Startable – Healy Jones’ & Prasad Thammineni’s Blog

I don’t know if you’ve noticed, but the venture capital industry is undergoing a bit of a contraction. The WSJ recently noted, “Not since the dot-com bust has the industry experienced as much turnover as it is now. Since the end of 2007, the number of venture-capital principals, who make investment decisions and are directors of start-up companies, has tumbled by more than 15%, according to the National Venture Capital Association.” There is a ton of discussion about how the shrinking of the venture industry will impact “innovation in the USA,” and “what does this mean for new companies chances of getting funding.” However, there is another group of startups that is being impacted by this personnel exodus – funded companies. What happens when you are a startup that has raised venture capital and the VC who sits on your board leaves their fund and your company becomes an “orphan deal.”

Well, you should probably freak out a bit.

Let me explain. Everyone knows that there is a lot of rational, thoughtful analysis and diligence work that goes into a venture partnership making a new investment in a startup. However, there is also a bit of passion that goes into any given investment. Fred Wilson recently blogged on this topic when he discussed the leap of faith that goes into any new investment. This leap is mainly taken by the partner who is leading the investment. That partner stands up to the venture firm’s partnership and says: “I believe in this. Here is my work and here is my thought process, and here is why I want to risk our investors’ money in this business and with these founders. If the going gets tough, it will be on my back to figure out how we save this investment.” 

The lead partner knows the startup better than all the other partners at the fund. When the startup hits the inevitable bump (or two) on its road to world domination, it is that partner’s job to pound the table at the fund and say “we need to continue to support this management team.” It is much easier for the partner who made the initial investment in the startup to provide this level of support because the partner: 1) was supportive of the company during the first investment, and assuming the startup has been doing well, has probably also been providing positive updates to the partnership; 2) has seen the team in action, and (assuming the team is good) has developed confidence in their ability to execute; 3) understands the product development timeline and why it will work for the company’s eventual plans; 4) because of the time spent around the startup for the past months/years knows the market well enough to speak very confidently about the fact that there is a real need and addressable market; and 5) knows how and where the company will burn cash and how this will generate leverage in the business model and returns for the investors. (I have updated this post to include this sixth point) 6) Limited partners (the investors in venture capital firms) do not give real deal “attribution” to partners unless they were the one who made the initial investment. Regardless of the reasons why, this does not provide the proper motivation to a different partner taking over responsibility for the investment in the orphaned startup. Being an active board member and managing an investment takes a huge amount of time and effort, and if the new partner isn’t going to get real credit for managing the investment to an exit then they are less likely to be as supportive as the original partner.

The other partners at the fund just can not offer this same level of support/advocacy because they haven’t spent as much time with the company. If your venture capitalist leaves their fund, you need to get a new advocate within that fund ASAP. Usually you’ll get a call from your VC explaining that a new partner will be managing the investment in your company. You need to reach out to this partner quickly and get them to fall in love with you just as your original partner once did.

I would not take this lightly. Some business school professor should do a study on the percent of follow on rounds that are supported by venture firms after the investing partner has left vs. the average when the partner is still around. I bet there is a statistically significant difference… I am very much suggesting that you may not get the same level of financial support in your business from that fund as you had in the past. If you are going to be raising additional capital this is a big deal.

Over the next 18 months venture funded companies will struggle as they try to get financing from funds where their partner has left. Some will get that support. Others won’t… and trying to get a new venture fund to support your startup after your existing venture capital firm has passed on investing is as close to a kiss of death as you can get in the early-stage financing world. Who could know more about your company than the fund that is currently an investor? There is no bigger red flag for potential new investors in your startup than the current investors not having enough faith to make a follow on investment, even if this pass is due to a change in investment professionals at the fund.  

Tomorrow: the steps you should take if your VC leaves their fund. There are things you can do to land on your feet and help manage a smooth transition with your investor…