Conflicted Capital(blog.aaronkharris.com)
blog.aaronkharris.com
Conflicted Capital
https://blog.aaronkharris.com/conflicted-capital
75 comments
This is not cool - I am sorry. Investor here - they should never do that. Make sure you tell others about how this went down. If they were planning on getting rid of you, that needs to be part of the upfront discussion etc.
It was evidently Insight Partners. They led the Series A on OP's last startup: Insight Partners. They evidently led the Series A for OP's last startup, which according to their LinkedIn is Numetric. Crunchbase tells you what you need to know: https://www.crunchbase.com/funding_round/numetric-series-a--...
We need ratemyinvestor.com to weed out the flock of bad investors.
They are a large and very lawsuit happy VC. It's not worth the risk to warn other people about this VC.
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It would be a shame if someone else created a throwaway account to express similar sentiment about a similar firm and named them.
It doesn't take a lot of insight to look at the crunchbase of OP's former company and look who lead the series A...
Yeah - I more mean... don't go out there and go out of your way to advertise that they did this.
But founders should talk to other founders about their experience with different investors. The good, the bad and the ugly.
In those situations, you can make it clear - in objective terms - what happened and why you would not take money from them again. Don't call them names or anything.
But founders should talk to other founders about their experience with different investors. The good, the bad and the ugly.
In those situations, you can make it clear - in objective terms - what happened and why you would not take money from them again. Don't call them names or anything.
Did you make some money though?
None.
That really sucks. I think in the bubble of YC seems like this doesn’t happen but then there are counter examples like yours. Thank you for sharing.
I know of at least three successful YC companies that fired founders and then took a hit... YC isn't that special of a bubble, especially these days.
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What VC?
Insight Partners. They evidently led the Series A for OP's last startup, which according to their LinkedIn is Numetric. Crunchbase tells you what you need to know: https://www.crunchbase.com/funding_round/numetric-series-a--...
I'm aware of Max Levchin doing something similar to a YC founder, but with the involvement of another VC at the time.
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Why would you even give up more than 49% of your company?
It doesn't matter what % of your company you own. What matters is whether or not you control a majority of the board seats.
Well....technically.... what matters is your ability to replace and/or appoint board members :)
Because you need the money and have a weak negotiating position. Not every startup is like Facebook.
Did you and your accountant review the shareholders' agreement thoroughly before finalising the fundraising with the new investors?
So, that's a bad trip, sorry to hear about this, and noted.
Being friendly is much like being powerful - if you have to say that you are, you aren't.
(with tons of apologies to Margaret Thatcher)
(with tons of apologies to Margaret Thatcher)
Same thing with honest.
>The lesson for founders is to never, ever, ever give up control of your board/company. Always maintain control of a majority of the board seats.
Maybe you're too close to the situation so what you say above feels to you like a universal truth but it actually doesn't help me as a reader.
To raise the quality of discussion, we'd need to know what your realistic options were at the time you raised Series A.
E.g... Did you have meaningful revenue making VC capital optional? Did you need VC money to have a runway and make payroll for a few months?
In other words, if you're in a situation where rejecting VC money means your business shuts down, it becomes a moot point if you're still 100% in control of all board seats.
As for board seats composition, was it something like You=1, VC=1, and Independent=1? If so, was the independent automatically on VC's side to fire you or were they truly independent?
If you don't want to get into the details to maintain privacy, that's understandable. But also understand that your advice born out of your experience doesn't have enough context for us.
Maybe you're too close to the situation so what you say above feels to you like a universal truth but it actually doesn't help me as a reader.
To raise the quality of discussion, we'd need to know what your realistic options were at the time you raised Series A.
E.g... Did you have meaningful revenue making VC capital optional? Did you need VC money to have a runway and make payroll for a few months?
In other words, if you're in a situation where rejecting VC money means your business shuts down, it becomes a moot point if you're still 100% in control of all board seats.
