Enable continues with its virtual university for startups. Today, we continue with our theme of Those Who Do - Should Teach. We utilize an extraordinary piece of work by a venture capitalist name Scott Chou. As a Kauffman Fellow, Chou wrote Maxims, Morals, and Metaphors - A Philosophical Guide to Venture Capital. The piece is extraordinary for several reasons. First, there is very little written on the subject of how to be a venture capitalist. Second, the insights provided are usually never exposed to non-venture capitalists. Finally, as an investor myself, I must say that the Chou's content is right on point and any VC who claims he/she did not learn anything from the piece is only fooling him/herself.
Chou's objective in writing this piece was to help readers internalize a number of best practices. He used simplicity and humor to concepts to the subconscious level where they can always be relied upon for the innumerable snap business judgments that are typical of the venture capital industry.
Enable will utilize his work in two parts. Part one will provide an overview of the work and focus on general advice for venture capitalists. Entrepreneurs should also heed this advice and understand where VC are coming from. Along these lines, next week in part two, Enable will turn the tables on the venture capitalists and show entrepreneurs how to use the "primer for venture capitalists" to their own advantage. By getting inside the head of the VC, entrepreneurs will be able to work with them better.
General Advice for Fledgling Venture Capitalists
Chou provides fledgling venture capitalists with the following words of wisdom:
- Founders are like players. CEO's are like team captains. Early stage VC's are like team coaches. Later stage VC's are like team owners.
- In other words, do it, run it, teach it, or own it. It doesn't sound like much but these are important lines to be drawn. One of the easiest mistakes to make is for an entrepreneur-turn-VC to invest in ideas that he/she could do instead of what the management team can do. Mismanaging the balance of time and transaction size can also lead to problems.
- Venture capital is very much an apprenticeship trade where you learn on the job. It's all about experience and dealing with ambiguity so there won't be a cookbook procedure.
- You learn from your mistakes but try not to become a genius this way.
- If nothing else, your hindsight should be 20/20.
- Hindsight will also tell you that the heroes of this business are the ones who do the big deals. The lasting legacy of a great company that you helped create will do more for credibility and deal flow than anything else.
- Don't be content with being average. Being average means you are as near the bottom as you are the top.
Investment Strategy
Chou points out to all venture capitalists that, "You are what you eat." According to Chou, nothing else establishes the reputation of a venture firm that its deals. Other people will make assumptions on the tastes and expertise of the VC based on the types of companies in the particular VC's portfolio. The nature of the deals will not only determine the type of investment professionals that it attracts but also the investment syndication to which it is invited.
Chou recommends that VC watch their conduct as well. He states that although a firm's portfolio establishes its public reputation, venture community insiders will form an additional opinion based on how the firm conducts itself during deals. For example, a trigger-happy fund can establish a competitive, differentiating factor by deciding very quickly. However, it can be a dubious distinction when poorly managed. Other dubious distinctions include whether the VC cuts and runs at the first sign of trouble, or rakes the entrepreneurs over the coals.
On the other hand, Chou maintains that VCs can get their hands dirty and have the mixed blessing of being known for heel marks at the edge of the cliff by supporting companies to the very end. Other factors include whether the firm likes being the lead dog on deals or if it prefers to coattail. Management style issues include whether the firm is hands-on or if it just wants a ticket to the play.
Investment Philosophies
Some of Chou's investment philosophies include:
- If you're going to swing for the fence, you better be prepared to strike out.
- This is a fundamental aspect of doing high risk, high reward deals.
- However, a corollary is: Strikeouts are no justification for swinging for the fence.
- The shotgun strategy won't automatically work just because of portfolio theory. It still takes a smart investor to pick good pitches and to have the skills to carry a deal around the bases.
- Don't put all your eggs in one basket.
- Buy enough lottery tickets and you'll eventually find the right one.
- Lemons ripen faster than the plums.
Closing the Deal
Chou points out that VCs are bound to come up with problems if they over-analyze a deal. There are no perfect deals. If deals were perfect, they wouldn't be talking to venture capitalists. Chou reminds VCs that they are being paid to take risks. If it were a sure thing, they'd be talking to bankers or their mothers. Chou then provides the following words of wisdom for closing the deal:
- So why not go out on a limb? That's where the fruit is.
- If Columbus had turned back, no one would have blamed him. No one would have remembered him either.
- These are basically the same as no guts, no glory but they are also reminders that you can't make money without investing it. Should you choose to take the plunge, rest assured that you're not at the mercy of gravity.
- It's not how the wind blows that matters; it's how you set the sail.
- One school of thought believes that any deal is a good deal with the right management. This includes your deal so don't dwell on the zits and start looking for ointment.
The Turndown
Most VCs I know should read this over and over again. Chou states that one could argue that this business is more about saying no than it is about doing deals. VCs typically say no more than a hundred times for every yes. How VCs handle the turndowns can determine their reputation as well.
Chou recommends that VCs never fall in love with a deal or a management team. By doing so they run the risk of spinning problems into gold.
Chou also recommends that after deciding to pass on a deal, VCs should be gracious and offer encouragement when parting ways with the entrepreneur. They can still walk away grateful by getting constructive feedback.
Feedback should be clear. Ambiguous or missing feedback can result in endless follow-up from entrepreneurs despite dismal chances of funding. Once VCs have done the dirty deed, they should not regret it or dwell on justifying it.
Enable strongly recommends that both venture capitalists and entrepreneurs read each and every word of Chou's work. It is that good and that useful. Next week we will focus on how entrepreneurs can use Chou's work to get into the head of venture capitalists. Stay tune, this is stuff you will never find in a book.
Published by Israel's Business Arena on October 10, 2000.