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Dialog
Between Geras and Sahakian
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1/2/01 ePrairie
Article - Illinois Ranks 11th in December VC Fundings From: Rgeras@aol.com > > > In a message dated 1/8/01 12:41:04 PM, cpart@interaccess.com writes: > > << I view them (eprairie's proposed questions) as not relevant to what I have to say. >> > > Curtis, Just out of curiosity, could you try and clarify for me what you mean by the above? I'm really interested in exactly what your "message" is and what your primary goals are related to that. Thanks, From: Curtis E. Sahakian cpart@interaccess.com Bob, I try responding to your question... 1. There are a lot of unwritten and unspoken rules making and receiving venture investments. 2. Most founders are less experienced and less savvy than VCs at understanding and playing to these rules. 3. Professional investors get a lot more times to screw it up... and then get it right. They become better at it. 4. As a result founders are generally at a disadvantage when their interests conflict with those of investors. Those four questions from Tom Alexander at eprairie are nice I guess, but answering them isn't going to educate the entrepreneurs with the knowledge they lack and need. 1. One real important thing. I believe that these rules of investing are really a function of how money works and that no one player can change the rules. It may even be that all the players together could not change the rules. For example, I scanned your outline on private company investing and I didn't notice a single thing that I would disagree with. It was all good stuff. I suspect that there are very few facts on which you and I differ... we are both living in the same universe... its just that we disagree on the interpretation of these facts. 2. What is not good about the current situation is that, in my opinion, most of these founders are not being fully advised with respect to what their personal best interests are... perhaps they are being advised as to what is best for their venture... but not for them. And I think the unreasonablness of the investment agreements is out of control. If I answer those Tom's five questions, the point counterpoint between you and I will not be particularly exciting... and I don't even know if I can get pumped to put any passion into them.... they are just too antiseptic. And on one of them, I didn't even have a strong opinion to express. I guess I just don't find the questions intellectually stimulating. 3. To properly answer some of the questions requires restating them and clarifying them. For example the question about VC lawsuits has two parts. Whether you can sue a VC and how you go about. Whether there is going to be much of it happening. I believe these fights happen much more often than is commonly known. I have been personally involved in at least two major ones (and probably a number of minor skirmishes that I wouldn't recall without reviewing my files). investors money to buy their way out of the dispute's unpleasantness. The suit was merely threatened. It took about 3 months of negotiation to settle it. They made the settlement look like an investment decision. In the second my client called me at 11pm saying he had just been fired from his own company... by the VC acting in concert with the CEO he hired. They screwed my client good in the financing transaction. Most of his stock was basically non-vested. This in a company he started from scratch with his own $250,000. Life has its little victories, this one was mine. I engineered a hostile takeover of this privately held venture capital controlled company. It's something I have never heard of anyone else having done successfully. The VC and company were using a large California law firm with an entire department specializing in VC transactions. In the end my client was made whole and the VC got an unwelcome liquidity event. These kinds of fights have been going on since long before dot.coms came along. They will continue long after. Will there be a surge of fights over dot.com investment relationships? I don't know. There is nothing particularly special about dot.com companies except the founders (and perhaps the investment decision makers) were on average probably younger and less experienced than in the past... and the general carnage more wide spread than anything probably since the beginning of venture capital investing in the US. It may be that it will take one high profile case followed by two or three lesser profile cases to encourage plaintiffs lawyers to take these cases on contingency and cause many people to take their situations to lawyers for evaluation. But I can't say that with the belief and certainty that I can marshal about the subject of taking down arrogant bullies hiding behind one sided unreasonable agreements foisted on the unprepared and unsuspecting. Curtis From: Rgeras@aol.com Thanks for the long dissertation Curtis. I really appreciate that you took the time to try and elaborate on your thoughts and why you feel the way you do. It is much too late at night for me to think through a lengthy response, but let me make a couple of comments. I get my joule's from helping people too, as you may have guessed. I also agree that many VCs are arrogant and that not all of them are good and not all entrepreneurs are bad. If I felt that way, I would never have bet on the many dozens of founders that I did by investing in them and spending tons of time mentoring them. In return, most never even came close to doing what they originally were telling me. Many times I found that much of what they stated about their product, abilities, and future prospect were untrue, exaggerated, under researched, and/or very incompetently executed. Did I sue them? Never. Did that make me cynical? Of course not. More careful, yes, but