[HN Gopher] Conflicted Capital
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Conflicted Capital
Author : adora
Score : 88 points
Date : 2021-03-09 17:48 UTC (1 days ago)
(HTM) web link (blog.aaronkharris.com)
(TXT) w3m dump (blog.aaronkharris.com)
| ncmncm wrote:
| > _Investors mostly want to do the right thing for founders._
|
| See, that's an important difference between investors and VCs.
|
| A VC firm or division gets (say) $1B, and a deadline: invest it
| all by end of quarter. All they can invest in are what come
| through the door. They know most of those have no future. A few
| do, but not enough to absorb the whole allotment. They can't not
| invest. What to do? No choice, really; invest it all, with 9 of
| 10 expected to flop.
|
| Having identified, at the outset, which should flop, start
| milking them. There's no reason to waste that money, even though
| it's lost to the actual investors. Make them spend their nut
| where it will do _somebody_ some good. Maybe make them hire a
| crony, who will hire more. Make them use a pet staffing agency.
| HR pros are (to first order) all grifters, so provide them one of
| yours. Make them buy software from one of the not-flops from this
| round or last quarter 's, or somebody you own part of,
| personally. Be creative. You can draw it out, deposit more cash
| from next quarter's infusion, and extract that. Maybe they can
| build, code, patent something of value that can be bought for
| pennies at the bankruptcy.
|
| There are a million variations on this, all used.
| evancharles wrote:
| When I've seen founders try to keep investors at arms length it
| seems to result in mistrust, leaving investors feeling like they
| can't get the real story, and thus decreasing the likelihood they
| invest further. So rather than keeping insiders at arms length,
| I'd suggest being direct about wanting to meet other investors. I
| suggest uncomfortable candor over comfortable misdirection.
| ganzuul wrote:
| Isn't the purpose of financial instruments to resolve these kinds
| of conflicts? Seems like in the days of smart contracts these
| meatspace concerns could be coded around.
| zuhayeer wrote:
| My issue with the whole fundraising circuit (esp for low cap-ex
| startups) is how much you have to strain yourself to convince a
| non-customer to believe in you
| pirate787 wrote:
| I didn't take VC and my company was chronically underfunded and
| died a long, slow, painful death to VC backed competitors. I'd
| take VC if I did it over again-- the focus and faster cycle
| would have made a difference, even if I failed again it would
| have been 3 years wasted not 10.
| pm90 wrote:
| Only slightly related to your point, but I find almost the
| entire VC community not one that I would want to be working
| with very closely with. It's just not the kind of people I find
| interesting. Not that they're not skilled or provide value, but
| the whole fundraising dance seems to be tiring and honestly
| pointless. Harkens back to an equally pointless endeavor I've
| been through before: the struggle to get good grades in
| college. Artificial struggles created by humans for other
| humans. I guess some people like that but it has an element of
| "rat race" that I find deeply disturbing.
|
| If I had a wish to materialize an ideal VC firm, it would be a
| place with both business types and highly skilled engineers who
| are on top of their skills and continue to build things.
| clairity wrote:
| > "If I had a wish to materialize an ideal VC firm, it would
| be a place with both business types and highly skilled
| engineers who are on top of their skills and continue to
| build things."
|
| idealab is somewhat like this. they cycle in engineers to
| work on an itch for a limited time on salary, then go through
| an internal round of fundraising (pitch idealab itself for
| seed money), then seek external rounds if there is traction.
|
| branch[0] is a company that successfully launched from
| idealab this way. they started as a shift-swapping chat app
| for hourly workers and have branched (haha) into payments
| now.
|
| [0]: https://www.branchapp.com/
| akharris wrote:
| There are quite a few VC firms that model what you're talking
| about - for instance I think this describes what Garry's
| doing at Initialized.
|
| But raising money is a choice that some founders will make
| because their businesses require it. If you don't need it,
| don't raise it. If you do need it, go into the process and
| decision with as much information as you can get.
