There are a lot of things that in the VC world that bug me. One of them is hearing other VCs talk about companies and as part of an argument or plan mention that they don’t have any leverage.
On the one hand, I totally understand where those in the investment community are coming from. Our job, as venture investors, on a fundamental level, is to return money to the stakeholders in our fund. Given that, it might seem that the best way to maximize returns is to negotiate for the best possible terms at the long-term expense of the founding team. A company with “no leverage” would therefore be more likely to face an aggressive negotiation.
But if I’ve learned anything from methodically studying winning consumer internet models, it’s that the best companies create a win/win outcome both for their customers and their employees. Let’s take Trunk Club, for example. Part of the company’s success is rooted in the fact that their stylists are extremely well compensated. Customers look and feel great while employees also win from the company’s success. One of the pioneers in this model was SouthWest Airlines: literally every employee from the pilots to the janitor participate in a company-wide profit sharing plan. It’s often cited as one of the reasons your service is so good – every employee is literally connected both with the overall status of the business and their own compensation.
The same applies to relationships with customers and building a growth base. Dan Goldman, former Director of Marketing at PokerStars, the undeniable category leader in online poker, relates that whenever he brought a marketing initiative to Isai Scheinberg, the CEO:
“Almost any time I brought some huge proposal to Isai, he asked the same question: “What if we just gave that money to our players?”
As a customer, we all felt that. While PokerStars was growing, despite the billions of dollars they spent on customer acquisition, it mostly felt that the customer was the focus and getting a great deal.
So if it’s true for employees, and it’s true for customers, why should it be any different in venture investments?
The inherent problem with the statement “they’ve got no leverage” is that it creates misalignment between investor and entrepreneur. It may well be factual. But if an investment is predicated on making founders (or employees) unhappy, I’d guess it’s likely to end badly (caveat: having only been in this business for three years, I don’t have a large enough sample size yet to know. But it feels wrong,)
Like everything in life, it’s ultimately a balance. Not every company can raise money at staggering terms with the founders feeling like rock stars (and investors feeling like rock stars for getting access!). In many investments we’ve made where I’d describe the process as “smooth” or “positive” there have still been tense moments and some unhappiness. Often, founders are unhappy about valuation, for example, yet that price is literally the only way to get a syndicate together. Alignment can sometimes be as simple as a transparent communication, where both parties air their priorities and concerns. I’ve found that when I relate to an entrepreneur that we’re not asking for a vesting schedule because we want to handicap them, but rather because it (a) protects them if a co-founder leaves the business and (b) we have a fiduciary responsibility to our investors to adhere to market norms, they get it really quick. Instead of being untrusting jerks, the conversation is re-aligned of one where both parties care about long-term success.
As with most of thoughts, tl;dr. But the point is to focus on win-win scenarios, not on besting another party. Frankly, it’s Negotiation 101.