Startups are often put under the microscope when they go belly-up. The press is quick to do the forensics on what went wrong. What about the investors who put in the money? Where’s the scrutiny there? We’ve seen the bar raised for founders, but what about that other side of the table?

“Here’s the problem: this entire system optimizes for investor survival, not startup success,” said Paul O’Brien in a LinkedIn post. “A 90% startup failure rate? That’s not an inevitability…But no one in venture has an incentive to change. The funds get raised, the 2% management fees roll in, and the game continues. If investors actually cared about optimizing startup success, they’d be applying First Principles thinking, not just playing the same old VC lottery. They’d be using frameworks like the Bell Mason Diagnostic, which systematically assesses startups based on real, stage-appropriate criteria, rather than some partner’s gut feeling on whether the founder has “the right energy.”

“But most firms don’t do this because, why fix a system that already benefits them?

“Joe Milam bluntly illuminates. ““The venture industry seems to have avoided any steps to establish itself as a proper profession. There is no training required to become a VC, no ‘best practices’ to study, no oversight of the bad actors. There are no barriers of entry to become a GP of a fund. Even hairdressers have to go to school to become licensed beauticians.’ ‘This absence of standards – First Principles of Venture Investing – is the root cause of the many symptoms that represent what’s wrong with venture investing today.”

Many investors are founders who’ve had successful exits. There are advantages to working with those who’ve spent time on both sides of the table and understand the founders’ journey and frustrations.

Then there are corporates with an investment arm. They’re at least somewhat in sync with a startup working on a tech that might align with the corporate mission, and potentially see the value add.

There are also those investors whom we’ll call ‘right time, right place,’ who were part of a company that had a considerable exit, private or public, who find themselves flush with cash, who might not necessarily have been in the C Suite of said successful company, but money is money, right?

Wrong.

We’ve noticed something else in investing and this is a heads up to founders. The VC model may be broken, as we often hear. There are also investors out there who are out to break the founders themselves.

We heard from a reader who was offered terms by an investor. But when it came to the final call before term sheets were sent, the investor said he’d put in the money necessary to complete the build, and once that was done, the rest of the funds would be made available. BUT, the investor would take a majority share of the company, move the IP and assets into a new entity where that money would be deployed, and the founding team would become minority shareholders in the new entity. A new CEO would be chosen, by the investor, to run the newco.

Note to self: the founding team had bootstrapped and had put much more money into the company than what the investor offered for the ‘completion round.’ The offer was refused. That’s not negotiating in good faith. That’s just unbridled greed and theft.

While that might have been something of an outlier, we heard from another reader who’d been offered terms, again, switched at the last minute to terms similar to those offered our other reader. That was a ‘huh???’

When we heard a similar story from a third reader, well, to paraphrase Voltaire, once is an experiment, twice is a perversion. In the case of this new breed of investors, one is an outlier, two in a curiosity, three is a pattern.

There’s always negotiations involved when dealing with investors. That’s how it goes and all well and good, as long as all parties are negotiating in good faith and therein lies the rub. This was not the case with Co #1, where the company’s tech dovetailed nicely with one of the investor’s existing portfolio companies, so why not ‘appropriate’ it on the cheap, or at least try. All did work out with Co #2, where the investors saw the value of keeping the founder in place as well as the potential of the technology itself. As for Co #3, they’re still going through the Dance of the Seven Veils.

So, heads up, founders: alignment is important.

As are ethics.

But we do wonder if one of the reasons why startups fail, which we never see mentioned on any of those Top Ten Reasons lists is improper alignment with the investors. So, when you’re meeting with investors, you need to ask questions of them, too, founders. This relationship will go on throughout the life of your company. In other words, meet your new business partners. Choose wisely. And keep in mind that the investors aren’t necessarily the smartest guys in the room, so also choose carefully.

Speaking of which, “One of Sequoia’s most prominent investors, managing partner Roelof Botha, sees signs of another greed cycle brewing in venture capital, one where the least sophisticated investors will likely get most hurt,” TechCrunch reported.

“He posted a warning on X, writing, “We remain destined to repeat the mistakes of the past! SPVs are making a come-back, where the lead investor speaks for less than 10% of the capital, yet eagerly lines up the latest set of tourist chumps who think the story will end differently this time.”

Which is Einstein’s definition of insanity: doing the same thing over and over and expecting different results.

Yes, the VC model is broken and as Paul O’Brien observed, investors get their management fees whether they’re deploying the money wisely or not, and speaking of beauticians requiring training, when it comes to investors, it does come out in the wash, re raising their own next round of funding. It’s often noted that investors run lemming like to the Next Shiny New Thing, these days AI being a case in point.

Not all of those AI companies receiving insane amounts of investment will make it. Again, it all comes out in the wash, so the question founders must also consider is: does the investor deploy money wisely overall re will they have dry powder left in the fund, when and should you need an infusion of funding down the road? The last thing you need on your cap table is a fund that hasn’t had successful exits, hasn’t had experience in investing and doesn’t consider First Principles. In other words, a fund without gravitas when it comes to the process. Otherwise, you’re looking at a fund that’s taking a stab at investing – and more or less doing little more than running with scissors. Onward and forward.

 

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