| pm90 wrote:
| I think I should have phrased my comment better. I'm not
| opposed to the idea of raising funds to grow a company, but
| the way that it's usually done today. In particular: the
| people that the money needs to be raised from (VCs) seem to
| not be the kind of down to earth engineers that I love and
| respect, and the process itself involves a lot of marketing
| fluff that I find off putting.
|
| I am willing to accept that, it may not be possible to have
| such a process. Perhaps to succeed in the "real world" you
| absolutely need to be fantastic at marketing and pitching.
|
| I'm trying to describe what a process would look like that
| I personally would find enjoyable to work with, ignoring
| the reality of what might actually be required.
| bgroat wrote:
| This is kind of what I'm working on.
|
| Basically a product studio with LPs
| jacquesm wrote:
| It's been done, I know of a couple of these. They start out
| well intentioned and end up being backseat drivers in every
| company they launch, usually with bad side effects.
| bgroat wrote:
| I think the big distinction is avoiding launching
| companies and instead launching products.
|
| I'm increasingly convinced that very few products need to
| be companies, and the insistence that they do is why a
| lot of them end up so shitty.
| yowlingcat wrote:
| Having seen this model before, I think the challenge
| there is incentives, motivation and focus. If you have a
| winner, it's likely that through power law effects it
| makes sense to double down on it unless you have too much
| capital to deploy through that company.
|
| With that said, I think running a product studio before
| you find product market fit or the killer company is not
| a bad idea, especially if you can work directly with LPs
| to source the funds. Then the challenge is just making
| sure people don't step on each other's toes when you
| staff the winner.
| jacquesm wrote:
| Another note about 'internal' investors getting preferential
| treatment as opposed to outsiders: this is usually a result of
| SHA conditions and elements in the articles of incorporation that
| stipulate that in case of a sale or issue of new shares existing
| shareholders have first right of refusal. That this makes for a
| less competitive environment is something that everybody seems to
| take as normal, but after reading this article I'm wondering if
| it really should be normal or of there are other important
| reasons why this right always seems to be granted.
| sytse wrote:
| You should avoid giving a right of first refusal even at great
| cost (20% valuation discount).
|
| If there is a right of first refusal many investors will
| decline to engage in future rounds since if they end up
| negotiating a good deal it might fall apart at the last moment.
| ahstilde wrote:
| So...how do founders get unconflicted capital?
| Comevius wrote:
| Investors for software startups are not that great if you want
| your business to be self-sustaining without becoming a unicorn or
| a Ponzi scheme.
|
| I'm not saying that participating in bubbles cannot be
| economically rational, but venture capital today is especially
| suited for making decisions that are bad for everyone involved,
| prioritizing future valuation over good business.
|
| It's the same growth or sustainability choice we keep failing at
| as a civilization.
| xiaolingxiao wrote:
| "Investors for software startups are not that great if you want
| your business to be self-sustaining without becoming a unicorn
| or a Ponzi scheme. " - can you elaborate on this? Gut check
| wise this feels correct, but I'd like to hear your thoughts.
| Comevius wrote:
| It's nothing new, investors chase valuation over profits,
| which among others depends on growth because of the benefits
| of network effect. As a result most invested capital goes
| into user acquisition, and products become heavily
| subsidised.
|
| This venture model is good for unicorns like Facebook, who's
| network effect allows it to be eventually profitable, but the
| rest of the industry is not profitable. But VCs are, because
| of their management fees and because they avoid to be the
| greater fools, otherwise known as the bagholders who end up
| paying for it. VCs tend to encourage wasteful spending in the
| name of valuation on salaries, rents and user acquisition.
| It's a Ponzi-scheme where the bagholders tend to be limited
| partners and employees of the funded companies.
| kenneth wrote:
| I strongly disagree with the premise that a founder should keep
| "internals" at arms length and run a process without them to
| avoid any pressure from internals to lead and somehow maximize
| terms.
|
| Your existing investors have a vested interest in making you
| successful. A higher valuation is more acceptable to them than to
| outsiders (due to being able to officially mark up their
| investment, which helps them raise their next funds and improve
| their apparent performance prior to liquidity). Founders also
| have a far better idea of what kind of support they can expect
| from an existing investor than a newcomer.
