While the chief executive was prepared to give Aslin and other investors a specific set of information, 'beyond that, you could ask questions, but you wouldn't get answers.'

The strong execution skills of the company's technology founder kept the company moving forward, but resolving the differences in management style between investor and CEO took its toll. In particular, the development of the front end of the business - sales and marketing - was held back, and Aslin believes the company's now a year behind where it should be. 'It was purely down to misalignment,' he concedes.

Aslin isn't alone as an investor in having problems with CEOs - in fact, three of the five stories told at the conference were about senior management problems. One investor explained how he'd had a heart-to-heart with the CEO of a company he was doing due diligence on, suggesting he was better suited to taking on the role of chairman and bringing in a president to run the day-to-day business. Later, he had to have a second heart-to-heart with the same person - and then a third. Even when a president was finally brought in, the CEO couldn't let go of the reins and the new recruit eventually quit.

Or take the case of Lisa Lambert, managing director of Intel Capital Software and Solutions Group, where she's in charge of software equity and M&A investments. Eighteen months ago she got involved in an early funding round at a company where an industry luminary was brought in as CEO. That change of control caused friction with the two technology founders - friction that probably wasn't helped when the new boss set a different strategic direction and tried to oust two other executives. The board sided with the CEO, the two directors went - but so did the founders, filing a lawsuit in the process. By the time the founders had finished calling their former customers to tell them they were setting up a rival operation, the game was pretty much over. The moral for entrepreneurs? 'Know what you want, know what you need,' says Lambert. 'They wanted a passive investor, but they needed a strong investor.'

Not all the blame for company failure lies at the management's door, of course, and the conference session also heard of problems on the investor side. Glenn Ballman, CEO of angel investment network Genesis Exchange, told how he'd got involved with a Canadian company that received a $50m buyout offer - only to see it rejected by a VC investor because it didn't generate a big enough return. The company subsequently hit the wall.

So what advice do these investment veterans give entrepreneurs to help them avoid the same kinds of mistakes? Firstly, says Bill Collins, managing director of Starboard Venture Partners, people need to understand that 'investment is like marriage, except there's no possibility of divorce'. The money goes in - and there's no way it's coming out again. He looks for a sense of partnership - since debates over control mean that one party doesn't trust the other - and also wants to be sure that there's a common objective to build a valuable company, rather than merely a valuable technology. Collins also suggests getting an advisory board together and speaking to other entrepreneurs in your market.

In a similar vein, Aslin advises entrepreneurs to shop around for investors, find one who understands your business, and choose the individual that you'll be working with, not just the firm.

And as Ballman concludes, entrepreneurs need to make sure they're not rushed into deals when investors give them just a week or two to make a decision. 'Investors will never tell you to talk to other investors - but you should,' he says. 'It's one of the most important decisions of your life.'

By Keith Rodgers, Webster Buchanan Research