New Shoes

This isn't really a post about new shoes, I promise.  Remember, I live in the world of pattern matching and analogies.  But I did go running yesterday morning — my first run in a new pair of running shoes.  I usually get new running shoes every 3-6 months, depending on how much mileage I'm logging.  And I find the same thing every time:  I may not realize I'm uncomfortable running in the old shoes, but the minute I put the new ones on, I realize just how far the old ones had deteriorated and just how much better life is in the new ones.  Same model shoe – just a fresh pair.  And I run faster, stronger, and happier.

How much of your professional life works the same way?  I often find that small tweaks to renew and refresh existing processes, relationships, thought patterns, and work product make an enormous difference in the energy I bring to work, and in the quality of the work I do.  Last week, for example, I had two such events.

First, I went through and overhauled what I call my "operating system," which is really my fancy, David Allen-style to-do list.  I changed some categories and formatting, cleaned out some dead items, rethought some items, added some new ones.  And voila – I went from semi-ignoring the system to running my priorities by it once again.  And I've had my most productive week in a long time.

Second, I completely re-thought the dynamics of my relationship with someone on the team.  They had grown stale.  Check-in meetings weren't interesting or productive any more, just perfunctory.  Together we sat down and crafted a new way of working together, a new list of topics we were going to tackle together that added more value to the organization.  It was like a breath of fresh air.

We can't completely reinvent ourselves every time we need a career pick-me-up.  But we can remember that every few months, it's time to put on a fresh pair of running shoes and put some spring back in our steps.

Ten Characteristics of Great Investors

Fred had a great post today called Ten Characteristics of Great Companies.  This link includes the comments, which numbered over 70 when I last looked.  Great discussion overall, especially for Fred’s having come up with the list on a 15-minute subway ride.  Fred used to write a series of posts about VC Chiches, and I would periodically write a Counter-Chiche post from the entrepreneur’s perspective.  This post inspired me to do the same.

So I’ve taken 15 minutes here, pretended I’m on the subway, and here is my list of Ten Characteristics of Great Investors, in no particular order:

1. Great investors know how to give strategic advice without being in the operating weeds of a company
2. Great investors get to know whole management teams, not just CEOs — in fact, great investors become part of the extended management team of their portfolio companies
3. Great investors invite you to do diligence on them by giving you a list of every CEO they’ve ever worked with and asking you to pick the ones you want to talk to
4. Great investors ask great questions
5. Great investors don’t publicly take credit for the success of their investments, even if they were major drivers of that success
6. Great investors show up for meetings on time and don’t spend the meeting using their smartphone
7. Great investors treat their portfolio companies’ money as if it were their own money when spending it on things like lawyers or travel
8. Great investors look for connections to make between their portfolio companies or relevant people but have a strong relevance filter and don’t send junk
9. Great investors never have a ready-made list of the ways they add value to companies — and they specifically never talk about the help they give in recruiting executives or making sales/bus dev introductions
10. Great investors recognize when they have a conflict around a portfolio company and are clear to represent their separate points of view separately

I’m not sure I’ll be invited to present this anywhere, but there it is for discussion.

From Founder/Builder to Manager/Leader

After I spoke at the Startup2Startup event last month, one of the people who sat with me at dinner emailed me and asked:

I was curious–how did you make the transition from CEO of a startup to manager of a medium-sized business? I’m great at just doing the work myself and interacting with clients, and it’s easy for me to delegate tasks, but it’s hard to have the vision and ability to develop my two employees into greater capacity…

I’d be interested in reading a blog post on what helped you make that transition from founder/builder to manager/leader

It feels like the answer to this question is about a mile long, but I thought I’d at least start with five suggestions.

