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The Hidden Pitfalls of Venture Capital

There are a lot of hidden pitfalls in the area of Venture Capital. As corporate lawyer turned venture capitalist, I can personally attest to some of these pitfalls, and how to avoid them.

#1: Picking Individuals, Not a Team, Leads to Intramural Competition

When I started my first venture business, I picked people who had the best resumes I could find, thinking that they would naturally get along or would seamlessly work together. Unfortunately, this was not the case.

One of the problems you have in forming a new firm, including a venture capital firm, is that by definition the people typically have not worked together. Therefore, you don’t know for sure what the chemistry or psychology will be. The other problem is that the people who are available, by definition, are not working out somewhere else.

For instance, I had a partner who led me on to believe I stole him from a large firm, when in reality he was fired. It’s very difficult to overcome ab initio case of fraud; my relationship with this partner was never the same, and I only found out about it because the firm was nice enough to call me up and tell me the truth. In general, the number one hidden pitfall of venture capital is the fact that you can form teams of individuals with outstanding resumes who can’t function collectively.

Drew Brees just won this award for being the most successful passing quarterback in history. This glorifies Drew Brees, but what it understates is the teamwork involved and making sure that everybody on the team felt glorified by supporting Drew in that effort.

And also, the second thing is that in order to have the greatest passing record, you have to have people who know how to catch the ball. The fact that his team caught such a high percentage of his passes is a tribute to his team, yet they never once went on TV and say hey – look at me, look at all the passes I’m catching. They were content to be members and follow the leader. That is a good example of a successful team that has a leader.

So, while occasionally you meet teams where people say “we’re all equal”, in reality there are very few organizations that are successful without leadership, as a general rule.

#2: Investments That are Too Small Aren’t Worth It

Another hidden pitfall of venture capital is that sometimes the investment is so small in venture that it doesn’t justify the costs that are necessary. The modern world has gotten progressively more complicated and more international, which means the costs of doing adequate due diligence have risen dramatically.

This explains why the Silicon Valley has been the birthplace of many successful companies because everyone in Silicon Valley knows everybody, and it’s one of these situations where you have to get along. So, you can’t afford to be dysfunctional because then you’ll be an outcast — you have to play the game.

The famous rule of Silicon Valley venture capital is that “We only invest in companies we can drive to.” That seems silly, because what’s the chance the world’s greatest companies are going to be within driving distance? But as we know now, it turned out to be a very high percentage.

It’s the ecology, the total system, and the culture that creates a successful venture. This system has really only happened historically in this one place.

#3 Investor and Company Mismatch Can Create a Disaster

Sometimes there is a complete mismatch between the investors and their philosophy and the company’s, and that too is a potential problem. Funding is not just about the funds. The worst mismatch I’ve ever seen is a group of investors with essential asset-based workout experience trying to become VC’s. It didn’t work because workout people are used to being cost-driven where venture is revenue driven, and they’re used to slashing and burning instead of building.

The bottom line is that just because you’ve found an investor ready to sign a check doesn’t mean you’re setting up a good deal. The company’s vision, leadership, and business model must match up with the investor’s experience and preference in order for the relationship to produce long-term success.

October 31, 2018