Good VCs optimize for upside, bad ones for downside

Konstantin shared a great Quora answer by Mike Maples of Floodgate with me yesterday evening. I was thinking about it for a while as Mike really nailed it on an important topic.

The question was “As a VC, how does one balance the pressure to provide a return for their fund LP’s with their pledge to their portfolio companies?“. Mike’s answer was basically that in good venture firms there isn’t really a conflict between the goals of our (VC fund) investors and helping entrepreneurs. Because all that matters for a VC fund is being a shareholder in companies that get really big. And to be a part of big successes you want the best entrepreneurs to work with you. That is all that matters.

So being pro-entrepreneur is actually pretty much the same thing as being pro-LPs (limited partners, what venture capital firms call their investors). LPs get that too.

The second point was that when things are heading South there is no point in burning relationships, reputations and energy by optimizing what you get when the cake is going to be very small. For example – our partner team manages a €150m fund – if we return a few million or less it does not matter when we need to return hundreds of millions. But it’s easy to get in to fights around small cakes. I have been there and it was ugly and I don’t want to go there again.

It also  – plain and simple – does not make sense for venture funds. What does make sense is that everyone walks away with their relationships and reputations intact.

Of course one thing that matters for a VC fund is having a reasonable shareholding in a company when things do go well. So I find good VCs to be relatively firm on valuation and how much they invest – that is optimizing for upside. I find bad VCs overly focused on liquidation preferences, control rights, protective rights, etc – so exactly the stuff that matters when things go wrong. Watch out for those signals carefully when negotiating a venture deal. 

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