As for board seats composition, was it something like You=1, VC=1, and Independent=1? If so, was the independent automatically on VC's side to fire you or were they truly independent?
If you don't want to get into the details to maintain privacy, that's understandable. But also understand that your advice born out of your experience doesn't have enough context for us.
"To raise the quality of discussion..."
To raise the quality of discussion, we need for all the email and Signal messages from the investors / VCs for a variety of deals to be made public. That would be a major step towards reducing the amount of information arbitrage in start-up funding (not to mention blog posts like the OP).
To raise the quality of discussion, we need for all the email and Signal messages from the investors / VCs for a variety of deals to be made public. That would be a major step towards reducing the amount of information arbitrage in start-up funding (not to mention blog posts like the OP).
Jesus...
Did they at least buy you out or did they literally rob you of your company?
Did they at least buy you out or did they literally rob you of your company?
Everyone has their own incentives and when things get tough, they will work to maximize what their incentives say should be maximized - keep that in mind before signing up with investors if you are a founder. The term sheets and final docs - and the specific rights in them - matter a lot.
Examples from Charlie Munger [1]:
"One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally, somebody got the happy thought that they were paying the night shift by the hour and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked."
"Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he couldn’t understand how their better, new machine was selling so poorly in relation to their older and inferior machine. Of course, when he got there he found out that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine."
[1] https://www.butwhatfor.com/charlie-munger-the-psychology-of-...
Examples from Charlie Munger [1]:
"One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally, somebody got the happy thought that they were paying the night shift by the hour and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked."
"Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he couldn’t understand how their better, new machine was selling so poorly in relation to their older and inferior machine. Of course, when he got there he found out that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine."
[1] https://www.butwhatfor.com/charlie-munger-the-psychology-of-...
In Xerox case, it was the same company that wouldn't enter the personal computing market because it might impact their copy-machine market.
I've seen that happen in hiring decisions as well. Junior people are in charge of screening candidates... really strong candidates, if hired, will make the average employee look bad.
So, why should the person screening the candidates suggest the strongest candidates?
This is why I tend to suggest equal seniority individuals should not screen candidates. It's a subconscious thing ("He's too aggressive" "She seems like not a good culture fit" "He is too senior for this role") that most people don't think of directly, but happens.
So, why should the person screening the candidates suggest the strongest candidates?
This is why I tend to suggest equal seniority individuals should not screen candidates. It's a subconscious thing ("He's too aggressive" "She seems like not a good culture fit" "He is too senior for this role") that most people don't think of directly, but happens.
One way to offset that is to make sure that team performance is as much of an incentive as individual performance.
A stock compensation helps in that regard: hiring strong individuals will help ship a better product faster and should increase the stock value. Meanwhile traditional stack-ranking and a mostly salary compensation will encourage individuals to make sure they are seen as the top performer no matter what.
A stock compensation helps in that regard: hiring strong individuals will help ship a better product faster and should increase the stock value. Meanwhile traditional stack-ranking and a mostly salary compensation will encourage individuals to make sure they are seen as the top performer no matter what.
This is best - for sure; thats why I am a fan of broad equity allocations etc. The larger the company gets, the hard that can be.
But in that situation, I can give top performers more equity, but in the grand scheme of things, thats not much incremental total dilution to the average employee. We all still make more the same way - when the company makes money or is sold.
If you are at a larger company that is a going concern for a long time... it gets a bit harder and takes some more thinking.
But in that situation, I can give top performers more equity, but in the grand scheme of things, thats not much incremental total dilution to the average employee. We all still make more the same way - when the company makes money or is sold.
If you are at a larger company that is a going concern for a long time... it gets a bit harder and takes some more thinking.
Most people want to hire the best candidates they can despite some of the misaligned incentives. You don't want to spend overtime on someone else's bug because you hired poorly. The risk of a smaller bonus or less promotion chances is complicated as sometimes there is more available if the teams performance improves as a whole. When you deliver on a major project the team's pie is often much larger, and even if you end up with a smaller slice of said pie you're usually better off.
