Everything is setting up perfectly – you’ve got a great relationship with your lead VC – he’s even saying “we” and painting pictures of being on the podium with you for the NASDAQ opening eight years from now. Then he tells you he likes being an investor but *really* misses being an operator, and is joining another one of his other portfolio companies as COO. You grit out a smile and weak ‘congrats’ while thinking ‘“fuuuuuuck.”
Across town a different CEO is having a breakfast with her Series A Board partner. It’s off-schedule – the two usually meet every other week – but she’s an awesome VC, much better than the older dudes at her mediocre shop, so any time you have is appreciated. You almost spit out your coffee when she lets you know that she’s leaving for a Tier 1 firm but that her partners John, John Jr or Robert will be great stewards of your startup until she has the pull at her new gig to lead your next round.Hunter’s draft script for SVU: Silicon Valley
There’s lots of movement in the venture world these days. Former operators return to operating; GPs trading up (or being managed out); wealth-effect retirements; whole firms dramatically changing strategy. All the disruption can be pretty jarring to an entrepreneur, especially in situations where the exiting partner represents the top line on your cap table. Observing this both inside and outside of our portfolio I’m sure of two things: a) there’s not a whole lot of public discussion on the topic and b) most founders (and their other investors) should be more aggressive addressing the implications of these changes. I’m going to try and make my contributions to both of these here.
First though a few high-level points:
- Needless to say, every situation is different. Below I’m really talking about startups between Seed – Series B. After that, there’s often enough people around the table to manage the loss/transition of a GP/Board Member (even if it sucks).
- Founders (and the other investors) should focus on derisking the downside in these scenarios, not pushing for their own self-interests. It’s the COMPANY that’s being put at risk.
- It really helps if you are able to remain in contact with the former Partner or have another trusted backchannel at their fund, even if that backchannel is a more junior professional.
- You’ll often need the support – both structurally and symbolically – of some other investors on the cap table to make the case for some of the ideas below to work. Such as Homebrew 🙂
Okay, time for some game theory. A lot of what happens next is tied to the firm’s perspective on whether you’re going to be a meaningful investment or not (and how much their reputation is tied into your company). Basically they’re either Bullish, Written It Down/Off or Too Early To Tell.
BULLISH aka YOU ARE ABSOLUTELY KILLING IT: You’ll get the sense because the rest of the firm immediately is overly attentive to your needs, wanting to make sure there’s a ton of goodwill. In these cases you can usually negotiate who you want as a Board member from their partnership and if for some reason there isn’t a GP you feel comfortable with, even discuss a Board Partner scenario, where a mutually agreed industry exec/CEO from their network takes their seat on their behalf (but this is higher degree of difficulty). If the reason for your partner leaving was some sort of change in firm strategy or scandal and you just don’t want to be associated with the entity, you can sometimes get the firm to sell into the next financing to the point where they’re not the largest shareholder any longer, etc (but again, degree of difficulty here is expert-level).
WRITTEN YOU OFF: In these cases you’re gonna have almost no hope of getting a new, engaged GP on to your Board. Most likely either a junior representative or a GP that’s assigned to “clean up/wind down,” whether they’ve communicated that to you proactively or not. In these cases you are still basically looking at the options listed below under “Too Early To Tell” but with a very high degree of difficulty. Given that reality, the CEO probably needs to be very direct – challenge the firm to let you know under what circumstance they’d consider additional funding, and if the answer is “never,” try to negotiate them off the Board.
TOO EARLY TO TELL- SOME GOOD STUFF, SOME CHALLENGES BUT A LOT TO DO: Here’s where I think founders and cap tables can should be more proactive. The default is to let the firm assign another person at the fund (hopefully a GP) and then just keep working on the plan of record as if nothing changed. My experience suggests this will be neutral to negative long term, unless you end up in the “killing it” camp by next fundraise. Instead here are some potential shorter-term actions to take:
- Re-Pitch The Whole Partnership – Some firms are really good at keeping one another up to date on portfolio progress, others are lone wolf models. Either way it’s been a while since you presented to the whole partnership and you probably never really got the story from your original pitch. Yeah, they did the deal, but it probably wasn’t consensus and those Nays are still sitting there, just without your previous GP pounding the table. It’s time to go back in and win the room over. Note – this is also a reason to make sure you’ve got some redundant relationships – ie proactively bond with some other partners at each of your VCs.
- Propose a Top-Off of the Last Round – Again, every VC is different – and god bless those who behave as a true partnership (you know who you are!) – but this business is ultimately about who believes enough to put capital behind a company. Your new GP/Board member didn’t personally sign the check last time – get him or her to do so, sooner rather than later. Even at the cost of a little more dilution. I’m a believer in the psychology of sunk costs. Ask them to take X% of their pro rata reserves for you and do it now as a note or extension of the last round. And the rest of the cap table can come along or not with their pro rata. (A variation on this is getting the new GP to expend a bunch of social capital and increasingly tie their reputation to your company. You can do this through a variety of means.)
- Assume You’re Going to Need To Raise the Next Round on Your Own – Goal is to get a new investor on to the cap table who is just beginning their journey with you. Again, I think it’s worth taking a little more dilution than you planned if needed to get this round done as soon as you’re ready. And if the exiting GP can still serve as a reference for you, that helps a ton too.
- Ask to Keep Exiting GP on Your Board – If the exiting VC is retiring or returning to operating (vs moving to a different fund), you might be able to retain them until the next fundraise. They are still representing the firm but everyone agrees that due to relationship continuity and capacity for other GPs to absorb Board seats, that things should just remain ‘As Is’ for now. Years ago when my Homebrew partner Satya left Battery Ventures to run Product at Twitter, he kept all his Board seats and incrementally transferred them to his partners over time.
- Put Your Investors on the Spot – Make sure you have clarity from your investors whether you are on track to their continued support. If you don’t have Board-level milestones/targets agreed upon, the Board isn’t doing its job anyway. Make sure that your execution will result in support and ask these questions upfront.
As suggested earlier in the post, this is totally a Your Mileage May Vary. My POV is simply that when a company underestimates the impact of a change in their VC relationship, it has potential to be damaging down the road in ways that the founder can no long control, so they should address any elephants in the room ASAP.
If you have different opinions – or even better, experience! – let me know and I’ll append any supplemental thinkings.
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