Roger Ehrenberg of IA Ventures has a thoughtful post up today about VCs adding value to their portfolio companies. Firstly he talks about the importance for a VC to know in their own minds whether they are a firm that seeks to make money by clever stock picking alone, or through a combination of picking the right companies and adding value post investment (we at DFJ Esprit are in the latter camp):
If I view venture investing as an exercise in asset allocation, e.g., if I assume I can’t add real value beyond my dollar investment, and therefore focus 100% of my efforts on investment selection and portfolio diversification, this would create one type of portfolio. Conversely, if I view myself as being able to have a material positive effect on my portfolio companies, then I’m less concerned with diversification and more focused on creating opportunities to build concentrated positions in companies with high expected returns. Either can be a rewarding path, but I think it is really important to know who you are
His killer point comes towards the end of the post when he notes that if you are a value add investor then you should only be investing in entrepreneurs that want your help, and you should therefore have a thorough discussion prior to investment about how the relationship will work and the value will be added. Otherwise there is a potential mismatch in expectations between the two sides which could cause tension in the relationship. The most common source of tension comes when the investor works to add value but the entrepreneur doesn’t see the benefit, leaving the investor feeling like they have wasted their time and maybe that the entrepreneur is missing a trick, whilst the entrepreneur starts resenting the investor for wasting the company’s time. This dynamic is so common that it isn’t funny.
The answer, clearly, is to align expectations, but that is easier said than done. Having an open and honest dialogue prior to investment about what assistance is needed can be tough though as both parties are in sales mode. The company is trying to show itself in the best light whilst the investor is typically focused on building a positive working relationship with the entrepreneur and getting the deal closed rather than building the best platform for working together afterwards. I think (hope) that I get a little better at this with every deal that I do, but it isn’t easy, and I don’t think I’ve got it nailed yet.