If any of that were true, we'd have universal healthcare and live in a utopia. Crabs in a bucket. If you're focused on the ladder, you're not going to hire someone that has the potential of making you look bad.
Investors for software startups are not that great if you want your business to be self-sustaining without becoming a unicorn or a Ponzi scheme.
I'm not saying that participating in bubbles cannot be economically rational, but venture capital today is especially suited for making decisions that are bad for everyone involved, prioritizing future valuation over good business.
It's the same growth or sustainability choice we keep failing at as a civilization.
I'm not saying that participating in bubbles cannot be economically rational, but venture capital today is especially suited for making decisions that are bad for everyone involved, prioritizing future valuation over good business.
It's the same growth or sustainability choice we keep failing at as a civilization.
"Investors for software startups are not that great if you want your business to be self-sustaining without becoming a unicorn or a Ponzi scheme.
"
- can you elaborate on this? Gut check wise this feels correct, but I'd like to hear your thoughts.
It's nothing new, investors chase valuation over profits, which among others depends on growth because of the benefits of network effect. As a result most invested capital goes into user acquisition, and products become heavily subsidised.
This venture model is good for unicorns like Facebook, who's network effect allows it to be eventually profitable, but the rest of the industry is not profitable. But VCs are, because of their management fees and because they avoid to be the greater fools, otherwise known as the bagholders who end up paying for it. VCs tend to encourage wasteful spending in the name of valuation on salaries, rents and user acquisition. It's a Ponzi-scheme where the bagholders tend to be limited partners and employees of the funded companies.
This venture model is good for unicorns like Facebook, who's network effect allows it to be eventually profitable, but the rest of the industry is not profitable. But VCs are, because of their management fees and because they avoid to be the greater fools, otherwise known as the bagholders who end up paying for it. VCs tend to encourage wasteful spending in the name of valuation on salaries, rents and user acquisition. It's a Ponzi-scheme where the bagholders tend to be limited partners and employees of the funded companies.
>Investors mostly want to do the right thing for founders.
See, that's an important difference between investors and VCs.
A VC firm or division gets (say) $1B, and a deadline: invest it all by end of quarter. All they can invest in are what come through the door. They know most of those have no future. A few do, but not enough to absorb the whole allotment. They can't not invest. What to do? No choice, really; invest it all, with 9 of 10 expected to flop.
Having identified, at the outset, which should flop, start milking them. There's no reason to waste that money, even though it's lost to the actual investors. Make them spend their nut where it will do somebody some good. Maybe make them hire a crony, who will hire more. Make them use a pet staffing agency. HR pros are (to first order) all grifters, so provide them one of yours. Make them buy software from one of the not-flops from this round or last quarter's, or somebody you own part of, personally. Be creative. You can draw it out, deposit more cash from next quarter's infusion, and extract that. Maybe they can build, code, patent something of value that can be bought for pennies at the bankruptcy.
There are a million variations on this, all used.
See, that's an important difference between investors and VCs.
A VC firm or division gets (say) $1B, and a deadline: invest it all by end of quarter. All they can invest in are what come through the door. They know most of those have no future. A few do, but not enough to absorb the whole allotment. They can't not invest. What to do? No choice, really; invest it all, with 9 of 10 expected to flop.
Having identified, at the outset, which should flop, start milking them. There's no reason to waste that money, even though it's lost to the actual investors. Make them spend their nut where it will do somebody some good. Maybe make them hire a crony, who will hire more. Make them use a pet staffing agency. HR pros are (to first order) all grifters, so provide them one of yours. Make them buy software from one of the not-flops from this round or last quarter's, or somebody you own part of, personally. Be creative. You can draw it out, deposit more cash from next quarter's infusion, and extract that. Maybe they can build, code, patent something of value that can be bought for pennies at the bankruptcy.
There are a million variations on this, all used.