1. Hire Up!  The place where I see most founders fumble the transition is in not hiring the best people for the critical roles in the organization.  Sometimes this is for cash flow reasons, but more often it is either due to subconscious fear (“will I still be able to control the organization if this person is in it?”) or due to bravado (“I can do engineering way better than that guy”).  Lose that attitude and hire up for key positions.  Even if you COULD do every role better than anyone you’d ever hire, you only have so many hours in the day.
2. Learn the magic of delegation and empowerment.  You can never get as much work done on your own as you can if you get work done THROUGH others.  Get comfortable delegating work by setting clear expectations up front in terms of timing and quality of deliverables and giving your high level input.  And never be a bottleneck.  If people are waiting on you for decisions or comments, that means they’re not working…or at least that they’re not working on the highest value or most urgent things they could be working on.
3. Don’t fear some elements of larger organizations.  Larger organizations require some process so they don’t fall apart.  Make sure you pick your battles and accept that some changes, even if they feel bureaucratic, are critical to ensure success going forward.  I still get a queasy feeling in my stomach half of the times I see a new form or procedure or a suggestion from a lawyer, but as long as they are lightweight and constantly reviewed to make sure they’re having their intended impact AND ONLY their intended impact, some are inevitable.
4. At the same time, don’t lose the founder/builder mentality.  Your company may have grown larger, but if you’re still running it, people will naturally look to you and other founders for much of the energy, vision, and drive in the business.  You will also likely be more inclined to be scrappy and entrepreneurial, which are good traits for any business.  Don’t lose those qualities, even as you modify them or add others.
5. Look to the outside for help.  In my case, I’ve consistently done three things over the years to learn from others and to prevent myopia.  First, I have worked on and off with a fantastic executive coach, Marc Maltz from Triad Group. Second, I have always had one or two “CEO mentors,” e.g., guys who have built larger businesses than Return Path, on my Board, at all times, as resources.  Finally, I do a lot of CEO peer networking, some informal (breakfasts, drinks meetings), and some more formal (a CEO Forum group that I established) to make sure I’m consistently sharing information and best practices with others in comparable situations.

Any other entrepreneurs who have made the leap have other advice to offer?

Yiddish for Business

Contrary to popular belief, Yiddish isn’t “Jewish slang” (I hear that a lot).  According to Wikipedia, Yiddish is a basically a High Germanic language with Hebrew influence of Ashkenazi Jewish origin, spoken throughout the world. It developed as a fusion of German dialects with Hebrew, Aramaic, Slavic languages and traces of Romance languages.  It is written in the Hebrew alphabet.

I don’t speak Yiddish.  Like many American Jews whose families came to America in the late 19^th and early 20^th centuries, my grandparents spoke it somewhat, or at least had a ton of phrases they wove into everyday speech.  Presumably their parents spoke it fluently before coming here and Americanizing their families.  My own parents have a handful of stock phrases down.  My brother and I have even less.

What I like best about Yiddish is that I find it to be a very descriptive and also onomatopoetic language.  I can never verbally describe a Yiddish word without a lengthy description and some examples, and usually some level of gesticulation.  I’ll try to be more succinct below.  But in the end, words mean a lot like what they sound like they should mean.  A lot of New Yorkers who aren’t Jewish end up knowing a handful of Yiddish words because they’re pretty prevalent in the City, but many people outside New York don’t.  So I thought I’d have a little fun here and do something different on the 6^th anniversary of launching this blog (today) and list out some of my favorite Yiddish words and describe them with a business context.  In no particular order…

–          Schmooze – to chat someone up, work them, frequently with some kind of hidden agenda in mind.  Business application:  “She showed up at the charity event just to schmooze Alice, who was a potential client.”

–          Chutzpah – nerve, as in “wow, he has some nerve.”  My dad always said the classic description of chutzpah was the kid who murdered both of his parents, then pleaded with the judge for leniency because he’s an orphan.  Business application:  “He missed all his goals this quarter and asked for his full bonus and a raise?  Now that takes real chutzpah!”

–          Spiel (pronounced schpeel) – a monologue or lengthy pitch.  Business application:  “I’m raising money, so I have to really organize my spiel before I go talk to the VCs.”

