Can VCs Add Value?

What entrepreneurs should consider when raising venture capital

Prompted by the recent discussion between Parker Conrad (co-founder and CEO of Rippling) and Parker Thompson (partner at SAX Capital) on how much "value-add" investors can offer founders, we offer our experiences on the topic.

The common process for founders to raise money includes scheduling pitches, answering VCs’ questions, driving to a decision, and then moving down the list of potential investors. A common mistake: founders look at VCs with only one objective—to raise funds. The better way: founders should think of a capital raise not just as a fundraising tool but as a strategic hiring process, or rather a strategic weapon if used appropriately.

How to Weaponize Fundraising?

At Marlinspike, we invest in dual-use technologies addressing national security and commercial use cases. It should not come as a surprise that we like to use military analogies. Fundraising is a weapon that provides an opportunity for founders to find the right partners, align economic incentives, and accelerate the development of their company. Fundraising strategies should be very similar to hiring strategies. Founders must identify areas where strategic help is needed and look for VCs with relevant experience and networks. Just like with the right executives, the right VCs can significantly accelerate the growth of the company.

Selecting VCs is one of the key strategic choices founders make; getting the cap table right is perhaps even more critical than hiring the right executive team. Executives can be (and often are) replaced, but VCs are a permanent fixture of the cap table, whether they add value or not. Founders should use the fundraising process as a two-way street and learn about the VCs and how their resources can be strategically leveraged to assist the company. Founders should not shy away from sharing their strategic plans and expectations for the cap table investors. The right VC should be able to articulate how/where they can be helpful. Asking detailed questions and scheduling calls with the VCs’ connections should be a part of the process. Each fundraising is an opportunity to strengthen the company—do not just raise funds for funding’s sake, but rather raise funds with a strategic purpose in mind.

Strategic VCs generally understand the benefits they bring to the table, and founders should not be surprised if the terms offered are not the most aggressive. In the long run, it is always beneficial to find the right partners, even if this means initially accepting a lower valuation. Getting the cap table right can sometimes make the difference between success and failure. While non-strategic VCs might offer a higher valuation, founders should always think a few steps ahead and consider what risks need to be mitigated for the next fundraise to be successful. Good VCs will be able to advise founders on striking the right balance between capital raised and valuation. Raising more money at a higher valuation increases expectations of what founders need to achieve before the next funding round. At the same time, raising less money at a lower valuation risks founders turning into investment bankers—constantly pitching investors to raise more money and neglecting other aspects of running a business.

Post-Investment

Post-investment, founders should leverage the connections and advice that their VCs have to offer. Some of the most successful founders we have worked with are constantly asking all their VCs for advice, introductions to partners, other VCs, subject matter experts, etc. They are using all available tools at their disposal to accelerate the growth of their company. The right VCs welcome such a symbiotic relationship and are happy to assist.

Tapping into VCs’ relationships can help accelerate the sales process with clients. VCs’ brands and connections can assist with recruiting higher-caliber executives. While history does not usually repeat itself, it often rhymes; having VCs who have experienced success/failure, economic growth/downturn, and management issues can offer new founders useful and prescient counsel.

Stage Matters

Companies in different stages need different types of accelerators. Companies in the early stage need more help thinking through their go-to-market strategies, product-market fit, and business models. However, 90% of that work should be done by founders. VCs can support by offering advice—what has worked in the past, offering introductions to potential early adopters, and/or introductions to other founders who have wrestled with similar problems.

Once a company is generating and growing revenues, the value added by VCs needs to shift towards other aspects—assisting with fundraising to maintain growth, preparing the company for an M&A, or IPO. Investors funding those companies have different skill sets and networks. Those late-stage investors are more generalist in nature, and their value added should reflect their expertise in capital markets.

Common Mistakes

VCs are in the business of delivering returns for their LPs. When deciding on a term sheet, founders should consider the size of the raise and the overall size of the VC’s fund. One question not asked enough by founders: “What’s your fund construction strategy?” Fund deployment strategies differ; size matters. It is not uncommon for larger funds to make lots of small “toe-hold” investments with expectations to deploy larger amounts in later rounds. Smaller funds must be more prudent; each investment is more consequential—the portfolio is smaller, and most of the consequential checks for the fund are written in the early stages. Larger funds cannot afford to miss the next unicorn—they need to deploy hundreds of millions, with the majority of capital being deployed in later stages. These different deployment strategies lead to different approaches to working with companies. Smaller funds engage early and over time become less relevant as new investors join the cap table. For larger funds, it is the exact opposite; small toe-hold positions are not important, but as invested capital increases, the importance of a company increases and funds become more involved.

Much like hiring, founders need to be realistic about their roles and the roles of VCs. Expecting VCs to start acting like an outsourced business development team is not realistic; VCs are accelerators who can compress a process that might take nine months into a few weeks. VCs cannot, and should not, be expected to grow a company’s revenues. Accelerators are an interim solution; eventually, the company needs to stand on its own and have internal resources to develop new relationships, scale sales, and make strategic decisions.

Parting Thoughts

At the end of the day, VCs can be a tremendous strategic weapon, but weapons on their own cannot set strategic goals and win wars. For that, we need military commanders and an army of soldiers. While getting the right VC to invest can help drive the company toward success, founders must recognize that an investment in every start-up is, in the end, a bet on the management and not on its cap table.