|
| Of course, as a seed stage investor, I am biased in my views on
| this. But I do really believe that making potential adversaries
| out of your existing investors is a deep mistake.
| rsweeney21 wrote:
| Raised money from VCs for my last startup. Series A investor made
| all sorts of overtures about how founder friendly they were and
| how supportive they would be.
|
| The week after we closed our series A they told me I had to hire
| a COO. I asked, "You trying to get me to hire my replacement?"
| "No, we'd never do that. How could you even think that?"
|
| Less than two months after we hired the COO they fired me. The
| COO was made the CEO and he ran the company into the ground.
|
| The lesson for founders is to never, ever, ever give up control
| of your board/company. Always maintain control of a majority of
| the board seats.
| vcvc wrote:
| What VC?
| [deleted]
| fractionalhare wrote:
| Insight Partners. They evidently led the Series A for OP's
| last startup, which according to their LinkedIn is Numetric.
| Crunchbase tells you what you need to know:
| https://www.crunchbase.com/funding_round/numetric-
| series-a--...
| choppaface wrote:
| I'm aware of Max Levchin doing something similar to a YC
| founder, but with the involvement of another VC at the
| time.
| jasode wrote:
| _> The lesson for founders is to never, ever, ever give up
| control of your board/company. Always maintain control of a
| majority of the board seats._
|
| Maybe you're too close to the situation so what you say above
| feels to you like a universal truth but it actually doesn't
| help me as a reader.
|
| To raise the quality of discussion, we'd need to know what your
| _realistic options were at the time you raised Series A_.
|
| E.g... Did you have meaningful revenue making VC capital
| optional? Did you need VC money to have a runway and make
| payroll for a few months?
|
| In other words, if you're in a situation where rejecting VC
| money means your business shuts down, _it becomes a moot point
| if you 're still 100% in control of all board seats_.
|
| As for board seats composition, was it something like You=1,
| VC=1, and Independent=1? If so, was the independent
| automatically on VC's side to fire you or were they truly
| independent?
|
| If you don't want to get into the details to maintain privacy,
| that's understandable. But also understand that your advice
| born out of your experience doesn't have enough context for us.
| choppaface wrote:
| "To raise the quality of discussion..."
|
| To raise the quality of discussion, we need for all the email
| and Signal messages from the investors / VCs for a variety of
| deals to be made public. That would be a major step towards
| reducing the amount of information arbitrage in start-up
| funding (not to mention blog posts like the OP).
| cgb223 wrote:
| Jesus...
|
| Did they at least buy you out or did they literally rob you of
| your company?
| throwaway98797 wrote:
| Did you make some money though?
| rsweeney21 wrote:
| None.
| throwaway98797 wrote:
| That really sucks. I think in the bubble of YC seems like
| this doesn't happen but then there are counter examples
| like yours. Thank you for sharing.
| choppaface wrote:
| I know of at least three successful YC companies that
| fired founders and then took a hit... YC isn't that
| special of a bubble, especially these days.
| [deleted]
| k__ wrote:
| Why would you even give up more than 49% of your company?
| nradov wrote:
| Because you need the money and have a weak negotiating
| position. Not every startup is like Facebook.
| sebmellen wrote:
| You might not realize that a 5% stake with two board seats is
| much more powerful than a 25% stake with one board seat.
| Corporate dynamics are weird.
| k__ wrote:
| Ah, okay.
|
| I think, in Germany it's different, sorry.
| sebmellen wrote:
| Ganz ok. Ist ja sehr verwirrend.
| rsweeney21 wrote:
| It doesn't matter what % of your company you own. What
| matters is whether or not you control a majority of the board
| seats.
| texasbigdata wrote:
| Well....technically.... what matters is your ability to
| replace and/or appoint board members :)
| stanrivers wrote:
| This is not cool - I am sorry. Investor here - they should
| never do that. Make sure you tell others about how this went
| down. If they were planning on getting rid of you, that needs
| to be part of the upfront discussion etc.