–          Schtick – someone’s standard song-and-dance.  Business application:  “I stood up in front of the room and gave my usual schtick about our values and mission.”  Kind of like Spiel.

–          Schlep – to make a long, pain-in-the-ass kind of trip.  Business application:  “I had to schlep all the way to Toledo for a meeting with that guy, and he didn’t even end up signing the deal.”

–          Mazel tov – literally means “good luck” but usually used in regular conversation to mean “congratulations.”  Business application:  “You got a promotion?  Mazel tov!”

–          Noodge – someone who inserts himself into a conversation in a somewhat unwelcome manner.  Related to Kibbitz – to give unsolicited advice from the sidelines. Business application:  “Sally is such a noodge.  She kibbitzes about my unit’s strategy all the time and just stirs up trouble.”

–          Maven – an expert, even a self-styled one, in a very niche area.  Business application:  “You want to figure out what smartphone to  buy?  Ask Fred – he’s the maven.”

–          Kosher (a Hebrew word as well) – completely by the books, originally referring to dietary laws that religious Jews follow.  Business application:  “Ask Marketing if it’s kosher to use our partner’s logo like that.”

–          Verklempt – choked up, overcome.  Business application:  “When I got my review and promotion and raise, I was so verklempt that I couldn’t speak for a minute or two.”

–          Schlock, Dreck, Chazerai, Bupkis – all have slightly different literal meanings (apparently Bupkis means “goat droppings”), but I use all of them somewhat interchangeably to mean junk or something of limited or no value.  Business application:  “That presentation was nothing but chazerai.  What did I get out of it?  Bupkis.”

–          Kvell – to beam or burst with pride, related to Nachus – warm “gooey” feeling of pride.  Business application:  “I had so much nachus when my company won that award for being the best place to work, I was just kvelling.”

–          Mishegas or Bubbamyseh – craziness or self-imposed silliness.  You might have heard the word Meshugenah before, which means crazy.  Business application:  “I can’t get all caught up in his mishegas.  I’m going to make my own decision here.”

–          Kvetch – either a noun or verb meaning complain, in a harpy kind of way.  Business application:  “Frank is such a kvetch.  He is just never happy.”

–          Mensch – a good guy.  Business application:  “Michael is such a mensch.  He always helps his colleagues out even when he doesn’t have to or doesn’t get credit for it.”

–          Fercockt (pronounced Fuh-cocktah) – crazy, messy.  Business application:  “John’s project plan is totally fercockt.  No one can follow it even when he tries to explain it.”

–          Mishpochah – family.  Business application:  “Welcome to the company – we’re happy to have you in the mishpochah.”

–          Tsuris – heartache or sadness.  Business application:  “Boy that’s one client that gives me nothing but tsuris.”

–          Tchotchke (pronounced chach-kee) – a trinket or little toy.  Business application:  “What kinds of tchotchkes are we giving away at our booth at the upcoming trade show?”

Pull one of these out in your next meeting – see what it gets you!

Macroeconomics for Startups

I’m not an economist.  I don’t play one on TV.  In fact, I only took one Econ class at Princeton (taught by Ben Bernanke, no less), and I barely passed it.  In any case, while I’m not an economist, I do read The Economist, religiously at that, and I’ve been reading so much about macroeconomic policies and news the past 18 months that I feel like I finally have a decent rudimentary grip on the subject.  But still, the subject doesn’t always translate as well to the average entrepreneur as microeconomics does – most business people have good intuitive understandings of supply, demand, and pricing.  But who knows what monetary policy is and why they should care?

So here’s my quick & dirty cut at Macroeconomics for Startups.  What do some of the buzzwords you read about in the news mean to you?

