How to Turn Your VC into Your Worst Enemy (by Denny K Miu)
Editor Profile - Denny K Miu is the former CEO and one of the six co-Founders of Gigamon Systems. Denny has extensive experience in developing technology, products and business relationships. He has been a Professor, an engineer, an entrepreneur, a team leader as well as an individual contributor.
Note: The opinions, facts and fictions expressed here are strictly personal and do not reflect any corporate positions, Gigamon or anyone else, especially not those of any VC's whom I might know or might not know. And if any of the contents or even the style of presentation offend you, then you probably shouldn't be reading them in the first place.
TEN YEAR JOURNEY
Prior to starting Gigamon in 2003, I had started another company and prior to that, I was a faculty member at UCLA. I left academia in 1995 because I was interested in “learning” to become an entrepreneur. Being a technologist, I knew I was a “problem-looking-for-a-solution” but I was determined to find a market for my patented technology.
Since I already knew how to apply for grants from government agencies, I didn't want to fund the necessary commercial product development with potential SBIR contracts. Instead, by learning, I naively had in mind that what I was going to do was to learn to build company from scratch with other people’s money (i.e., VC’s money) because that was what I thought VC's are for.
So essentially I have spent the next ten years satisfying my own curiosity and struggling to figure out what VC (venture capitalist) is all about. In the process, I have raised $65 million in four rounds of VC funding but burned through all but $3 million before I was fired from my own company in late-2002. There were human costs as well.
Between April of 2000 and April of 2001, I grew the company from 8 to 163 employees (interviewed and hired every single engineer) but subsequently had to lay off 130 over the next eighteen months (I can still recall their faces). I remember one layoff was executed just days before 9/11. The same VC’s who complained that I didn’t hire engineers fast enough in 2000 were the ones who cursed me for not terminating them fast enough in 2001.
I believe I did the best I could. When the second plane crashed into the South Tower, I remembered my first thought was “I should have laid off two-third of the company, not one-third.” In retrospect, my gravest mistake was keep thinking that since things could not be any worse, they must be getting better. They did get much worse and eventually they did get better. But unfortunately for my 130 employees, the economy turned around in 2004, not 2002 (Lesson #1 – As an entrepreneur, I cannot afford to be a pessimist but as a CEO, I cannot afford to be an optimist).
Over a span of ten years, I have seen NASDAQ rise and fall together with my own paper net worth (to a high water mark of $30 million in late 2000 corresponding to 10% of the post-money valuation of my money-losing startup, the funding of which included an unprecedented $25 million strategic investment from Cisco - enough to pay off the national debt of Greenland in 2000).
I had spend years not taking salaries alternated with months when I was so well paid that I could afford to fly first class. At times, things were going so badly that I had to take out a second mortgage on my house to make payrolls and then at times, things were going so well that I had to fight with my fellow investors to invest more of my own money into the company in order to increase my potential upside (with Cisco as an investor, everyone was confident that a multi-billion dollar acquisition was imminent).
In early 2000, I had VC’s calling me early in the mornings and late at nights to try to convince me to take their money. In late 2000, I was such a rock star that I had one VC (who remains a friend) inviting my wife and I to travel to south of France to dine with their limited partners because I had delivered one of the best IRR (on paper) in the history of their fund.
But aside from 2000, I had been turned down unceremoniously in over 300 VC meetings and most VC’s thought that I stink so badly that they wouldn’t even return my calls. And to top off the comical scale, in 2000, I actually had swarms of VC’s scorning me for NOT taking their money but fortunately by 2001, they were thanking me profusely for doing the same.
In other words, VC's have been my best friends and my worst enemies, in ways that are not always within my immediate control. In the process, ironically, I have come to respect Venture Capitalist as a profession, which I believe is the least understood if not the most misunderstood. And I am convinced that mistakes I have made with VC’s (eventually turning many of them into my worst enemies) were a result of my inexperience as a CEO compounded by a total lack of understanding of who VC's are and what they do for a living.
LESSONS BEST SERVED COLD
I also believe that I will make the same mistakes again (or at least some of them) because I believe an experienced entrepreneur could never be an entrepreneur again if they truly learn from their past - a man who has been bitten by a snake once and thinks that all fallen tree branches could be snakes would never walk the forest again.
In particular, I believe if I were to be a successful “serial” entrepreneur, I must ignore the many mishaps of my past for the same reason that if my mom (or any mom) did not love her offspring (or their startups) so unconditionally and unselfishly, and was not physiologically capable of shutting out memory of labor pain, I would most certainly remain the only child.