My issue with the whole fundraising circuit (esp for low cap-ex startups) is how much you have to strain yourself to convince a non-customer to believe in you
Only slightly related to your point, but I find almost the entire VC community not one that I would want to be working with very closely with. It’s just not the kind of people I find interesting. Not that they’re not skilled or provide value, but the whole fundraising dance seems to be tiring and honestly pointless. Harkens back to an equally pointless endeavor I’ve been through before: the struggle to get good grades in college. Artificial struggles created by humans for other humans. I guess some people like that but it has an element of “rat race” that I find deeply disturbing.
If I had a wish to materialize an ideal VC firm, it would be a place with both business types and highly skilled engineers who are on top of their skills and continue to build things.
If I had a wish to materialize an ideal VC firm, it would be a place with both business types and highly skilled engineers who are on top of their skills and continue to build things.
This is kind of what I'm working on.
Basically a product studio with LPs
Basically a product studio with LPs
It's been done, I know of a couple of these. They start out well intentioned and end up being backseat drivers in every company they launch, usually with bad side effects.
I think the big distinction is avoiding launching companies and instead launching products.
I'm increasingly convinced that very few products need to be companies, and the insistence that they do is why a lot of them end up so shitty.
I'm increasingly convinced that very few products need to be companies, and the insistence that they do is why a lot of them end up so shitty.
Having seen this model before, I think the challenge there is incentives, motivation and focus. If you have a winner, it's likely that through power law effects it makes sense to double down on it unless you have too much capital to deploy through that company.
With that said, I think running a product studio before you find product market fit or the killer company is not a bad idea, especially if you can work directly with LPs to source the funds. Then the challenge is just making sure people don't step on each other's toes when you staff the winner.
With that said, I think running a product studio before you find product market fit or the killer company is not a bad idea, especially if you can work directly with LPs to source the funds. Then the challenge is just making sure people don't step on each other's toes when you staff the winner.
It's still early days, and there are a lot of hypotheses that will be invalidated.
But one of my goals at the moment is to *not* double-down on winners. The thesis being, whatever is working, is clearly working.
I think a lot of products are killer, and should be left alone, and "doubling-down" or "iterating" might make them worse.
For example, Reddit v. HackerNews
But one of my goals at the moment is to *not* double-down on winners. The thesis being, whatever is working, is clearly working.
I think a lot of products are killer, and should be left alone, and "doubling-down" or "iterating" might make them worse.
For example, Reddit v. HackerNews
> But one of my goals at the moment is to not double-down on winners. The thesis being, whatever is working, is clearly working.
Then you will likely end up so far diluted that you won't make enough on your winners to cover your losses. It's a tricky balance to find.
Then you will likely end up so far diluted that you won't make enough on your winners to cover your losses. It's a tricky balance to find.
There are quite a few VC firms that model what you're talking about - for instance I think this describes what Garry's doing at Initialized.
But raising money is a choice that some founders will make because their businesses require it. If you don't need it, don't raise it. If you do need it, go into the process and decision with as much information as you can get.
But raising money is a choice that some founders will make because their businesses require it. If you don't need it, don't raise it. If you do need it, go into the process and decision with as much information as you can get.
I think I should have phrased my comment better. I’m not opposed to the idea of raising funds to grow a company, but the way that it’s usually done today. In particular: the people that the money needs to be raised from (VCs) seem to not be the kind of down to earth engineers that I love and respect, and the process itself involves a lot of marketing fluff that I find off putting.
I am willing to accept that, it may not be possible to have such a process. Perhaps to succeed in the “real world” you absolutely need to be fantastic at marketing and pitching.
I’m trying to describe what a process would look like that I personally would find enjoyable to work with, ignoring the reality of what might actually be required.
I am willing to accept that, it may not be possible to have such a process. Perhaps to succeed in the “real world” you absolutely need to be fantastic at marketing and pitching.