· Productivity Gains – This is something frequently cited as critical to developed economies like ours in the US.  Here’s my basic example over the past 10 years.  When I left my job at MovieFone in 1999, there were approximately eight administrative assistants in a company of 200 people – one for each senior person.  Today, Return Path has less than one administrative assistant in a company of the same size.  We all have access to more tools to self-manage productivity than we used to.  Cloud computing is another great example here of how companies are doing more with less. We have tons of software applications we use at Return Path, none of which require internal system administration, from Salesforce.com for CRM to Intacct for accounting. Ten years ago, each would have required dedicated hardware and operational maintenance.

· Fiscal Policy vs. Monetary Policy –  Fiscal Policy is manipulating the economy through government taxing and spending.  Monetary Policy is manipulating the economy by controlling interest rates and money supply.  For a small company that has revenue and accounts receivable, you probably are more inclined to Monetary Policy as it has more to do with your ability to access debt capital from banks through credit lines.  But if you’re in an industry where government grants or support is critical, Fiscal Policy can mean more to you in the short run.  Of course, if you’re losing money as many startups are, business tax credits and the like aren’t so relevant.

· Inflation – As my high school econ teacher defined it, “too many dollars chasing too few goods.”  Inflation may seem like a neutral thing for a business – your costs may be going up, but your revenue should be going up as well, right?  And we can inflate our way out of debt by simply devaluing our currency, right?  The main problem with inflation is that too much of it discourages investment and savings, which has negative long term consequences.  To you, rapid inflation would mean that the money you raise today is worth a lot less in a year or two.  That said, inflation is certainly better than Deflation, which can paralyze an economy.  Think about it like this – if you’re in a deflationary environment, why would you spend money today if you think prices will be lower tomorrow?

· Strong Dollar, Weak Dollar – Sounds like one of those things that’s politically explosive…of course we all want a strong dollar, right?  Why have a mental image of Uncle Sam that’s anything other than muscular?  And yes, it’s a lot more fun to travel to Europe when a latte costs you $4, not $8.  But the reality is that a strong dollar doesn’t necessarily serve all our interests well.  For a startup, sure, you can buy an offshore development team in India for less money than a development team in Silicon Valley, and for a more established company it makes it much cheaper to try and expand to Europe and Asia.  But an artificially strong dollar means that few people outside the US can afford to buy your product or service.  This is related to…

· Trade Surplus/Deficit and Exchange Rates – The net of a given country’s exports minus imports, and how much one currency is worth in terms of the other.  There’s been much talk lately about whether and how much China is manipulating its currency and holding it down, and if so, what impact that has on the global economy.  Why should you care?  If China is articifically keeping the value of the yuan down, it just means that the Chinese people can’t afford to buy as much stuff from other countries – and that other countries have an artificial incentive to buy things from China.  If the Chinese government allowed the yuan to appreciate more, the exchange rate vs. the dollar would rise, and your product or service would find itself with a lot more likely buyers in the sea of 1.3B people that is China.

I’m sure there are other terms of note and startup applications, but these are a handful that leap to mind.

Counter Cliche:  I Know When I See One, Too

I haven’t written a counter to one of Fred’s VC Cliche’s of the Week for a while now, but today’s was too good to resist.  While I haven’t (and most entrepreneurs haven’t) worked with 200 VCs, I have seen, heard about, been one (sort of), and worked with enough of them to know enough to comment as follows:  as is the case with Fred and entrepreneurs, I’m not sure I can define what makes a great VC in one phrase, but I know one when I see one, and here are some of the characteristics they exhibit:

– Major pattern recognition — "I’ve seen this movie before, and I know how it ends…";
– Deep understanding of the market and/or customer set to add strategic value;
– Fundamental desire to be a product manager or marketing manager of your product, but also —
– Ability to stay out of the weeds with day-to-day details when the Board meeting ends;
– Always ready with a story or bon mot about other crazy investors or even crazier entrepreneurs to make you feel better about your own life;
– Complete transparency about the motives of his/her fellow GPs and LPs and ability/appetite for follow-on financings (and needless to say, no/limited blocking of transactions that are clearly in the company’s best interests but might run counter to his/her firm’s own short-term interests);
– Willingness to jump into a debate with the strongest of convictions, yet without 100% of the facts, since 100% of the facts are never available;
– Equal willingness to admit being wrong if a clear and compelling argument comes forth; and of course the most critical —
– No fear of yielding to Management when Management knows best!
– Note — note included — major rolodex (a nice to have, but not required)

The other part of the counter cliche is that I’m sure there are some great entrepreneurs who only exhibit a few of Fred’s list of traits…much as I’m sure there are some great VCs who only exhibit a few of my list above.

Book Short:  Required Reading

The Leadership Pipeline, by Ram Charan, Stephen Drotter, and James Noel, should be required reading for any manager at any level in any organization, although it’s most critical for CEOs, heads of HR, and first-time managers.  Just ask my Leaderhip Team at Return Path, all of whom just had to read the book and join in a discussion of it!

The book is easy to read, and it’s a great hands-on playbook for dealing with what the authors call the six leadersihp passages:

From Individual Contributor to Manager (shift from doing work to getting work done through others)

From Manager to Manager of Managers (shift to pure management, think beyond the function)

From Manager of Managers to Functional Manager (manage outside your own experience)

From Functional Manager to Business Manager (integrate functions, shift to profit and longer term views)

From Business Manager to Group Manager (holistic leadership, portfolio strategies, value success of others)

From Group Manager to Enterprise Manager (outward looking, handle external and multiple constituencies, balance strategic and visionary long-term thinking with the need to deliver short-term operating results)

All too often, especially in rapidly growing companies, we promote people and move them around without giving enough attention to the critical success factors involved in each new level of management.  I’ve certainly been guilty of that at Return Path over the years as well.  It’s just too easy to get trapped in the velocity of a startup someitmes to forget these steps and how different each one is.  This book lays out the steps very neatly.

It’s also one of the few business books that at least makes an attempt — and a good one at that — at adapting its model to small companies.  In this case, the authors note that the top three rungs of the pipeline are often combined in the role of CEO, and that Manager of Managers is often combined with Functional Managers.

Anyway, run, don’t walk, to buy this one!

You Have to Throw a Stone to Get the Pond to Ripple

This is a post about productive disruption.  The title comes from one of my favorite lines from a song by Squeeze, Slap & Tickle.  But the concept is an important one for leaders at all levels, especially as businesses mature.

Founders and CEOs of early stage companies don’t disrupt the flow of the business.  Most of the time, they ARE the flow of the business.  They dominate the way everything works by definition — product development, major prospect calls, client dialog, strategy, and changes in strategy.  But as businesses get out of the startup phase and into the “growth” phase (I’m still trying to figure out what to call the phase Return Path is in right now), the founders and CEO should become less dominant.  The best way to scale a business is by not being Command Central any longer – to build an organization capable of running without you in many cases.

Organizations that get larger seek stability, and to some extent, they thrive on it.  The kinds of people you hire into a larger company aren’t accustomed to or prepared for the radical swings you get in startups.  And the business itself has needs specifically around a lack of change.  Core systems have to work flawlessly.  Changes to those systems have to go off without a hitch.  Clients need to be served and prospects need to be sold on existing products.  The world needs to understand your company’s positioning and value proposition clearly — and that can’t be the case if it’s changing all of the time.  Of course innovation is required, both within the core and outside of it, but the tensions there can be balanced out with the strengths of having a stable and profitable core (see my colleague George Bilbrey’s guest post on OnlyOnce a couple months back for more discussion on this point).

Despite all of this required stability, I think the art of being a leader in a growth organization is knowing when and how to throw that stone and get the pond to ripple — that is, when to be not just disruptive, but productively disruptive.

If done the right way, disruption from the top can be incredibly helpful and energizing to a company.  If done the wrong way, it can be distracting and demotivating.  I’ve been in environments where the latter is true, and it’s not fun.  I think the trick is to figure out how to blaze a new trail without torching what’s in place, which means forcing yourself to exercise a lot of judgment about who you disrupt, and when, and how (specifically, how you communicate what it is you’re doing and saying — see this recent post entitled “Try It On For Size” for a series of related thoughts).