cynical, no. Who was the "disadvantaged" in those situation? I maintain that it was neither. A lawyer gave a presentation at a seminar on oil drilling financing I was at and started off with this statement..."Before they meet, the oil prospector has the experience and the investor has the money. After they meet the prospector has the money and the investor has the experience!" The business promoters are presumed to know one heck of a lot more about their business than I did. And I'm the one who took most, if not all of the financial risk just so they might have a chance to grab the brass ring. Most really do try to do a good job. But too many represent that they have more ability to execute than they do. But, that's the nature of the animal, and if you can't take the risk and uncertainty without complaining when it doesn't work out quite right you shouldn't be an investor or an entrepreneur! Blaming is for crybabies, sore losers and people who don't want to shoulder their share of responsibility for the results. In any case, Curtis I think it is way too easy to revert to paranoia when things don't work out and try to play the blame game with 20-20 hindsight. When things don't work out, there's probably enough mistakes to warrant fingerprinting at almost everyone involved after the fact. So what? I honestly feel that you really believe in what your doing, Curtis. But I'm equally convinced that you're conclusions are largely off the mark because of your intense mistrust of VCs and an incomplete feel for what really goes on in an investor's head...VCs or otherwise. You stated above that not all VCs are nice guys. Well, I think it's equally true that not all VC's are greedy, deceitful devils either. Let's get together for lunch soon. I'll buy. Bob From: Curtis E. Sahakian cpart@interaccess.com "Many times I found that much of what they stated about their product, abilities, and future prospect were untrue, exaggerated, under researched, and/or very incompetently executed." Bob, I can only agree with the above. Almost all founders misrepresent and overstate their proposition. Sometimes it is intentional, sometimes ignorance, sometime by accident. Usually it is a combination of all three with a heavy emphasis on a studied disrespect for the truth. Most people treat others the way they are treated. Even the biggest jerk will treat you better than otherwise if you treat him well. Even the nicest person will treat you less well if you treat him poorly. So founders, by their behavior, encourage the VC policies and behavior that I am complaining about... and provide them with the grist to justify and rationalize it. By the way, if you think I thoughtlessly encourage people to get into disputes. Take a look at the section in Sahakian's Rules I sent you on "Adversaries and Disputes." I am a firm believer in avoiding fights (i.e. litigation) when at all possible. I don't believe I have said that everyone should be suing VCs. Only that they can, and in many cases that they can prevail... more so than many would want them to believe. And that there is nothing immoral or unethical about it. Still any such a decision needs to be made on a case by case basis and should not to be made lightly. In many instances most founders will be best served by just moving on to their next deal (like a wrongfully fired employee). Though I think attempts to imply that most founders of failed VC financed companies typically get a second deal financed by their original VC is hogwash. While such founders are an important pool of talent to the VCs... I suspect that the odds for any individual founder are not so great. Though I admit I don't have the statistics. Of your 90 investments, how many non-real-estate investments (actual checks written) were made to a founder on a truly new (unrelated) venture after their first deal failed? Two or three? That would be significant to you but shouldn't be much of a motivating factor for the other 87 founders. Curtis ePrairie's interview with Bob Geras on VCs "Playing the Blame Game: Will Startups Start to Sue?" January 12, 2001 (Tom @eprairie) EP: There has been recent talk of the possibility that failing dot-coms will sue their VCs when their businesses begin to fail. What is your take on the possibility of this happening? Do you think it's a reasonable concern, and do you think it is something we are going to see more of in the near future? BG: It's still a little early in the dot-com tailspin cycle. Since there are over 800,000 lawyers in this country (as compared to 20,000 or so in Japan, which has about half our population), I'm sure many in the legal profession are now sifting through the ashes to see if some technicality will lend itself to generating legal fees in the name of retribution for alleged abuses by those nasty people who risked their money to help an under-funded entrepreneur wannabe have a chance to grasp the brass ring. Unfortunately, this is a country where the main national lottery is "sue the bastards!" Too many people play the blame game. It takes a certain amount of integrity and honest introspection to admit ones own culpability in failure. Unfortunately, throughout today's society, finger pointing has become much more common than "mea culpa." Does this mean there haven't been abuses? Of course not. Since investors (of all types) are human too, I'd expect a representative cross section of the whole spectrum of competence and integrity, and lack thereof, as exists in other professions as well as in the general population. However, I have seen much more questionable behavior by those seeking money than by those providing it. Constantly missed "conservative" projections, resume puffing, glossing over known risks, exaggerating potential and nondisclosure of past failures are just a few that prospective investors have to contend with. EP: How fundamental to the VC/startup relationship is