In other words, similar to the central character from my favorite movie, Momento, I believe I am destined to suffer from irreversible short-term memory loss. Therefore, just in case, I believe I would benefit greatly from markers that are thoughtfully left behind in previous journeys to remind myself of any impending hidden dangers in future paths.
It is with this in mind that I summarize my lessons in the following, in hope that in the future they will forcefully “remind” me of what I have learned and in doing so, prevent me from unnecessarily turning my friends into my enemies. It is also my hope that perhaps these reminders could even help others who share a parallel journey as a fellow entrepreneur.
10) VC is not a content provider
Remind myself that a VC is NOT an entrepreneur (they might be one once but as a VC, they should not be one now). An entrepreneur is a “content” provider similar to a painter who puts ink on a clean sheet of paper or a writer who conjures words out of the empty ether.
As entrepreneur, our job is to “will” our creation into existence.
One successful VC had told me, “We don’t MAKE deals, we DO deals”. This turns out to be the best advise I ever received from a VC. VC’s are not here to MAKE something happen when it is not supposed to happen.
Creating something from nothing is our job and it is a lonely job.
Do not get discouraged when a VC tells me that I have a dumb idea. Chances are that they are right and it is a dumb idea but why should that stop anyone. Luck has so much to do with success anyway. Initial idea almost doesn’t matter, dumb or otherwise. To do a startup, one just needs to get started and make adjustment as reality presents itself.
The dumbest mistake I can make as an entrepreneur is to get discouraged when a VC tells me that my idea is dumb or even worse, believe them when they tell me that it is not. If I have to believe anyone, believe in myself. That way, at least when I lose everything I have (including my money, my family and my reputation), I wake up knowing why.
Ironically, having such determination is the requisite first step to establish friendship with a VC.
9) VC is not a service provider
A doctor is a “service” provider, so is a lawyer and an engineer. But they are not entrepreneurs. Anyone can be an entrepreneur but they must not have the mindset of a lawyer, an engineer or a doctor.
First of all, there are always more than two sides to an issue and often the right place is to be is in the middle - an option that a lawyer does not have. Also, there is not always an answer to every question; or if there is an answer, it might not be unique. So waiting for perfect data to arrive at a perfect solution is a luxury that I don’t have as an entrepreneur. If that bothers me, then I should go back to being an engineer. Finally, as an entrepreneur, I often have to shoot my patient (and I have).
Therefore, to help build a successful startup, I need to identify a family of “service” providers, find the best-of-the-class and figure out how to utilize them, motivate them and pay them with money that I don’t have. To put it succinctly, I need all the help I can “beg”.
But a VC is not a “service” provider. While entrepreneurs are “content” providers, VC’s are simply “capital” providers. With capital, I can buy quality service from “service” providers whose job is to provide quality service (no more begging).
This can get very confusing because VC’s seem to always go out of their way to tell me how they would add values. But they don’t really add values the way I normally think of “service” providers adding values. VC is fundamentally someone who is willing to provide working capital when no one else will. Therefore, I must remind myself that VC’s are smart people and it is difficult for them to stay in the sideline, so it is logical that they talk a lot about adding values (as if they were “service” providers or even “content” providers).
Remind myself that one time I asked advise from a VC (over sushi lunch) who was a successful entrepreneur and a successful early-stage VC and his answer was the most honest and the most insightful, “The hardest thing to get over as an investor for a startup, having come from an operational background, is the sense of impotence.”
In other words, to put it harshly, VC’s who insist on adding values is an overhead that I as an entrepreneur might not be able to afford. And if I inadvertently mistaken the VC's inherent desire to stay in control with a genuine offer to provide service, I will surely turn a friend into an enemy.
8) VC is not a banker
Remind myself that while VC’s are “capital” providers, they are not bankers. Another successful VC had told me that “the difference between a banker and a VC is that a banker will give you money when you don’t need money but a VC will give you money when ALL you need is money.”
In other words, in a perfect world, if an idea from an entrepreneur is not ready for funding, VC's should simply tell them to go away and come back when it is ready. But the problem with VC’s is that they don’t know how to say NO.
Remind myself that while their instinct might tell them that I stink, their intellect would convince them that they might miss out on the next Google. So VC’s will never actually tell me to go away. Instead, they will hover around and keep me at a sniffing distance until they are convinced that I will never get funded by one of their neighbors.
