Who’s looking out for Who, The Venture Capital Myth:

What HBO’s ‘Silicon Valley’ hi-lights that most VC seeking startups aren’t thinking about.


You may know the show on HBO…. ‘Silicon Valley’,  just ending it’s 3rd season, is an hour long dedication giving a slight glimpse into the tech / startup / VC world, with humor, drama and of course inaccurate realities. While I am sure it’s quite humorous and engaging, it has the possibility to inflate expectations of many young startups seeking venture capital.

In my last 30 years in the legal profession as a New York litigation attorney, I spent a number of years serving as General Counsel to an institutionally - backed private equity group. It was here that we primarily invested in buy-out and consolidation plays identifying under performing media and technology companies, those projects many were not paying attention to.

We believed, with the right "clean-up" and a strategic acquisition strategy we could capture a robust exit with those companies, typically at 12 times EBITDA. Our charter was to make the acquisition at 3 times EBITDA. If executed correctly, with the roll-up strategy, this would yield an excellent return to the limited partners. 

We also did pure VC investing in pre-revenue, or limited revenue start-ups with disruptive technologies, superior management, and hyper-growth potential.  Those projects with limited marketing spend required --a viral play. In these instances our goal was to grow the company quickly with a holding period 24 to 36 months prior to an exit. 

Since 2008 and the crushing market meltdown, the venture capital investing model made a radical change, and, in my mind, the term venture, became a misnomer, or “Myth”. This "Myth" however applies principally to mid-market venture groups since they typically fall to the bottom of the venture ecosystem when attempting to compete with the mega-venture groups that always get the top-tier venture plays. 

A big problem for these smaller venture groups is "sourcing" deals, and dealing with risk in these less robust and disruptive start-ups that present a much higher risk profile.

The result is simple — venture firms become reluctant to deploy capital. Concurrently, if they decide to proceed a lengthy due diligence, or "tire-kicking" process, that can be a major distraction to the start-up they are vetting. 

Just think for a moment, a startup seeking VC gets entangled in this process, could quite possibly give in to demands of such firms that don’t align with their original intent. How would you know to avoid this process as a startup?

In the event the venture capital group decides to move forward the terms of the investment can be extremely draconian to management.  Not just from a valuation standpoint but critically removing from management the free reign respecting day-to-day business operations.

In many instances, structures that are designed to take control of the company in the event the company does not hit its projected targets. Which typically is the case since the business model is always a futuristic pro-forma at the businesses beginning stages. 

In my mind, this is a way for the venture firm to protect its limited partner investors to the detriment of the company, which raises fiduciary concerns not to mention the potential for a conflict of interest. Suffice it to say, for the start-up business the process can be daunting, highly time consuming, and distracting to management -- not a good thing! (We witnessed this happen in the Season 3 Finale of ‘Silicon Valley’.)

Bottom line -- venture capital, especially, in the middle market, is a tricky proposition, and emerging companies need to be aware of that fact. 

My recommendation for any start-up with mid-market venture interest is to get your early investors from accredited individuals (who take a passive position), or go on the hunt for strategic plays. Companies whom might see your asset as highly strategic to their product offering. Strategic players are less concerned about valuation, and give the management much more flexibility in growing their business. 

This is critical for any emerging companies success.