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The VC's Customer
Many of the people I know in the venture capital business think their customers are their investors, called LPs in the industry vernacular. I've always thought that was dead wrong.
The entrepreneur is the customer and the LP is the shareholder. That's the only way to think about the venture capital business that makes sense to me.
What makes this so hard to grok for many in the venture business is that much of the selling we have to do is when we raise money. Once the money is raised, the entrepreneurs are the ones who come into our offices in "sell" mode. And that dynamic warps many VC's perspective of the business.
I start with the value chain. The entrepreneur creates the value, they are the "raw material" in the venture capital business. If there were no entrepreneurs, there would be no venture capital business. So the VCs who treat the entrepreneur like the customer and invest heavily in customer service will be rewarded with the loyalty of the most important component in the value chain.
Money on the other hand is a commodity, whether its in the hands of the LPs or the VCs. Money flows to the best returns and always will.
So if the VC does a good job of serving his customers well and generates superior returns as a result, the money will always be there as long as the price of his fund is reasonable. That's why I am convinced that the LPs are the shareholders. That is exactly the same dynamic that exists in company/shareholder relationships.
This "entrepreneur is the customer" mantra gets hard in a couple places in the venture capital process.
The first is the VC deal flow process. Take our firm. We are getting something like 30 new deals a week coming into our office that are generally in our area of interest and are at the stage we like to invest. We will make investments in roughly four of them per year. So we have approximately 1500 potential "customers" walk in our door a year and only take four of them. It's natural that the other 1496 will leave our office unhappy at some level and may never return. That's a big customer relations problem. We try really hard to be helpful, candid, and quick in our triage process, but at our best we might only make a third to a half of the rejected entrepreneurs comfortable with our process and eager to come back.
The second area where customer relations gets sorely tested, and where the "entrepreneur is the customer" mantra is the most difficult is when the entrepreneur is not doing a very good job of minding their own store. I believe that once the entrepreneur accepts an investment from the VC, the VC's customer set expands to include the company, its employees, and its customers. The entrepreneur is still an important customer, probably the most important customer, but the entire stakeholder group in the entrepreneur's company comes into the equation once the investment closes. When the entrepreneur starts failing this expanded stakeholder group, it becomes the VC's job to help them by getting them to change or getting them out of the way. Most entrepreneurs don't view that as help and therein lies the problem.
But in a funny twist, this is exactly where the "entrepreneur is the customer" is the most helpful mantra. If you really view the entrepreneur as your customer, when you walk into their office with the hard news that you aren't going to keep funding their company if it continues on its current path, or that you want them to step aside and bring in someone better suited to run the company, or that they need to get a coach and start behaving differently if they want to keep their job, you will deliver that news as a friend, a person who honestly cares about them and their dreams, and with compassion and understanding. And that is the only way to get through those really hard discussions with a chance of coming out the other side with a relationship.
Entrepreneurs are really difficult customers to serve well. It takes a significant investment of time, energy, money, and intellect to satisfy them. But if you do it well, you will develop a reputation for great customer service that will keep the best ones lined up at your door.
And that is the best way to deliver exceptional returns that I know of.
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Posted November 12, 2005 in Venture Capital and TechnologyComments
Fred, I totall agree with you. At Venrock, we use the term 'customer sevice' all the time to describe how we interact with entrepreneurs. Your post does a great job describing the complexities in the relationship. Each partner in the firm must manage these relationships well because a few bad experiences can poison the reputation of the entire firm.
Posted by: Mike Feinstein | Nov 12, 2005 8:38:49 AM
Fred: It is very refreshing to hear a VC acknowledge that money is fungible. So many VCs and investment banks try to create an aura of mystique around themselves (proably as a defense against the fact that dollars are just as green no matter who supplies them), and it gets tiresome.
That said, I don't think the "entrepeneur as customer" analogy quite works, for exactly the reasons you listed: the money flows the wrong way, you have to reject 99% of potential "customers," etc. The real customer is the entrepeneur's customer, the ultimate buyer of the product or service produced by the startup.
