Founder & VC Misalignment More Often Than Thought

The misalignment between vc’s and founders is painfully obvious from the quotes below from the IPO S-1 filing of Applied Medical Corp. (Dan Primack of Fortune did the reporting and should get the credit).  First is the company stating why they are going public (bold emphasis mine).  Second is the venture capital firm’s response.Founders need to make sure they are aligned with their investors.

“Institutional Venture Partners IV, L.P. is compelling us to register the shares of Class A common stock offered hereby by exercising demand registration rights. While we intend to comply with our obligations under the Master Rights Agreement, our board of directors and executive officers believe that filing the registration statement of which this prospectus is a part and effecting an initial public offering of our Class A common stock are not in the best interests of Applied.”

Response from vc Institutional Venture Partners (a very good venture capital firm):  “We invested in Applied Medical Corporation twenty-four years ago, when it was a start-up enterprise, and we led the follow-on financing twenty years ago. . . . . . . The problem we have is that IVP IV was supposed to be a ten-year fund, which is standard in the venture capital industry, so twenty-four years is a long time to try to keep maintaining a fund that was supposed to last for ten years.”

This example perfectly states one potential misalignment between venture capitalists and founders — the time scale of their involvement in the company.  By definition, most professional investment funds  have 10-year funds (my investment fund Greybull Stewardship is a clear exception) and this drives all their thinking about when to invest, how fast to grow, and when to exit.  This is perfect for certain types of high-growth companies that require relatively little capital and have their strategy tuned up.  However, most companies do not fit the formula and would be much better off trying to not fit into the box.  This can actually be harmful to the company if the successful strategy of the company pre-investment did not have perfect 20% per year growth rates, expanding EBITDA margins, and clocklike predictability.  If that does not describe your company, you should consider different options.

Other Dimensions of Potential Founder VC Misalignment

There are some other dimensions where venture capitalists and traditional private equity are not necessarily aligned with most companies in America.  Some other dimensions are:

  • How Much to Gamble: For a vc, they want to swing for home runs and it does not affect them or their fund much if your company is the one that strikes out (they hope the other investments in their fund make up for it).  For the founder, it is completely different.  You would clearly be better off with a double or triple rather than a strike-out so a strategy that swings for the fences with your company is not the best strategy for you.
  • Differences (strategy, product, etc.) are Good, But:  Every investor claims to like differentiation.  At the first sign of trouble, however, investors run for the perceived safety of something they think is working better (like what your competition is doing), particularly when an investment time horizon is short.  There is no extra time to risk a misstep with a unique strategy — better get back the industry best practice, and fast.  Differentiation, when it is done well, seems to me to take twists and turns over a long period of time through hundreds and thousands of little decisions.  It is not built best under pressure of  a short time horizon.
  • Balance of Near-Term and Long-Term Profits:  For founders, taking some cash out along the way in the form of dividends or recapitalizations is smart.  VC’s and private equity firms usually prefer to not distribute profit (tax-inefficient for their C corporations) along the way and bet on a bit exit — once again usually gambling all or nothing.
  • Non-Financial Factors in Decision-Making: In the businesses I admire, profit and financial decisions are important but not the only thing.  If you are in the business for the long-term, there are many decisions that are good for customers or employees or vendors that are not good financial decisions in the short run.  Any non-financially driven decision is much harder for vc’s and private equity firms to support.

My goal is for company founders and owners to know there are options to traditional venture capital and private equity.  I recommend they find the financing source that fits their strategy rather than make their strategy fit a financing source.

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