VC Cliche of the Week

Venture Capital is supposed to be patient capital, willing
to support an entrepreneur for a long period of time while he or she builds the
business. In general, I have found this
to be true of VCs, although there are clearly some in the business who can and
should work on their capacity for patience.

But even the most patient investors can get tired of
supporting an investment. This is called
“deal fatigue”. I have seen deal
fatigue, I have experienced it myself, and I think it’s an important emotion
for VCs and entrepreneurs to recognize and understand. 

The typical life cycle of a venture deal is five to seven
years. I have seen deals that have taken
longer than that. At Euclid Partners, we
had portfolio companies that were double digits in terms of years held. That is patience!

But beyond the years held, there is another factor that I
believe is more important in the deal fatigue equation. 

J_curveEveryone has heard of the J-curve. It is used to describe returns in
a venture fund. They are negative in the
early years, get positive in year 3 or 4, and then grow from there.

That J curve can also be drawn to show the typical annual
cash flows of a startup company. They
are negative for two to four years, turn positive, and grow from there, thereby
creating value for the entrepreneurs, operators, and investors. During the early years, the VCs support the
company with capital infusions, thereby acquiring their ownership stake. 

FlatlineBut sometimes the J-curve flatlines. It doesn’t turn positive.

In the simplest case, the patient dies. That’s usually good for everyone
involved. The company didn’t get
customers, revenues, and build a business. 

But it’s rarely that simple. Some companies get customers, revenues, create value, but don’t get cash
flow positive. They end up on life
support and nobody wants to pull the plug for good reason. This is by far the
most common cause of deal fatigue.

It’s important to get inside the head of the investor for a
moment. Let’s take an investor who is
putting up his or her own cash. The
first time they write a check to invest in a startup they are excited about the
possibilities and are eager to make the investment. When the Company comes back for another
investment, the investor often continues to be excited by the possibilities and
eagerly opens the wallet. But a second
emotion starts to creep in and that is obligation. After that, every time the wallet opens, the
excitement dims and the obligation increases. It’s just human nature. 

Now, let’s add to that simple investor emotion equation the
notion of investing other people’s money in a partnership structure. The VC isn’t opening his or her wallet. They are asking their partners to authorize
the investment of other people’s money in the company. That is called “going back to the well” and
is another great VC cliché. Think about
the emotions for everyone involved in this exercise if it’s done time after
time.

So that’s deal fatigue. It’s driven more by money than time and it can be a very destructive emotion
in the board room if it is not managed properly. 

So what can an entrepreneur do to protect him and his company
from investor deal fatigue?

First, don’t let the J curve flatline. Get profitable in a reasonable period of time.
Two to three years is typical, five
years is too long. 

Second, bring new investors into the syndicate every time
you raise money. The investors who wrote
the checks in the A round might be tired by the E round, but the D round
investors will have fresh legs.

Third, start with a low valuation and slowly and carefully
build it in each investment. The
investors will be less tired if they see the value of their investment
increasing in each round. But if you
start at too high of a price and then get stuck there or worse, go down, then
you are in for trouble. There is nothing
worse than a tired investor with a paper loss on his or her hands. 

In summary, VCs as a group are the most supportive and
patient investors I have ever met, but they are investors and are subject to
the same emotions that all investors experience. There is not an unlimited supply of capital
and patience in a venture capital firm and entrepreneurs need to be acutely
aware of that fact if they choose to finance their company with venture
capital.