I think a better analogy for the VC/entrepeneur relationship is that of a movie studio and a director or movie star. The VC is in the position of bankrolling an individual with a project you think has potential. The entrepeneur is probably an extremely talented individual (possibly with other successes under his belt), but will have very strong ideas about how to do things, and in most cases just wants you to give him a check and then go away. And at the end of the day, everyone wants a big hit, but the reality is that the big hits are very rare.
Posted by: Shivering Timbers | Nov 12, 2005 9:24:56 AM
Fred and Mike, I appreciate the perspective. But at the end of the day, the metaphor breaks down. Your LPs are in fact your customers. You are delivering returns to them--that's your product. The entrepreneur provides the mechanism and opportunity to deliver those returns. And while it is in your interest to treat the entrepreneur like a customer, the better analogy would be, depending on your orientation or the deal, that you are either partners or, as likely, that the entrepreneur works for you until you perceive he/she no longer serves the goal of meeting your customers' interest.
The sales pitch is great--the entrepreneur wants to be treated like a customer. But our goals might be different; I might want to build a great company (in my case i do and am), and you have a legal responsibility to act in a way that provides return on your LPs investments over the life of the fund (or whatever your angle is on that--7 years, 35% a year?).
When I say "you" I mean the VC in general; you're a great guy from all accounts and the blog is great to read. I believe you have great relationships with you entrepreneurs and companies (the two are different), and that you have great respect for them. You both start out with the same goals, in theory; they might want to build a great company (they might want to flip, too), and you might want them to build a great company, with the added requirement that there be an exit in a prescribed period of time or when a decent exit arises.
So the entrepreneur might be your friend, or not, and might share similar but not entirely compatible goals over time. Your customer is still the LP, isn't it?
Posted by: Charlie Crystle | Nov 12, 2005 10:03:44 AM
Fred - nice post! Even if Charlie Crystle is right (which to some extent i think he is), it's a great approach and philosophy to have that i'm sure serves you and your various "customers" well.
Posted by: eric goldstein | Nov 12, 2005 11:02:00 AM
Sorry, but I call bullshit.
The entrepreneur creates the value, they are the "raw material" in the venture capital business.
Silicon is the raw material for Apple's computers and iPods. When is the last time Steve Jobs had to make a sales pitch to Silicon producers?
Yeah yeah yeah - VCs need to have good relationships with their entrepreneurs, and they need to build relationships with potential portfoilo companies down the road, but don't give me a snow job.
If you had something to sell to entrepreneurs, do you really think so many of them would subscribe to your blog? VCs are buyers, not sellers. It's a lot easier to get someone's attention by waving (the potential for) money in somebody's face, no matter how commiditized greenbacks may be. (And money is not a commodity. It's a store of value. If it was a commodity, then the Rockefellers could just as easily keep their cash in, say, cotton. They don't. They keep it in a currency they trust.)
Posted by: Derek Scruggs | Nov 12, 2005 3:43:35 PM
Amen.
Fred, please accept this as the compliment it is intended to be: only you could have written this post.
Posted by: steve | Nov 12, 2005 6:05:28 PM
Derek, VC's do sell and entrepreneurs do buy... capital.
This is entirely consistent with the way I know VC's (the smart ones anyway) interact with their own investors, their LPs -- they constantly act as if, and constantly work to create an environment that suggests, capital is cheap -- ergo, the VC firm is not selling pieces of funds but rather is buying capital from a buyers marketplace of LPs eager to get rid of -- to sell -- their capital.
Posted by: steve | Nov 12, 2005 6:12:01 PM
I'll agree with the technical argument made in comments that the better analogy is that the entrepreneur is a supplier to the VC, rather than a customer. Indeed there is a pretty simple value chain - business creates equity, which it sells to the VC, which then sells the equity at a later date, and remits (80% of) the returns to the LPs.
But I submit that even so, Fred's attitude is right on, and we entrepreneurs should take note: treat key suppliers as well as we treat customers. Business will be much better for it.
Posted by: Ray | Nov 12, 2005 9:50:03 PM
Steve said:
Derek, VC's do sell and entrepreneurs do buy... capital.
And Steve Jobs buys silicon. But you don't see silicon producers asking about his management team.