| rsweeney21 wrote:
| They are a large and very lawsuit happy VC. It's not worth
| the risk to warn other people about this VC.
| covidthrow wrote:
| It would be a shame if someone else created a throwaway
| account to express similar sentiment about a similar firm
| and named them.
| throwaway9172 wrote:
| It doesn't take a lot of _insight_ to look at the
| crunchbase of OP 's former company and look who lead the
| series A...
| fractionalhare wrote:
| https://www.crunchbase.com/funding_round/numetric-
| series-a--...
| [deleted]
| stanrivers wrote:
| Yeah - I more mean... don't go out there and go out of your
| way to advertise that they did this.
|
| But founders should talk to other founders about their
| experience with different investors. The good, the bad and
| the ugly.
|
| In those situations, you can make it clear - in objective
| terms - what happened and why you would not take money from
| them again. Don't call them names or anything.
| fractionalhare wrote:
| It was evidently Insight Partners. They led the Series A on
| OP's last startup: Insight Partners. They evidently led the
| Series A for OP's last startup, which according to their
| LinkedIn is Numetric. Crunchbase tells you what you need to
| know: https://www.crunchbase.com/funding_round/numetric-
| series-a--...
| Andy_G11 wrote:
| Did you and your accountant review the shareholders' agreement
| thoroughly before finalising the fundraising with the new
| investors?
| jacquesm wrote:
| So, that's a bad trip, sorry to hear about this, and noted.
| DenisM wrote:
| Being friendly is much like being powerful - if you have to say
| that you are, you aren't.
|
| (with tons of apologies to Margaret Thatcher)
| InitialLastName wrote:
| Same thing with honest.
| jacquesm wrote:
| > Founders need to understand that venture investing is a
| business where friendship is an input or an outcome, and not the
| other way around.
|
| Does anybody know how to parse this?
| statstutor wrote:
| "Your business colleagues are not your friends"
| evancharles wrote:
| My guess is he means that VCs don't make decisions out of
| friendship.
| robaato wrote:
| Yup that struck me too as poorly phrased and unclear. Maybe
| crystal clear to writer, but not to readers...
| [deleted]
| mbesto wrote:
| > In fact, the vast majority of the investors I've met, even
| those that have fired founders, are good people. It's deeper than
| that, even. Investors mostly want to do the right thing for
| founders. There are emotional and business reasons for this
| impulse, but ultimately the fiduciary responsibility has to win.
| Founders need to understand that venture investing is a business
| where friendship is an input or an outcome, and not the other way
| around.
|
| Cynical viewpoint coming in:
|
| VC investors are only "good people" because that is what
| currently drives the market for dealflow. What I think a lot of
| entrepreneurs miss is that VCs are _finance_ professionals first
| and foremost. If the market dynamic starts to change, you might
| see them behaving differently but still aligned ultimately to the
| interest of their LPs.
|
| TL;DR - VCs who create good content, are helpful, are nice to
| founders, etc. ("founder friendly") in a professional context are
| only that way because it's generally what has been proven to
| generate good leads for deal flow.
| akharris wrote:
| I don't think it makes sense to lump a whole group of people
| into a single categorization this way. You're right that being
| seen as good helps drive deal flow, but, again, most of the
| people I've worked with are actually pretty "good" in the
| moral/ethical sense.
|
| Where and how personal ethics, business ethics, business needs,
| financial incentives come together and produce results is
| immensely complicated.
| Cederfjard wrote:
| These are humans, after all. It seems unlikely that all of them
| should be unscrupulous, fundamentally dishonest, profit-
| maximizing robots who only exhibit benevolent traits as a
| charade to lure in entrepreneurs. Surely some are simply good
| people.
| yowlingcat wrote:
| It sounds a little hyperbolic and black and white to consider
| those two things as being mutually exclusive. It's possible
| (and maybe even common) for someone to be a good person to
| others in matters that don't pertain to money -- but, when
| the rubber hits the road with respect to money, they end up
| being making decisions that make sense given how much
| leverage they have. At the end of the day, VCs are subject to
| their LP stakeholders. They are also subject to their founder
| stakeholders, but the degree to which the various entities in
| that three legged interaction hold sway varies based on
| environment.
