This post originally appeared on steveblank.com.
One of the biggest mistakes entrepreneurs make is not understanding the relationship they have with their investors. At times they confuse VCs with their friends.
Let's Go to Lunch
Rocket Science, my video game company, was struggling. Hubris, bad CEO decisions (mine), and a fundamental lack of understanding that we were in a “hits-based” entertainment business—not in a Silicon Valley technology company—were slowly killing us.
One day I got a call from my two investors, “Hey Steve, we’re both going to be up in San Francisco, let’s grab lunch.” I liked my two investors. I’d known them for years, they were smart, trying to figure out the video game market with me, (in hindsight a business that none of us knew anything about and shouldn’t have been in) coached me when needed, etc. Our board meetings were collegial and often fun.
We were just about to have a board meeting in another week to talk about raising another round of financing to keep our struggling disaster afloat. I had assumed that my VCs were behind me. Thinking we were having a social call, I was completely unprepared for the discussion. (Lesson—never take a VC meeting without knowing the agenda.)
“Steve, we thought we’d tell you this before the board meeting, but both our firms are going to pass on leading your next round.” I was speechless. I felt like I had just been kicked in the gut and stabbed in the back These were my lead investors. It was the ultimate vote of no confidence. If they passed the odds of anyone in the entire country funding us was zero.
I knew they had been questioning our ability to stay afloat as a company in the board meetings so this wasn’t a complete surprise but I would have expected some offer of a bridge loan or some sign of support. (I finally got them to agree if I could find someone else to lead the round they would put in a token amount to say they were still supportive.)
“Is this about me as the CEO?” I asked. “I’ll resign if you guys think you can hire someone else you want to back.” They looked a bit sheepish and replied, “No, it’s not you. You should stay and run the company. However, we realized that we’ve backed a business we don’t know much about, the company is a money sink and both our firms have no stomach for this industry.”
“But I thought you guys were my friends?! You’re supposed to support me!” I said out of utter frustration.
VCs Are Not Your Friends
I had just received a very expensive reminder. I liked my board members. They liked me. But while I was just seeing a single board member, I was just one of 20 companies in their current fund portfolio. Their fiduciary responsibility was to manage a portfolio of investments for their limited partners. And what they promised their own investors was that they would invest money in deals that would grow in value and achieve liquidity. As much as they liked me as the entrepreneur, they couldn’t throw good money after bad when they thought the deal went south.
I wish I could tell you I understood this all at the time. I didn’t. I was angry, took it personally for a long time (past the demise of Rocket Science) until I realized they were right.
While the best VCs treat entrepreneurs like you as their most important customer, and they add tremendous value to your startup (recruiting, strategy, coaching, connections, etc.) they are not doing it out of the goodness of their hearts. Understand that VCs are simply a sophisticated form of financial investors who in turn need to satisfy their own investors. At the end of the day VCs have to provide their limited partners with great returns or they aren’t going to be able to raise another fund.
If you succeed, so do they. Great VCs do everything they can to make you successful. But just like your bank, credit card company, mortgage holder, etc. they are not confused where their long term loyalty lies.
And it’s not with you.
The irony is 15 years later, no longer doing start-ups, these two VCs truly have become my friends. We have lunch often, teach together, and swap war stories of the day they pulled my funding.
It wasn’t an easy lesson.