Look, I think Fred has the right attitude and applaud it.
But in the darkest moments of entreprensurship - those days when everything seems to be going to hell in a handbasket, you can't sleep at night and you're worried about meeting payroll - the entrepreneur doesn't think "I know - I'll go buy some capital!" He thinks "Damn, I guess I need to sell a piece of the company."
Entrepreneurs may be the buyers on some level, but the marketplace has all the characteristics of a monopsony in which they are the sellers.
Posted by: Derek Scruggs | Nov 13, 2005 10:29:48 AM
Derek is right--if you want to buy capital, it implies there is a market willing to sell it to you, but there isn't when the "sellers" have "selling criteria" plus a continuing relationship with that capital.
But Derek, when I'm sleepless because of cash flow, I think I need to boost sales, not raise money. For us, raising money is a longer-term thing, and expanding markets and selling products is a much shorter term answer to payroll issues, which are there because of pushing the edges rather than mismanagement (though some might think that pushing the edges is in fact mismanagement). Raising capital is for expansion of a working business, not to give us running room, which is perhaps the difference between 1997 and 2005. If you're a new company with a long way to revenue, it's a different story, of course.
So now we're finally starting to raise a round, and yeah, I'm selling equity to the firm with full knowledge of their goals, and they're selling me on what they can do as a firm--which would be great if it means getting distribution deals, hiring talent, and tightening processes, but in general we don't count on that, we count on raising the round and relying on ourselves for those things.
Their goal is total liquidity, which is part of the product they are selling to LPs, and is not the same as building a great company which then has liquidity options. And we're not looking for friendship, though that's great if it happens, but it happens independent from VC liquidity goals. We've got friends, we don't have capital.
And we're not looking for specific expertise in a firm, because the likelihood of raising from the firm with the right skillset and ability to leverage it for our purposes is fairly low, though welcome if it's there. So we're looking for capital, and capital that can bring more capital when we need it. That's why we go to venture capitalists, and no, when we go, we're not buying; at best we're trading equity for capital. If we get anything more with the deal, it's icing on the cake, not the cake itself.
Posted by: charlie crystle | Nov 13, 2005 11:25:56 AM
I find it interesting that Rick Segal from JLA Ventures in Canada wrote a similar write up about the importance of the entrepreneur as customer in his blog The Post Money Value url here http://ricksegal.typepad.com/pmv/2005/11/the_new_vc_hand.html one day before you, is it possible Canada is the trendsetter in VC thought?
Posted by: Estelle | Nov 13, 2005 7:37:50 PM
When you think of an entrepreneur as a customer of professional services (like accounting, legal or PR services), the analogy works better. Money, like silicon, is fungible. Good advice is not. The better service providers do (or at least should) work hard to invest heavily (in terms of time and effort) to maintain those relationships and build customer loyalty. We also have issues when the interests between the entrepreneur and the portfolio company diverge. And like VCs, we have intake processes that we need to use to ensure that we get a return on our investment (which, in our case, means getting paid). But I think that hard feelings between VCs and rejected entrepreneurs are pretty rare. If it happens, it's often because the VC invests in a competitor and the entrepreneur feels like he or she has been used.
Posted by: JayR | Nov 14, 2005 10:54:21 AM
i completely understand derek's and charlie's and everyone's points, but no one commented on my point about how VCs themselves raise funds. if entrepreneurs can't work this way, then smart successful experienced entreprenuers will never repeat with venture capital -- the standard system is way too lopsidedly weighted by VCs towards the young dumb entrepreneur, or the brilliant inventor who doesn't know squat about finance (no offense to my VC friends, I'd do it myself in their position if no one challeneged me the way no one challeneges them)
i do think the best analogy is indeed to movie studios. for one thing, contrary to VC myth, VC is every bit as much "hit driven" as hollywood. more importantly, studios actively recruit and partner with proven "entrepreneurs" (directors, writers, stars, producers) whose value increases with success (Tom Cruise's value doesn't reset just because its an "A" round) and whose econimics don't change based on the turbulent path to market (the Wachowski brothers don't get paid less or have to sell back their carried interest if say, a star drops out of the project causing a finance "recap").
so while of course newbie entreprenuers may have to go to VCs hat in hand -- as sellers -- experienced entreprenurs, like proven hollywood folks, should view their relationships with VC funds as if the VCs are the sellers...
