Truth or dare | If you want a venture capitalist's backing, better tell the whole truth and nothing but
Growth-oriented entrepreneurs are, of necessity, in constant selling mode. They have to sell their family and friends on providing early emotional and financial support. They sell their product or service to customers. They sell their opportunity and experience to investors. And, when raising capital, owners understandably try and sell their best story —“We have a great product serving a large, fast-growing market with an experienced team” — to optimize the odds of getting the capital they want without forfeiting too much ownership or committing to other strings that come with investment.
In the normal course of investment evaluation, we equity investors perform our own research to augment what is provided in the business plan and presentation. We interview customers, former employers, industry experts and everyone we can find to gain a complete picture of you. We expect to learn things you might wish we didn’t know about you and your professional history. Most of the unfavorable stuff is not a big deal — after all, everyone makes mistakes.
Of course, some details do turn out to be a big deal for professional investors. What determines a big deal? Most of my peers use the expression, “If you wouldn’t want it on the cover of The New York Times” as the litmus test for identifying big deals. Our research often turns up a mixed bag of true, not-so-true, false or “not disclosed” information presented by the owners, as well as, from time to time, something that’s a big deal.
Fess up, or else
Fifteen years ago, I worked as an investment analyst researching venture capital opportunities for a large private equity fund. We were close to closing a deal for an environmental remediation opportunity that involved some respected Boston investors. The CEO of this venture had approached our fund and we were very interested in the deal. My colleague and I began market research and customer-related due diligence while the lead partner on the deal spent time with the company’s management and oversaw reference checking. At one point in the process, the partner sensed there was something the CEO was not telling us. A quick bit of Internet research turned up a small article related to the CEO’s conviction for U.S. Securities and Exchange Commission violations in one of his prior operating roles. The partner asked the CEO if there was anything else about his background that he thought we ought to know, and when he again didn’t fess up to the conviction, we passed on the deal. We shared our reasons with the earlier investors, who soon dismissed the CEO.
During another evaluation, I was in a meeting in which the CEO of a large management team was looking to buy his division from its publicly traded parent company. The division had been built based on a series of acquisitions of smaller companies, some of whose senior staff were still in place. We saw one particular senior staffer as critical to the opportunity going forward. The CEO asserted that the senior staffer was going to be part of the team post-buyout. But when the team was in the room, the senior staffer seemed unusually quiet.
Pressing him over a cup of coffee, I learned that he in fact didn’t plan to stay but was put in a difficult position because of the CEO’s plans. Following that meeting, I asked the CEO to describe his team’s commitment, and shared the information from that conversation with the senior staffer. Although we were close to closing the investment, we passed on the opportunity based on the CEO’s lack of transparency.
The moral of the story is clear — lying, outright or by omission, doesn’t pay. Would we have invested in either company if the CEO had fully disclosed his past? Possibly. While there are issues that would certainly make us uncomfortable, hiding those issues guarantees we’re not going to pursue a relationship through investment. It’s one thing to have to explain a prior lapse in judgment, it’s quite another to demonstrate a present lack of judgment by hiding something that can be uncovered through research. So give your best pitch and tell a complete story, warts and all. Let the cards fall where they may. If you’ve got talent and a good opportunity, truth will serve you far better than fiction.
Incidentally, my business partner and I just launched a venture capital fund called Clear Venture Partners. We named it Clear to express our disposition toward transparency. So, go ahead... tell us anything.
Michael Gurau, Managing General Partner of Clear Venture Partners in Portland, can be reached at mg@clearvcs.com.
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