I’m trying to describe what a process would look like that I personally would find enjoyable to work with, ignoring the reality of what might actually be required.
> "If I had a wish to materialize an ideal VC firm, it would be a place with both business types and highly skilled engineers who are on top of their skills and continue to build things."
idealab is somewhat like this. they cycle in engineers to work on an itch for a limited time on salary, then go through an internal round of fundraising (pitch idealab itself for seed money), then seek external rounds if there is traction.
branch[0] is a company that successfully launched from idealab this way. they started as a shift-swapping chat app for hourly workers and have branched (haha) into payments now.
[0]: https://www.branchapp.com/
idealab is somewhat like this. they cycle in engineers to work on an itch for a limited time on salary, then go through an internal round of fundraising (pitch idealab itself for seed money), then seek external rounds if there is traction.
branch[0] is a company that successfully launched from idealab this way. they started as a shift-swapping chat app for hourly workers and have branched (haha) into payments now.
[0]: https://www.branchapp.com/
I didn't take VC and my company was chronically underfunded and died a long, slow, painful death to VC backed competitors. I'd take VC if I did it over again-- the focus and faster cycle would have made a difference, even if I failed again it would have been 3 years wasted not 10.
> Founders need to understand that venture investing is a business where friendship is an input or an outcome, and not the other way around.
Does anybody know how to parse this?
Does anybody know how to parse this?
My guess is he means that VCs don't make decisions out of friendship.
"Your business colleagues are not your friends"
Yup that struck me too as poorly phrased and unclear. Maybe crystal clear to writer, but not to readers...
Another note about 'internal' investors getting preferential treatment as opposed to outsiders: this is usually a result of SHA conditions and elements in the articles of incorporation that stipulate that in case of a sale or issue of new shares existing shareholders have first right of refusal. That this makes for a less competitive environment is something that everybody seems to take as normal, but after reading this article I'm wondering if it really should be normal or of there are other important reasons why this right always seems to be granted.
You should avoid giving a right of first refusal even at great cost (20% valuation discount).
If there is a right of first refusal many investors will decline to engage in future rounds since if they end up negotiating a good deal it might fall apart at the last moment.
If there is a right of first refusal many investors will decline to engage in future rounds since if they end up negotiating a good deal it might fall apart at the last moment.
I strongly disagree with the premise that a founder should keep "internals" at arms length and run a process without them to avoid any pressure from internals to lead and somehow maximize terms.
Your existing investors have a vested interest in making you successful. A higher valuation is more acceptable to them than to outsiders (due to being able to officially mark up their investment, which helps them raise their next funds and improve their apparent performance prior to liquidity). Founders also have a far better idea of what kind of support they can expect from an existing investor than a newcomer.
Of course, as a seed stage investor, I am biased in my views on this. But I do really believe that making potential adversaries out of your existing investors is a deep mistake.
Your existing investors have a vested interest in making you successful. A higher valuation is more acceptable to them than to outsiders (due to being able to officially mark up their investment, which helps them raise their next funds and improve their apparent performance prior to liquidity). Founders also have a far better idea of what kind of support they can expect from an existing investor than a newcomer.
Of course, as a seed stage investor, I am biased in my views on this. But I do really believe that making potential adversaries out of your existing investors is a deep mistake.
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When I've seen founders try to keep investors at arms length it seems to result in mistrust, leaving investors feeling like they can't get the real story, and thus decreasing the likelihood they invest further. So rather than keeping insiders at arms length, I'd suggest being direct about wanting to meet other investors. I suggest uncomfortable candor over comfortable misdirection.
> In fact, the vast majority of the investors I’ve met, even those that have fired founders, are good people. It’s deeper than that, even. Investors mostly want to do the right thing for founders. There are emotional and business reasons for this impulse, but ultimately the fiduciary responsibility has to win. Founders need to understand that venture investing is a business where friendship is an input or an outcome, and not the other way around.