...of "dumb money." no offense to the great number of hard working, brilliant folks in VC (and I have worked with a lot of them) but, as a function of returns data ("cash on cash", not "IRR") for the most part VC "value add" is a myth. look at the data (see Calpers VC returns data, below): when the s--t hits the fan, essentially all VC firms tank -- no stars somehow avoid the carnage -- just as essentially all VCs do well in a boom market for technology (and essentially all rise and fall at essentially the same rate, caveat the firms with the huge "hits" like google and arrowpoint, etc.)
http://www.calpers.ca.gov/index.jsp?bc=/investments/assets/equities/aim/private-equity-review/aim-perform-review/aim-detail.xml&FundOfFunds=2
Posted by: steve | Nov 14, 2005 11:47:06 AM
whoops, the link didnt post
for the calpers data click here
Posted by: steve | Nov 14, 2005 11:48:45 AM
Interesting post, Fred. Care to expand on your idea that LPs are the equivalent of shareholders?
I'd be eager to read a follow up post on that.
Posted by: Michael Weiksner | Nov 14, 2005 4:43:08 PM
I wrote a post on my blog referencing venture capitalists as salesmen. I find all the arguments against this point of view interesting, especially the point of view of VC's being like movie studios (I'll have to think about it). As an early "first time" entrepreneur (one of the dumb guys listed above) I still think the situation of the entrepreneur being customer is right-on.
Quote: "Too much money chasing too few deals" How many times have you heard this repeated? I heard a VC give a presentation recently, and his whole spiel was essentially a sales pitch. "Use quality VC firms, like ours!", "only x% (where x is low I don't remember the number) of non VC backed firms are ever really successful", "VC's have lots of value add to the relationship!". All of this screams, "YOU WANT TO USE VC MONEY, RIGHT?!"
As to the sellers choosing who they wants to sell to, this isn't exactly new territory. When I apply for credit, (credit cards, bank loans) etc.. few would argue that *I* am not the customer in this situation. The bank will review my situation and decide whether I am worthy to "sell" to. So there is an example of selective selling, the VC is just more selective.
What am I trading? Future worth (my own) for capital now. This sounds very familiar to the overall VC/entrepreneur situation except with companies rather than individuals.
Indeed the analogy, while loose, can be carried further. There is now an ongoing relationship (payments/bills) with the entity that loaned me the money. If I default on the agreement, they will come to try and recoup their investment by liquidating my assets.
I think the confusion arises when trying to understand the motivations of the entities involved. Everyone keeps saying the VC's "customer" is the LP's because his job is to generate returns for them. In my mind it's like saying a credit card company's customer is itself because it needs to generate profit. I think there is confusion as well because the VC/LP is profiting off the entrepreneur.
News flash, this is how *all* companies generate profit. If someone sells me a hard good, I am paying more in currency than the object is actually worth, that's how the whole system works. *I* am still the customer in that transaction though.
There are multiple avenues for generating returns, so why does the LP turn to the VC? There *is* a market and demand (customers) for large capital with the possibility of larger than average return (profit). The trick is making sure those that default don't outweigh those that generate profit leading to a selective selling situation (again sounds like the credit card business). The situation is so selective through, that the entrepreneur must be in "sell" mode to be chosen to be sold to.
Posted by: MikePK | Nov 15, 2005 11:15:21 AM
charlie, i would argue all sellers have a "selling criteria" -- at base, its called "price."
Posted by: steve | Nov 15, 2005 12:06:12 PM
Interesting that you suggest the entrepreneur is your customer and at the same time mention the possibility that you could have to fire him.
I would love to call one of our "customers" and let him know I've decided that he doesn't have a job anymore.
That said, I think your notion that you should treat your "non investments" with more care is probably a grossly overlooked issue among investors.
Having been on the capital circuit a few times I can definitely say there are some firms that can deliver "no" a lot better than others. