Rage Against the Machine

Disclaimer – The following post includes strong opinions and strong language, It’ll also annoy a small, but ultra-powerful group of individuals. What the hell…..

Recently I had the privilege to have a first hand glimpse of the fundraising woes of an internet start-up. Without giving details, it’ll suffice it to say that I spent some time with a start-up that is looking at a traditional VC funding route and I had an opportunity to explore what that looks like from a position close to the action.

Now I have to explain my somewhat different take on business building (some would call it naive, I call it pragmatic, cautious and sustainable). I come from a background of business in the physical world. The world where growth is high but not stratospheric, where valuations are based on revenue largely and where sustainability from a business perspective is the desired outcome.

Last year I read Sarah Lacy’s book “Once You’re Lucky, Twice You’re Good”. In it she tells the apocryphal tale of Max Levchin wanting to protect Kevin Rose from what he calls “the sweater vests” those who take big stakes, pump big money but put big pressure on start-ups to ramp quickly – regardless of whether or not this is a smart approach for the company.

It seems that (at least a significant part of the time) venture capital firms aren’t looking out for the best interests of the business itself. They’ve got funds spread across multiple entities, their role is to pump companies for fast growth and quickly ditch those who don’t look like they’ll make the multiples – hardly a nurturing situation.

I was really interested to read a blog post (behind a paywall now unfortunately) talking about True Ventures, a sort of combination angel fund/VC player who has an interesting approach. True have some big name companies they’re funding – GigaOm, Syncplicity and Akismet to name a few. their approach is refreshing, from their website;

We partner with promising entrepreneurs at the earliest stages in the highest-growth segments of the technology market, where history demonstrates the best rates of return. We invest not the most we can, but the amount that makes the most sense for the business. Our investment gives the fund a meaningful ownership position, but more importantly reflects the actual needs and true value of the company.

We provide hands-on management support to guide our portfolio companies through the challenges of early growth.

In subsequent financing rounds, we work with trusted colleagues at other top-tier funds to build valuable syndicates for your company, but we have the financial strength to participate for the long term.

While it may be feel good VC-speak, it does seem their approach viz a vis multiple round involvement and hands-on support and mentorship is a somewhat unique approach among the realms of the “sweater-vests”.

Some similar sentiments were expressed by VC Partner Mark Suster in a recent post;

Raising venture capital is like adding rocket fuel to your business and for most businesses this a) isn’t warranted b) creates the wrong incentives and c) even if it is successful means that the founders don’t make enough personal money when the ultimate business is sold.

I repeat this advice on a very frequent basis to most entrepreneurs I meet and I find it usually surprises people.  ”You’re a VC – aren’t you supposed to want to give us money?”  No.  I want you to create a successful company that will be fulfilling to you and your employees and will make life better, faster and easier for your customers.

Getting back to the start-up I spent time with, they told a very sorry tale of a VC firm that invested without any real understanding of the business (which is a SaaS play). They then went on to make big demands of the company in terms of growth and go-to-market strategies, and have now become little more than an anchor around the neck of the business. To top it all off they don’t even bring the relevant and high-level connections that could at least bring some value to the business.

The recent sale of Zappos to Amazon is a perfect case study to looks at. Brandon has an excellent post in which he points out that;

1. Zappos management didn’t want the deal – the management team wanted to remain independent.  It’s a well reported meme that Zappos has a culture which is very unique, but has generated a booming repeat customer business, and one that has grown quite nicely, even in these tougher economic times.  Being part of Amazon will certainly change that.
2. The sale was forced – it appears from the reporting that the investors were able to force the sale of the business.  That’s their right if they own more than 50% of the business, but it could also be their right if they had what’s called a protection right in the security in which they invested.  These provisions allow for a great many things, including the ability to force a sale at a valuation of X times the value of the round invested.  That takes the decision out of management’s hands, and clearly not always in their best interest.

Ouch…. seems that the VC route, while providing fuel for the fire, sure has an undesirable flip side.

It seems there needs to be a better way – something that sits between traditional angel funding which is generally too passive and too low level, and venture capital which often puts unrealistic demands on companies. Luckily here on CloudAve we’ve got a couple of VC contributors who will no doubt justify the existence of VCs, and the role they play.

Over to you guys…

Update: this just in from Dharmesh.