Here are a few ideas for things that I’d consider productive disruption.  We’ve done some or shades of some of them at Return Path over the years.

• Challenge everyone in the organization or everyone on your team to make a “stop doing” list, which forces people to critically evaluate all their ordinary processes and tasks and meetings and understand which ones are outdated, and therefore a waste of time
• With the knowledge and buy-in of the group head, kick off an offsite meeting for a team other than the executive team by presenting them with your vision for the company three years down the road and ask them to come back to you in a week with four ideas of how they can help achieve that vision over time
• If you see something going on in the organization that rubs you the wrong way, stop it and challenge it.  Do it politely (e.g., pull key people aside if need be), but ask why it’s going on, how it relates to the company’s mission or values as the case may be.  It’s ok to put people on the defensive periodically, as long as you’re asking them questions more than advocating your own position

I’m not saying we have it all figured out.  I have no doubt that my disruption is a major annoyance sometimes to people in the organization, and especially to people to report to me.  And I’ll try to perfect the art of being productive in my disruption.  But I won’t stop doing it — I believe it’s one of the engines of forward progress in the organization.

Why is Seth Godin so Grumpy?

Permission marketing guru Seth Godin says we should all Beware the CEO blog. His logic? Blogs should have six characteristics: Candor, Urgency, Timeliness, Pithiness, Controversy, and maybe Utility — and apparently in his book, CEOs don’t possess those characteristics.

Certainly, CEOs who view blogs as a promotional tool are wasting their time, or are at least missing a fundamental understanding about the power of blogs and interactivity.

But many of the ones I read (and the one I write) do their best to be anything but promotional. One of my colleagues here describes my blog as “a peek inside the CEO’s head,” which is a great way of putting it. And I still stand by my earlier posting about the value of the blog to me and to the company — hardly “annual report fluff.”

How’s that for honest, timely, controversial, and pithy, Seth?

That’s not just the title of a mediocre 1980’s sitcom starring Tony Danza, it’s a question I get periodically, including last week in an interview. A writer I know is working on an article on entrepreneurship and asked me, “Before you started your own business, how did you like working for other people?”

The question made me think a little bit. I know what she was asking — how I liked being the boss instead of working for one — but the way she phrased it is interesting and revealing about what it’s like to be a CEO. One of the biggest differences between being in a company and starting or running one is that you’re not working for a person, you’re working for many people.

As CEO of the company, I work for a Board and shareholders, I work for our customers, and I work for our employees. That’s how I approach the job, anyway.

Return Path’s Board of Directors is my boss, even though I’m one of the people on it. I report to the Board, and the Board is responsible for hiring and (hopefully not) firing the CEO, so technically, that’s my boss. The Board is also made up (for small private companies, anyway) of representatives of our biggest shareholders. As the main owners of the business, they are concerned with the growth, profitability, and overall health of the company, and they want to make sure we are building shareholder value day in, day out. That’s one very important perspective for me to have every day.

But I also work for our customers. I have to see myself as serving them — and more important, I have to steer the organization to believe that our customers are at the top of our food chain. If I do, then things will go well in the business. We will have the right products in the market at the right time to bring in new accounts. We will have a tremendous service delivery organization that wows customers and keeps them coming back for more. We will beat out our competition any day of the week. We will keep people paying our bills!

Most important, though, I work for our employees. This is very simple. An organization thrives because the people who make it up come to work inspired, focused, and productive. When they don’t, it doesn’t. I can’t wave a wand and make everyone happy all the time, but I try to focus a significant part of my time on making sure this is a great work environment; that the managers and executives are religiously focused on developing, managing, and motivating their teams; and that we’re doing a good job of communicating our mission, our values, and why each person’s job is important to the cause. This one’s the hardest of the three to get right, but it’s worth the effort.

