How to identify the right VC’s for investment: The do’s and dont’s
I wrote an article last week on the key lessons I have learnt so far in the tech business and some people reached out to me to provide some advice when negotiating with a venture capitalist (VC) or an investor. This is from my own personal experience and observations and thus critical feedback and debate are welcome, particularly from investors themselves.
— by Kevin Mutiso
Sun Tzu, one of the greatest strategists in human history and author of one of my favorite books, The Art of War, has a quote that I live by: “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
Before I go into what to look for in a VC, it is good to understand WHO YOU ARE. In the world of ideas, the probability that you have a unique idea is next to zero. In the big scheme of things generally, you as an entrepreneur are nothing but another person roaming this earth just trying to figure out life. This video is a scaled representation of our solar system. When you realise how far the Moon is from Earth, or that it takes 5 hours for the sun rays to reach Pluto, it hits you how small you are in this infinite universe.
Secondly, a conversation with a VC is about an exchange of value. The entrepreneur has vision and an idea that he believes will have commercial success. A VC has cash and wants to take a risk with this cash and get above average returns. Usually in an early stage start-up the VC is buying into your ability to execute your vision and deliver these above average returns. So you both have something of value to exchange. You are equals.
With those two points in mind; let go of your ego the moment you meet with an investor and instead start observing and looking for their ability to understand your vision and idea.
What should you be looking for?
1. Does the VC insist that you get your own lawyer: The reality of life is that by the time someone has enough cash to invest in people’s ideas, they have learnt that a good lawyer is a must have. If they downplay the need for you to have a good lawyer, then be wary. This is a clear sign that they want to take advantage of your ignorance. “Lawyers -” as my mentor from CreditInfo once told me -“plan the funeral,” the entrepreneur and the investor usually plan the wedding – they only see the happily ever after. The lawyers usually see what could potentially go wrong in a transaction and thus depending on whom they are being paid by, provide the protections to this party. Yes, you are a start-up and you may not have money, but by the time you are engaging lawyers you have agreed to begin a relationship with the investor, and they should be willing to add the cost of your lawyers to the investment they are making. If they are not willing to do this, be aware of potential malice.
2. Does the VC understand the risks your business’ faces: An entrepreneur should always know what are the key risks to the success of their business and should strive to de-risk them. The VC too, should have an idea of the risks of the business they want to invest in. If they do not, then other than the money they might not be of much use. If you are not aligned on how to de-risk the business then you will have conflicting objectives and this will start affecting the business. A good of example of this is usually observable when it comes to allocating resources of the company.
3. Do you want to be in the trenches with this investor: The legendary John Doerr usually asks himself when evaluating entrepreneurs the following question, “If s*** hits the fan, do I want to fight the fight with this person?” I think that question also applies to the entrepreneur. Problems are part of your existence and things will not always be rosy, so when you have a major fraud in your business or the technology crashes, does a blame game start or is a brainstorm held? You can see this early on, observe how the investor negotiates their must haves in a contract or if a junior member of their team accompanies them to meetings. Do they naturally teach or do they instruct them on what to do? Do they apologize if they misunderstood something? These little things give you an indication of the kind of person you are about to spend a considerable time with – so can you live with this for the next 5 years?
4. Zero sum game vs. Positive sum game: The key lesson I learnt when I did the master negotiator program at Strathmore Business School (If you can, please do this course – it changed my life) is that a negotiation doesn’t have to be a winner and loser experience, it should be a win-win for both parties. If you are raising a sum of money and the VC wants to take anything over 50% of your business, I’d be wary. If an exchange of value is the point of the transaction then a fair price must be met. Both parties must be striving to solve for each other’s needs when negotiating and the must haves of both sides must be very clear. If you reach an understanding with the positive sum game strategy, you have found a partner you can work with through even most difficult of problems. Mark Zuckerberg is going through one of his most tumultuous times with all the data privacy issues, but when I looked at his board and saw he has the likes Peter Thiel and Reid Hoffman on his board, I was a little envious because the problem solving abilities he has at his disposal are at genius level. What I would do to be a fly on the wall during their brainstorming sessions. Both Peter and Reid were early investors in Facebook and have been with Mark from the beginning, and if I was to bet money, I’d bet that they will solve this too, not without some bruising. Entrepreneurship is lonely, and more so during tough times.
Finally, I’d like to add final tidbit that another mentor constantly reminds me. He says, “Good ideas do not chase money, money chases good ideas!” As an entrepreneur, it is always better to give a true and honest picture of your business to your potential investor and demonstrate that you have the ability to execute the idea and vision that will achieve commercial success.