|
| In a frothy environment like the present, founders really do
| have a lot of leverage because the demand for investable
| companies in many ways greatly outstrips supply; you see this
| in the SPAC craze. But in other environments, LPs and VCs
| have a lot more leverage over founders. When that is the
| case, it is only reasonable to expect them to behave
| according to their incentives. Now one could make the
| argument that it's still a poor long-term decision for VCs to
| sour community goodwill if they want to be in the game long-
| term. That may be the case, but it doesn't mean that a
| cunning VC cannot profit from exploitation in the medium
| term, enough to enrich themselves to the level where a poor
| reputation doesn't prevent them from continuing to operate.
|
| It's important to not over-anthropomorphize the way that
| financial professionals operate as agents in a system with
| incentives. When they do something unsavory, it's generally
| not meant to be personal even if the result is incredibly
| unsavory.
| [deleted]
| stanrivers wrote:
| Everyone has their own incentives and when things get tough, they
| will work to maximize what their incentives say should be
| maximized - keep that in mind before signing up with investors if
| you are a founder. The term sheets and final docs - and the
| specific rights in them - matter a lot.
|
| Examples from Charlie Munger [1]:
|
| "One of my favorite cases about the power of incentives is the
| Federal Express case. The heart and soul of the integrity of the
| system is that all the packages have to be shifted rapidly in one
| central location each night. And the system has no integrity if
| the whole shift can't be done fast. And Federal Express had one
| hell of a time getting the thing to work. And they tried moral
| suasion, they tried everything in the world, and finally,
| somebody got the happy thought that they were paying the night
| shift by the hour and that maybe if they paid them by the shift,
| the system would work better. And lo and behold, that solution
| worked."
|
| "Early in the history of Xerox, Joe Wilson, who was then in the
| government, had to go back to Xerox because he couldn't
| understand how their better, new machine was selling so poorly in
| relation to their older and inferior machine. Of course, when he
| got there he found out that the commission arrangement with the
| salesmen gave a tremendous incentive to the inferior machine."
|
| [1] https://www.butwhatfor.com/charlie-munger-the-psychology-
| of-...
| 908B64B197 wrote:
| In Xerox case, it was the same company that wouldn't enter the
| personal computing market because it might impact their copy-
| machine market.
| stanrivers wrote:
| I've seen that happen in hiring decisions as well. Junior
| people are in charge of screening candidates... really strong
| candidates, if hired, will make the average employee look
| bad.
|
| So, why should the person screening the candidates suggest
| the strongest candidates?
|
| This is why I tend to suggest equal seniority individuals
| should not screen candidates. It's a subconscious thing
| ("He's too aggressive" "She seems like not a good culture
| fit" "He is too senior for this role") that most people don't
| think of directly, but happens.
| 908B64B197 wrote:
| One way to offset that is to make sure that team
| performance is as much of an incentive as individual
| performance.
|
| A stock compensation helps in that regard: hiring strong
| individuals will help ship a better product faster and
| should increase the stock value. Meanwhile traditional
| stack-ranking and a mostly salary compensation will
| encourage individuals to make sure they are seen as the top
| performer no matter what.
| TimPC wrote:
| Most people want to hire the best candidates they can
| despite some of the misaligned incentives. You don't want
| to spend overtime on someone else's bug because you hired
| poorly. The risk of a smaller bonus or less promotion
| chances is complicated as sometimes there is more available
| if the teams performance improves as a whole. When you
| deliver on a major project the team's pie is often much
| larger, and even if you end up with a smaller slice of said
| pie you're usually better off.
| deckard1 wrote:
| If any of that were true, we'd have universal healthcare
| and live in a utopia. Crabs in a bucket. If you're
| focused on the ladder, you're not going to hire someone
| that has the potential of making you look bad.
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