dependency? That is to say, do VCs want to spawn companies that take off or is there an agenda at work where VCs are trying to keep the startups reliant on their funding? BG: The main objective of most investors is to have the greatest return with the least risk. Optimal risk-adjusted rate of return is the main objective. Therefore, there's a greater IRR if there's less money invested, not more, for a given result. The specifics of that arrangement varies, depending on type of investor, their risk/reward policy, the attractiveness of the investment, its potential and likelihood for success, investment climate, likely exit strategies, and the relative bargaining positions of the parties amongst many other variables. If the deal looks good, the investor may feel justified in asking to have the right to do follow-on investing since it is his risk capital that is enabling the enterprise to test it's assumptions to see if they were valid or not. Also, cash is sometimes "staged-in" depending on whether the company meets agreed upon milestones to justify further risk-taking by the investor. Is it common for investors to trap an unsuspecting company to accept inadequate money, knowing that it isn't enough, just so they have to beg for more under conditions that supposedly will allow the investor to take advantage? I've never seen that happen during the 30 years I've been in the arena as entrepreneur, investor, consultant and capital raiser. It is far more common for investors to insist that companies seeking capital raise more than they project the need for, to make sure there's a cushion for the unanticipated even though that may lower the rate of return. VCs often prefer to bring in other deep pocket, value added investors to spread the risk, participate in follow-on financing if necessary, and to help monitor and mentor the Company. Could there be instances where there is a staged pay-in agreement base on agreed upon performance levels? Yes. Often the money is invested anyway if reasons for the shortfall don't cast significant doubt on the basic validity of the business plan. But that arrangement is a lot different than saying the investor relishes the idea that he might have to become a bottomless pocket just to keep an under-performing company alive. EP: At what point should dot-coms cease seeking VC support? BG: That depends on what kind of progress the company has made, how well the VC experience has worked out, what the investment climate is, how much capital the company needs and for what purpose, and what the options are for alternative funding. The company needs to continually evaluate its options as needs come up and make decisions based on the usual criteria. VC money is sometimes viewed as expensive capital, and often it is. However, there are many times when the VC provides valuable mentoring, access to scarce talent, important entree's to potential customers, suppliers, banks, distributors, and introduction to important technology through it's network of contacts which could be critically important to young companies and which may otherwise be unavailable to them. EP: In the future, will VCs make more or less of an effort to protect their own interests going into dealings? BG: All parties should act rationally and prudently and fairly to make sure they aren't making careless mistakes nor taking undue risks. That goes for the Company as well as the investor. One of the most often cited factors for success in a new venture is good management with a successful track record. A reasonable balance addressing the interests of all parties should always be the objective in any negotiations. Gaining unfair temporary advantage by either party is shortsighted and almost always a short-lived victory. If finding and motivating good talent are main ingredients for success, why would a VC want to risk breaking trust and alienating and demoralizing the most important assets in which they invested by striking too hard of a deal or by taking advantage of unnoticed fine print in an agreement? That said, as we all learn through experience, covering bases in future deals which may have been overlooked to our chagrin in prior investments is certainly rational, fair and legitimate... as long as it is balanced and takes into consideration the proper interests of all parties. EP: Was there an amount of sloppiness about necessary legalities during the boom period? Is there anything to be learned from the shakeout? BG: When there is the kind of speculative frenzy of the type that existed in the dot-com, telecom and other technology areas over the past few years, many prudent investment rules and precautions were completely ignored. In the scramble to get a piece of the promised burgeoning "new economy" and all the starry-eyed wealth creation that it was expected to bring, a stampede of startups, inexperienced millionaire-wannabees, and careless hordes of investors and investment bankers with billions of capital in hand giddily chasing them, rushed headlong over the cliff of reality only to be smashed on the rocks of remorse and regret waiting far below. Sure there was a lot of sloppiness of all kinds by many parties, and plenty of blame to go around for everyone if you want to look for it. For a while, it didn't matter. We were all in Wonderland making decisions on precious little information because things were moving with lightening speed and those "old rules" didn't matter anymore anyway, right? So now to smugly sit back, survey the wreckage and second-guess all that was done by various participants in the heat of the battle, seems a little disingenuous to me. Let's stop the finger pointing and try to learn important lessons from the very expensive mistakes that too many of us made and move on with the rest of our lives... hopefully all the wiser for the experience. |
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