Therefore, as an entrepreneur, I need to understand that lack of a definitive “no” is very far from a “yes” and it will serve me best to “delineate” the fuzzy smoke signal and just go away until I am ready to return. To do anything different would be akin to pushing on a wet noodle, or forcing a pig to dance. Not only would it be a huge waste of effort, but it will surely annoy the heck out of the pig who could potentially be a very good friend.
On the other hand, entrepreneurs need to learn that while VC’s know that they are not a banker, they behave like one anyway.
Having participation rights on liquidity event basically turns their investment into a bank loan. That is, they get to “double-dip” and when the company is sold, they get to skim their principal off the top (often at a multiple and with mandatory accrued dividend which is basically usury) before getting a percentage of the remaining proceeds pro rata to their equity ownership.
Remind myself that with friends like that, I can hardly afford enemies.
7) VC is not a company builder
Remind myself that VC knows that they are not here to help build companies or to serve customers. They are here to ensure timely execution towards a financially successful exit, sooner rather than later.
So to protect themselves, VC's would demand draconian financing terms because if things don’t go the way they want, they would have no problem gaining control of the company and changing guards abruptly (i.e., firing me) to ensure a timely exit.
So however much I might romanticize that VC is my friend, there is a limit. And as they say in the old country, every banquet must come to an end. So I need to constantly remind myself that for an entrepreneur, the ends might not always justify the means.
Remind myself that even as a friend, VC's will always put their interest ahead of their “principle”.
6) VC is not an investor
Remind myself that VC’s know that they are an “agent” no different than any other agent who gets a cut on the transaction.
Whereas I am expected to put in my body-and-soul and my angel investor to invest their own cash, VC is all about making use of someone else’s money.
So unlike us, their financial interest is coupled with their professional interest, i.e., their career WILL come before mine. If they are not a partner of their firm, their personal goal is to make partner and and if they are not a managing partner, then their focus is on raising the next fund and becoming managing partner.
As a “friend”, I am expected to help in every possible way to advance their career. Doing less will surely strain our friendship.
5) VC is not a Board member
Remind myself that VC’s know that while they occupy a Board seat, their primary objective is not to fulfill their fiduciary duty. VC does not sit on Board to protect the interest of ALL shareholders. VC is there strictly as a portfolio manager and their job is to protect the interest of their investment.
In other words, no matter how many times they tell me that they are my “friend” and my “partner”, the truth of the matter is that they already have friend and they already have partner, they are in their firm and their interest comes before anyone else.
Challenging the VC's on this important priority will quickly turn a friend into an enemy.
4) VC is not a calculated risk taker
Remind myself that while the financial interest of VC’s might align with that of an entrepreneur, they are not identical. VC's portfolio is much more diverse than mine.
Therefore, it is not enough that I succeed; I must succeed big enough to make up for their other losses (or losses by other partners of their firm). In general the VC's and their partners are willing to take much greater risk than I alone since in the eyes of the VC’s senior partners, succeeding small is as bad as failing big (“go big or go home”).
So by taking money from VC, I actually increase my own risk profile and force my financial outcome to be binary, either big or nothing (which is very unnatural since I typically prefer to take a more measured path mitigating only calculated risks). Therefore, I must remind myself that with VC’s as my friend, the probability of a zero outcome is now quite real.
One VC had told me, in an attempt to convince me to take their money, that “Money is like gasoline, the only time to complain about having too much is when you are on fire”. Well, guess what, I have learned that you indeed invite self-combustion when you are surrounded by nothing but volatile fume (which explains the ugly patch of scars on my back).
3) VC is not a problem solver
Remind myself that VC’s do not want me to run to them when the company is in trouble since they don’t have the operational experience or the technical knowledge (or the time) to solve my problem anyway. However, while there are plenty of people (including me and especially me) whom they can blame for company failures, there is no one else to blame for surprises when they are grilled by their own partners in the Monday morning partners meeting.
Therefore VC's expect me to inform them when there is the first sign of trouble so that they can start to proactively manage the expectation of their senior partners. To do otherwise would be considered unworthy of our friendship.
2) VC is not a miracle worker
Remind myself that 5% of the VC’s make 90% of the money, therefore I am competing with 95% of the dogs for 10% of the meat; since none of their general partners and limited partners expect miracles, neither should I. Remind myself that a VC who boasts about their successes is tantamount to an engineer who boasts about their manufacturing yield after they throw away all the bad parts.
1) VC is not a paying customer
Remind myself that success of the company has nothing to do with success in raising VC money; remind myself not to listen to anyone except my team, my customers and my own instincts.