Cynical viewpoint coming in:
VC investors are only "good people" because that is what currently drives the market for dealflow. What I think a lot of entrepreneurs miss is that VCs are finance professionals first and foremost. If the market dynamic starts to change, you might see them behaving differently but still aligned ultimately to the interest of their LPs.
TL;DR - VCs who create good content, are helpful, are nice to founders, etc. ("founder friendly") in a professional context are only that way because it's generally what has been proven to generate good leads for deal flow.
Cynical viewpoint coming in:
VC investors are only "good people" because that is what currently drives the market for dealflow. What I think a lot of entrepreneurs miss is that VCs are finance professionals first and foremost. If the market dynamic starts to change, you might see them behaving differently but still aligned ultimately to the interest of their LPs.
TL;DR - VCs who create good content, are helpful, are nice to founders, etc. ("founder friendly") in a professional context are only that way because it's generally what has been proven to generate good leads for deal flow.
These are humans, after all. It seems unlikely that all of them should be unscrupulous, fundamentally dishonest, profit-maximizing robots who only exhibit benevolent traits as a charade to lure in entrepreneurs. Surely some are simply good people.
It sounds a little hyperbolic and black and white to consider those two things as being mutually exclusive. It's possible (and maybe even common) for someone to be a good person to others in matters that don't pertain to money -- but, when the rubber hits the road with respect to money, they end up being making decisions that make sense given how much leverage they have. At the end of the day, VCs are subject to their LP stakeholders. They are also subject to their founder stakeholders, but the degree to which the various entities in that three legged interaction hold sway varies based on environment.
In a frothy environment like the present, founders really do have a lot of leverage because the demand for investable companies in many ways greatly outstrips supply; you see this in the SPAC craze. But in other environments, LPs and VCs have a lot more leverage over founders. When that is the case, it is only reasonable to expect them to behave according to their incentives. Now one could make the argument that it's still a poor long-term decision for VCs to sour community goodwill if they want to be in the game long-term. That may be the case, but it doesn't mean that a cunning VC cannot profit from exploitation in the medium term, enough to enrich themselves to the level where a poor reputation doesn't prevent them from continuing to operate.
It's important to not over-anthropomorphize the way that financial professionals operate as agents in a system with incentives. When they do something unsavory, it's generally not meant to be personal even if the result is incredibly unsavory.
In a frothy environment like the present, founders really do have a lot of leverage because the demand for investable companies in many ways greatly outstrips supply; you see this in the SPAC craze. But in other environments, LPs and VCs have a lot more leverage over founders. When that is the case, it is only reasonable to expect them to behave according to their incentives. Now one could make the argument that it's still a poor long-term decision for VCs to sour community goodwill if they want to be in the game long-term. That may be the case, but it doesn't mean that a cunning VC cannot profit from exploitation in the medium term, enough to enrich themselves to the level where a poor reputation doesn't prevent them from continuing to operate.
It's important to not over-anthropomorphize the way that financial professionals operate as agents in a system with incentives. When they do something unsavory, it's generally not meant to be personal even if the result is incredibly unsavory.
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I don't think it makes sense to lump a whole group of people into a single categorization this way. You're right that being seen as good helps drive deal flow, but, again, most of the people I've worked with are actually pretty "good" in the moral/ethical sense.
Where and how personal ethics, business ethics, business needs, financial incentives come together and produce results is immensely complicated.
Where and how personal ethics, business ethics, business needs, financial incentives come together and produce results is immensely complicated.
Isn't the purpose of financial instruments to resolve these kinds of conflicts? Seems like in the days of smart contracts these meatspace concerns could be coded around.
The week after we closed our series A they told me I had to hire a COO. I asked, "You trying to get me to hire my replacement?" "No, we'd never do that. How could you even think that?"
Less than two months after we hired the COO they fired me. The COO was made the CEO and he ran the company into the ground.
The lesson for founders is to never, ever, ever give up control of your board/company. Always maintain control of a majority of the board seats.