How to spot a bad VC deal
Wednesday, May 28, 2008/
In the final analysis, if you really feel that the VC only brings money, then it could be the most expensive money you ever get! DORON BEN-MEIR
By Doron Ben-Meir
Last week I was at the awards night for the Melbourne University Entrepreneurs Challenge (MUEC) and met an accomplished academic who was quick to point out the shortcomings of venture capital. In essence he maintained that venture capitalists (VCs) rip you off with a combination of risk aversion and draconian investment terms.
We all know that good news travels fast and bad news even faster. It also depends which side of the transaction you talk to!
Quite simply, there are good and bad VCs, just as there are good and bad entrepreneurs. The real question for you to consider is what you expect a VC to provide and how can you tell the difference between the good and the bad?
It helps to get back to basics.
Venture capital is early stage funding for potentially high growth businesses, which is typically unsecured in favour of an equity position in the business. The objective of the VC is to work with you to build the business over a three to five year period and then sell it at several times the original valuation (hopefully!).
There are no guarantees, so this form of investment requires a high degree of domain and business building skill on the part of the VC so that investors in VC funds receive a consistent return over time.
There are many questions that entrepreneurs typically have of the venture capital process. What do VCs look for in deals; how do they value prospective investments; what protective provisions do they require, do I have to give up control, etc.
We will look at these issues in future articles, but they are essentially mechanical questions. The most important thing to realise is that when you take investment from a VC you are building a business partnership – it’s not just a financial transaction.
Doing a deal with a VC is like getting married. There are people who marry for money, but we know that such relationships are rarely fulfilling and often end in bitter acrimony. Venture capital is no different.
And as it takes two to tango, experienced VCs will probe you with due diligence questions and listen to the nature of your responses (not just the facts) in building a picture of overall character and capacity.
The takeout is that you should also do your due diligence on the VC. Can you work with each other? Do you get along? What skills, experience and resources does the VC bring that could be of benefit to you? The better the courtship, the more successful the marriage.
In the final analysis, if you really feel that the VC only brings money, then it could be the most expensive money you ever get!
Doron Ben-Meir has been an active venture capital manager for the last eight years. He founded Prescient Venture Capital and prior to that was a consulting investment director of Momentum Funds Management. He was a serial entrepreneur over a 12 year period, co-founding five new technology based businesses.
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