The New War Between VCs and Entrepreneurs
Patience
has never been a virtue for the investing crowd. But now they're really itchy
for growth and returns at a time when startups should be sticking to their
knitting.
BY HOWARD
TULLMAN, GENERAL MANAGING PARTNER, G2T3V AND CHICAGO HIGH TECH
INVESTORS@TULLMAN
Two of the most interesting post-pandemic
issues for the entrepreneurs running venture-backed businesses -- which have
basically been on an involuntary hold for the last year or two -- are pace and
story, and the conflicting attitudes toward each in the board room. Both are
already topics of painful and somewhat heated discussions in meetings everywhere,
pitting the impatient VCs against management teams. The VCs are all about IRR.
Every investment they make is "on the clock" and their investors
are always watching, waiting and wondering about how quickly and how much a
given fund will return. They're all in for pushing the pace of everything
forward as quickly as possible. Meanwhile, the far more conservative and
cautious management teams are still somewhat traumatized and only now starting
to recover from the shock of seeing their businesses abruptly shut down. These
managers are also realizing that their years of pain, sacrifice and stress were
almost lost forever.
In a curious but completely understandable
role reversal, even the careful and diligent venture investors are pushing to
go all out and bet the farm in order to make up for the two calculation years
that their funds lost while the world stood still, while the "crazy"
aggressive entrepreneurs are all about rebuilding slowly and sensibly. They're
trying mightily to hire back enough people to get the job done because - having
come so close to the edge - they don't really care to risk the ranch and end up
with nothing when they've spent years to build a perfectly solid business.
Doing it right is a lot more appealing right
now to most entrepreneurs than doing it fast. As Hunter Thompson said long ago,
"there's no honest way to describe the edge because the only people who
really know where it is are the ones who have gone over." For the VC
investors (with one eye always on their exit), it's ultimately just about the
bucks and usually it's someone else's money at risk anyway. But for the
entrepreneurs who are planning to be in the business for the long haul, it's
much more a matter of life and death. They've got families to feed, teams to
employ, and customers to properly serve and support as well. For many of them,
having gotten a glimpse of what success could look like and a glimpse of some
light at the end of a long, dark tunnel, the last thing that comes to mind is
doubling down and jumping back into the deep end so they can start swimming for
their lives and livelihoods again.
And, as if the constant pressure to pick up the pace and grow to the sky isn't enough, the problem the investors have with the company's "story" is the ugly second shoe that's also waiting to drop. Consistent and improving execution on the tried-and-true business that got the business here in the first place simply isn't exciting enough for impatient investors looking to jump on the newest, hottest stories and chase the next shiny object.00:43
Because they've rarely been on the front lines
themselves getting their hands dirty with the day-to-day operations, they just
don't appreciate what every successful entrepreneur knows. After spending years
breaking down barriers and walking through concrete layers of naysayers,
entrepreneurs finally get the in-place inertia and the accumulated
institutional momentum to finally start to work for them. Familiarity in these
cases doesn't breed contempt; it breeds important levels of comfort and
continuity. Being the incumbent provider is a great place to be. The
entrepreneurs are no longer the new "disruptive" kids on the block,
they're more productive and additive partners to the customers who vouched for
them early on. Shared success and bragging rights are important currency for
lots of corporate decisionmakers who are always looking over their shoulder as
more and more old-line organizations eliminate entire levels of middle and
senior managers.
Scaling business from inside the walls becomes
dramatically easier and faster and - especially when you're talking about
having successfully penetrated industry-leading customers in oligopolistic
markets. That's when the flywheel effect of focusing on growing the volume of
transactions, increasing the number of regions, serving more divisions and
units within the customer's organization kicks in . The doors your in-house
sponsors and champions can now open for you means that the upside opportunities
are virtually unlimited given the ultimately achievable total addressable
market size and the customers' clear and substantial overall requirements
for your products and services. In the service industry, this might take shape
in the form of turning pilot programs and trial offerings limited to certain
geographies into fully integrated and companywide sales that represent huge
multiples in terms transactions, revenues and end users served.
The very last thing any smart entrepreneur
wants to do - once he or she is inside the tent - is to confuse the issues or
distract anyone from growing the basic business. You can't be diverting scarce
people and resources away from seizing the moment and capturing all of the
available revenue embedded within major clients and customers. Having them
conclude that you're too small to handle all their business or not up to the
task is a virtual death sentence and an open invitation to your competition.
Worse yet, chasing new markets, rolling out
new offerings when you've got the prospect of too much rapid growth on your
plate, or otherwise taking your eyes off the main chance (and the low hanging
and very sizable fruit) is a bad approach and a bad message for your loyal
customers. Successful startups that eventually stumble and fail do so far more
often because of indigestion than starvation. Too much, too soon - an
embarrassment of riches.
Your best and biggest customers, unlike some
of your investors, don't want you chasing the next great thing. They want you
heads-down, focused, and taking care of their business. The future can take
care of itself for now - especially when it's distant, risky, and likely to be
diminished for quite a while. Even readily available and adjacent opportunities aren't
anything your direct customers want to hear about for now.
But the investors think this kind of deepening
customer and market penetration, comprehensive integration and growing
interdependence is old and tired news - just more of the same - and not
entitled to the kind of exciting multiples they see being applied to other
businesses in other industries. To them, it's not the short path to a
successful exit or acquisition that they're now looking desperately for because
they gave up two years of development and new growth to Covid-19. They hear all
about software eating the world and the dominance of the cloud and want to have
their portfolio companies chase that rainbow and forget about the old and
boring business as usual.
They don't understand that these massive
customer enterprises are perfectly happy to farm out various support services
to third parties, and, in fact, increasingly excited to do so as they seek to
turn their personnel costs more and more into variable rather than fixed expenses.
Insurance companies these days are perfect examples of institutional customers
happy to have other companies use their personnel to provide marketing data,
customer surveys, inspection services, call center support, field appraisals,
etc.
But big conservative outfits like insurers are
insanely protective and hidebound when it comes to replacing decades of old
enterprise level code with new software solutions, which are often untested at
scale. For new businesses competing in oligopolistic markets, the service bird
in the hand and a growing connection to a few of the key players is worth far
more to the business in the near term than the distant prospect of convincing
the giants to fundamentally change their entire operating system and adopt a
SaaS or similar approach provided by an outside firm.
The investors might be right in the long run
but asking a young company to make dramatic shifts in their base strategy -
moving from efficiently providing important services to developing and
providing enterprise-essential software - risks throwing the baby out with the
bathwater and simply hoping for the best down the line. It worked many years
ago for Netflix to basically bag the basic disk delivery business and shift to
streaming, but - even there - it was touch and go for several years along with
some fairly embarrassing stumbles like Qwickster.
The smart money in tough, troubled and
uncertain times is to stick with the guys who got you to the dance in the first
place. Investors who aren't happy with management's plans and strategies, and
especially with the early numbers, results and growing post-pandemic demand for
the business's basic services, should give some serious thought to taking their
chips off the table and heading off to find the next fantasy story or meme
stock.
JAN 25, 2022