Remind myself that financial success is about generating cash from operations. Once I can do that, then I am in control of my own destiny and I don’t have to listen to VC’s anymore. But if I can’t generate net cash on my own and I am spending THEIR money to make up for the losses, then I better LISTEN because there is no worse source of pain for an entrepreneur and no worse enemy than an unsupportive VC who is on my Board.
This is why I should always remind myself to never turn a VC from a “friend” into an “enemy”, and this is the single most important lesson I have ever learned (I suspect this is what those illegible characters tattooed on my forehead are all about).
“Love” to you all and good luck.
--Denny--
Other chapters finished or in progress ...
10. Why Startups Fail and Why Gigamon Should've Too
9. How to Turn Your VC into Your Worst Enemy
8. What I Learned From My Dad Who Taught Me How To Ride A Bicycle
7. Make Money Then Make Meaning
6. Team Building versus Bread Making
5. Middle Management Gone Wild
4. Marketing is to Sell Shit that You Don't Have
3. How to Turn Orange into the New Black
2. Entrepreneurship and Love Making
1. The Nail that Keeps the Air From Leaking
Some interesting blogs from current and former entrepreneurs sharing their thoughts on venture capitalists ...
“Now i'm not saying venture capital is evil or bad here... i'm just saying they exist because the market is not very efficient. And because it's not efficient, capital is VERY VERY expensive. And because VCs get hits on average WAY worse than baseball players, VCs are VERY VERY risk averse.”
A Unified Theory of VC Suckage - by Paul Graham
“There's a reason VCs are the way they are. It's not so much that the business attracts jerks, or even that the power they wield corrupts them ... VCs are like car salesmen or bureaucrats: the nature of their work turns them into jerks.”
The Hacker's Guide to Investors - by Paul Graham
“... what separates the great investors from the mediocre ones is the quality of their advice. Most investors give advice, but the top ones give good advice.”
Real entrepreneurs don't raise venture capital - by Jason Calacanis
“Venture capital money is highly combustible, and it can either propel you to heights of unimaginable fame and glory (Google, EBAY, etc.)—or it can blow up in your face and destroy you (Kozmo, WebVan, etc.).”
Fixing Venture Capital - by Joel Spolsky
“VCs do not have goals that are aligned with the goals of the company founders. This creates a built-in source of stress in the relationship. Specifically, founders would prefer reasonable success with high probability, while VCs are looking for fantastic hit-it-out-of-the-ballpark success with low probability.”
How I Learned to Stop Waiting for Investors and Start Building Companies - by Peter Ireland
“Venture capital brings with it tremendous pressure to create a liquidity event but this frequently results in bad decisions being made to launch products too early or enter into the wrong markets ... the venture capitalist’s knee-jerk response to every problem faced by a portfolio company is to fire the founders and evade any personal responsibility for bad decisions.”
The Top Ten Lies of Venture Capitalists - by Guy Kawasaki
“... so if you think it's hard to get a 'yes' out of venture capitalist, you should try to get a conclusive 'no.'”
An Introductory Guide to Startup Funding - by Benjamin Yoskovitz
“You’re about to get into bed with someone, you might want to check what they have under the covers ... Make sure you’re comfortable; because your investors are going to be major influencers on your company’s success.”
Continue reading other “Startup-for-Less” posts by Denny K Miu »
great post! A must read for an entrepreneur
Posted by: John Furrier | October 18, 2007 at 09:53 AM
I've not taken money from a VC yet in the ventures I have been involved in. Part of the reason is I have feared (based on others real-life examples) what Denny has so well described. After reading this, it will take a great pitch and deal from a VC to ever make me want to do it. I'm so glad the cost of being a tech entrepreneur is so much lower now...
Posted by: Fred Yee | November 01, 2007 at 08:58 PM
Fred:
Thank you for the comment. Look like you are doing quite well in your venture and sets a motivating example for us fellow bootstrapping entrepreneurs. Good luck.
For those who are interested, in addition to learning more about Fred's company (http://activeconversion.com/) and Fred himself (http://www.fredyee.com/?page_id=2), the following is a video.
http://video.google.com/videoplay?docid=-8501326330451184459&hl=en
--Denny--
Posted by: Denny K Miu | November 01, 2007 at 09:18 PM
A brilliant post. Well thought out and very accurate. Having been in the software entrepreneur space for 18 years now I've experienced almost everything you've touched on.
My advice to entrepreneurs is simple, focus and execution on a plan that solves customer problems. Get that right and people will want to do a deal.
Cheers,
Peter
Posted by: Peter Cranstone | May 10, 2008 at 06:54 AM