Certainly, I don’t respond to each of my “bosses” every day as I would a direct supervisor, but in the long haul, I have to balance out the needs and interests of all three constituencies in order to have the organization be successful.

More thoughts on some of Fred’s and Brad’s points about VC deal algebra, valuation, and liquidation preferences for venture-funded startups. My apologies if this gets a little too technical or too long!

On liquidation preference: Preferred stock makes sense, participating preferred makes less sense. Sure, a VC who puts capital at risk in a startup should be entitled to get his or her money out before management and common shareholders who are paid to run the business. But I’ve always had an issue (even when I was in the venture business, although admittedly not as a partner) with the participating preferred security which allows VCs to get their money out first, and then still receive their proportional share of the rest. Fred calls this “a loan with an option,” and that’s the best presentation I’ve ever heard of the security. But what’s always struck me as a bit over the top about this is that it gives VCs downside protection at the same time they’re negotiating even more upside in a deal.

One simple solution to this, if you can negotiate it, is a “kickout” provision which makes the participation feature on the security go away if the company becomes worth a multiple (usually 2x or 3x) of the post-money valuation of the financing. In other words, it gives the VC the downside protection they want but gives you and other shareholders more of the upside if things go really, really well.

On valuation and deal algebra: I completely agree that valuation is a derived number and that it’s completely misunderstood in early stage investing. However, I think that while there may be low correlation between valuation and what the business is worth today, there are a few things that have always bugged me about VC valuations:

While I understand that valuation is more a function of future potential than current value, it sometimes feels like companies get punished for having a track record. Let me clear about my point – it’s not that that I actually think VCs lower valuations unfairly when companies demonstrate poor results. It’s actually the opposite. VCs are quick to bid up the valuation on companies that don’t have revenue or even a lot of operations just because the idea is cool or because the theoretical market is large (Friendster, anyone?). I don’t think VCs as a group do a good enough job of risk-adjusting or future-competition-adjusting valuations for new companies, or they get caught up in what Fred once called Venture Fratricide and just pour money into new sectors en masse. This has the unintended side effect of making management teams of existing companies feel like their ideas aren’t interesting any more because they’re not new and shiny.

Second, it’s interesting to note that while VCs use valuation as a way of placing limits and getting protection on their bet about the future potential of the company and entrepreneur, entrepreneurs have no corresponding mechanism to place limits or receive protection against having a bad VC. (VCs actually have many tools at their disposal to reign in poorly performing management teams once the deal is signed – they can fire them, cram them down, force all their common stock to be on a vesting schedule or subject to clawback.) But make no mistake about it – a bad VC can almost kill a company, or certainly keep it from realizing its full potential, and once that deal is signed, the entrepreneur typically has little recourse. I’m not sure there’s an easy solution to this particular problem either, but it’s one that’s worth thinking through with a good lawyer the next time you negotiate a term sheet with a new venture investor (and certainly one that is easier to negotiate if you either have a good track record as an entrepreneur or multiple VCs interested in your company). I made one suggestion around participation in future financings in my earlier posting on term sheet negotiations — item #8.

The final thing that’s bugged me about valuations stems from what Fred calls the 1/3 rule (1/3 of a VC’s investments work out well, 1/3 go sideways, 1/3 go bad). As a result of the rule, valuations and deal structures can end up being about VCs getting as much upside as possible out of their winning deals to cover their losses from their zero-return deals. What bugs me about this is that entrepreneurs don’t have that same luxury of a diversified portfolio – they are 100% invested in terms of their human capital and often their investment capital in their company. I fully realize that this is the nature of the beast, but I’ve always felt as a result that entrepreneurs should negotiate – and VCs should be willing to give – proportionally much more upside to management in the event that the deal turns out to be a big winner. This point relates back to my first point about participating preferred securities.

Next up in this series…Reverse Engineering Venture Economics, and managing other kinds of investors (Angel and Strategic).