Entrepreneurs Getting Screwed By VC Bug

By Jay Valentine

The thirst for venture capital is a knee jerk reaction because it lingers as the model to those who have never seen a different way of doing things.

Venture capital may work for the VC, it may work for the management they bring in, but it seldom works for the employees of the startup and almost never works for the founders.

Why?

VCs are not your friend, although they are really friendly when they are calling on you. The immense flattery is wonderful for the exhausted founders who just want to get back to three meals a day. Then there is the bait and switch.

When you do a deal with a VC, you have made the decision to either take your company public or to sell it. Period.

If you find the company to be massively profitable, yet in a small market, where it could reward its investors, its angels, those who mortgaged their house, the employees who are working tirelessly—well too bad pal, the VC does not care a bit about that stuff.

The VC has three ways out. One, they make you go public. Two, they sell the company to someone who will get them out at a minimum of 10X their investment, hopefully 30X. Or three, they just stop investing and close it down.

You will note, there is not an option 4—to build a really great company, in a smaller market than one at first expected, that is helping humanity and paying everyone richly.

No, no option 4. Sorry, you gave up the profitable, private, fun, great customer satisfaction option when you said yes to that VC.

So when you bring in your new friend, the VC, you are making a bargain to sell or go public.

OK, so let’s see what that decision entails.

First, it is growth at any cost. Not profit. Growth.

No matter that your product needs a bit more development. No consideration that maybe it makes sense to build up customer service first.

The first board meeting is all about that new sales force and marketing team you are going to hire. It is sales steroids time dear founder and you need to put out that arm because the VC is going to inject the sales Miracle Gro into your veins.

Before the VC entered your world, your cost of sales and marketing might well have been 20%, maybe 25%.

Welcome to the new world where you are going to spend 50% to 70% of your revenues on sales and marketing.

The VC says, “well, if you could do $4 million in sales with a 20% cost of sales, we just need to triple that and you are at $12 million in revenue. Works every time it’s tried.”

Those dollars are not coming from your revenues really. They are coming off your balance sheet from the invested funds the VC put into those veins of yours. And those dollars are costing you the founder, and your loyal employees with stock options, about 40% dilution.

That means your options are now worth 40% less than they were when the VC invested.

Who cares? We just tripled revenues with these really smart guys who told us they do this all the time. “Wow mom, I am really going to be a startup CEO can tell your friends about.”

The cool thing about spreadsheets is how they make you feel when you first do those projections. $12 million in revenues! It may have cost me 60%, but who cares?

The other thing about spreadsheets is how they make you feel 6 months later.

Expenses are a constant. They happen no matter what else you do. They show up every morning before your first employee arrives and they are there every night after you leave the office to head home. Expenses, just grinding away.

Revenues are a little different, especially for that startup. They never come right away. They are not waiting for you when you show up in the morning and they often do not show up at all.

So that 60% – 70% cost of sales is now much higher because those sales are just not coming in.

In many startups, particularly the brain-dead DevOps ones, their cost of sales can be over 100% of revenues—being fed by that wobbly balance sheet.

Now let’s look at that “incredible” sales team, and the marketing team.

The VC probably gave you a list of potential candidates for your Sales VP and Marketing VP, and of course, the Business Dev VP.

You will probably find they came from the Nomadic Sales VP herd where they go to a startup, spend 18 – 24 months, bring in their “killer sales teams,” focus on execution, then fail to deliver. No big deal, off they go to another one.

Check out Chef, Puppet, MongoDB and you will find these nomads going from place to place, focusing on execution and never quite getting the exit trajectory they need to be successful. They are the C and D players who never hit it big—after all if they had hit it at their former gigs they would not have to work. Yet here they are.

But they are costly. They cost the startup a big part of that 60% cost of sales and when they fail to deliver (most D, E, F Round startups have had 5 or more Sales VPs) their failure is paid by stockholder equity. For those in MarCom – that means you got screwed on your options.

Then there is the marketing. Yes, you need to bring in a Marketo SPAM expert to do email campaigns, webinars, events. You need to buy lists, build killer web sites and have chirpy kids call incessantly when someone downloads a “whitepaper” which is what you call your sales brochures.

Even though prospects loathe getting SPAM marketing, you are all in on investing some of your VC funding. Of course, you do. It is what everyone does.

Then there is Business Development. Here you hire a couple of more senior sales people who are going to get “strategic partners” to sell your stuff. They churn out “partnerships” with the big software companies. Later, you dear founder, learn that each one was number 70,001 partnership for the “big company” with whom they “did a deal.”

Their expenses arrive every morning. Their revenues almost never cover their costs.

There they are again!

Expenses, expenses, expenses coming in every damn morning, not leaving at night. You the founder see there is no way you are going to hit $12 million. Heck, you aren’t going to hit $7 million.

The Sales VP tells you about the “long sales cycle,” the “land and expand” strategy, the immaturity of the market but that revenues are coming.

Well, they may be, but expenses are there at the table with you — now.

Time to do another funding round.

Now it is B round time.

Your pal the VC tells you they want to bring in another CEO, who has the experience to get you the trajectory you need. He or she has done it before. You are now the CTO, which you think stands for Chief Technology Officer.

No, sorry there pal. It is Chief Token Officer.

You are there for window dressing. You have no direct reports. You are not on the board any more. You are, conventionally speaking, screwed. Welcome to VC land.

Ask around. How many B, C, D funding series rounds still have the founder there? About none.

You make it on the A round or you are history.

Here they are again, expenses, expenses!

Only 10 sentences ago, expenses were at the table. Here, we have a sales force that cannot deliver exit trajectory (sell the company or IPO). Marketing is doing SPAM and the “leads” are laughed at by the sales force. The founder is in a cubicle wondering what happened.

Here is the Savior, the new CEO.

Wow, this is the ticket. Just like the Sales VP, this new CEO either never caused a company to hit exit trajectory or they were along for the ride on one who would have blown it out no matter who was in charge (think VMware).

Expenses, expenses. Fire the VP of Sales; hire another one who focuses on “execution.”

Revenue comes in but not enough. Need to do that C round.

OK, you get it now.

This happens year after year after year.

So ask around.

Who is making money on these D, E, F round companies? It is not the employees with stock options. It is not the early investors. The founders are screwed through endless dilution and are long gone.

The Sales VP Nomads come and go and fail and another round is needed. They get paid handsomely to fail, and fail they do, but they are built for that and they do just fine. Failing.

The problem, dear founder is 100% around the needless cost of sales issue. If you can deliver growing revenues, with 20% or less cost of sales, deliver profit, you are going to reach your dream.

If you focus on the innovator and early adopter market, get enough revenues to cover costs, you can focus on profit then growth.

It is most unlikely to happen with a VC.

You need to focus on the early adopter, but the VC will force you to focus on the entire market. The entire market is not ready for your stuff, so in come the expenses, out goes the dilution and you are screwed.

Getting screwed by a VC is, well, a constant, like Pi.

There is a better way.

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