CandidCapital

The VC investor often finds that the lustre of his role fades as an investment matures and hard decisions have to be made about selling the business or otherwise realising value.

It's the nature of venture investment that timing is critical to the success, or otherwise, of a deal. Investors are constrained by the lifespan of the funds they manage (typically 10 years); by the lifecycle of the companies in which they invest; and by the wider economic cycle. Getting to exit in years 7-10 of a fund's life, when the business has hit a sweet spot and when there are willing buyers with cash looking to buy, is a trick much aspired-to but infrequently achieved.

All of this is logical - even, one would believe, obvious. Yet my experience is that the interests or, more importantly, aspirations of founders and other investors conspire to thwart an effective and profitable exit. Why is this? I'll attempt to answer the question by looking at the factors that shape the attitudes of the three key sets of players in this process: the entrepreneur(s); other investors, typically angels; and the venture investors themselves.

Entrepreneurs
The adjective entrepreneurial is often synonymous with visionary (good) and willful (bad). The latter can be accompanied by a range of sociophobic traits that make the person decribed hard to work with and resentful of constraints that limit his or her freedom of decision-making or action. Yet industry-changing innovations, decribed so well by Clayton Christiansen in The Innovator's Dilemma, come from innovation-led start-ups that aren't constrained by existing investment in technology, production, delivery or even ideas. The best of entrepreneurs are imaginative, iconoclastic and adaptive and have the ability to grow with their businesses or see when their "sell-by date" has been reached.

Too often, however, and with a recurrence that I haven't been able to predict in 20 years as a venture investor, for 'imaginative' read 'dogmatic', for 'iconoclastic' read 'sociophobic' and for 'adaptable' read 'all talk and no action'. Where this really becomes a problem is in recognising failure of the business model, in part or in whole, when a self-lauded capacity for showing that "the tough get going when the going gets tough" is really the manifestation of a delusional inability to see that a deal at any price is better than insolvency. In its milder form, it's an inability to see that X on the table today (especially if it's cash) is worth much more than 5X, or even greater multiples, in an uncertain future.

Other Investors
Angel investors are a broad church. At one extreme, they can be 'dumb money' investing by intuition or because another investor whom they respect has led the way. At the other, they can be experts in the domain of the investee business providing input that may well be critical to the success of the business. The best of the latter, typified in the US by Y Combinator and in Europe by Seed Camp or Cambridge Angels add the combined expertise of their active angels to the development and success of the business in which they invest. Typically, they have strong links with follow-on investors - leading venture firms (though Cambridge Angels, in particular, steers clear of large US venture firms following bad experiences with Artimi and Cambridge Broadband), other private investor networks or corporate investors.

It's tempting for entrepreneurial businesses to seek out business angels, rather than venture capital investors, because the former frequently don't look for the comprehensive control and preference rights that are inevitable in doing a deal with the latter. However, a larger and more diverse shareholders' register brings its own challenges of communications and sustaining goodwil and support, expecially when the business is not performaing to plan (which is par for innovation led businesses).

This problem of communications is compounded if the investor group includes both one or more venture investors and more than a handful (say 5-10) of angel investors. There are too many angels to have them all act as active participants in the investor group, which drives a need for regular and clear communications with shareholders on the basis that such communications will be in the public domain. If there's any uncertainty among the investors - about follow-on funding or management change for instance - then it can become more prudent not to communicate with other shareholders than to run the risk of materially misleading them - and there's nothing like silence for eroding confidence.

Venture Investors
The breadth of the church of possible venture investors is almost as broad as that of angel investors. Smaller venture capital firms (in the UK typified by investors such as Oxford Technology Management) have specialised in co-investing with angels, who are often investors in the funds they manage, and can make angel co-investment work. Other institutional investors (larger VC funds and financial institutions) find the process of consultation with a wide shareholder base time-consuming, as well challenging when they have to try and preserve the EIS relief that most angels enjoy.

The nearer a conventional venture capital fund gets to its termination the greater will be the pressure on the venture fund manager to realise value from all its investments, regardless of the stage of development or the potential for further upside in any single investee. This may be entirely contrary to the wishes of management and any other investors, including other institutions, not least because the venture fund manager is likely to get most value for the fund's investors if the business is sold as a whole. This can be worse still if there is a fundamental divergence of view between one or more institutional investors over the right approach to the investment as well as a mis-match on exit timings. This state of affairs is common where a seed investor is seeking to exit before the main venture investor, but has no control or preference rights.

Resign Yourself...
No-one becomes a venture investor to be popular and there can be a perverse satisfaction in pursuing the interests of your investors no matter the opposition from others - especially if they are taking a unrealistically optimistic view of the potential in an investment. That said, however, the best way forward is to have a clearly thought-through corprate finance strategy in which all investors share ownership and can make sure, as far as is possible, that enough capital is made available to achieve at least one of the value points identified in that plan. No matter how disappointing, a sale is always better than insolvency!

16 June 2009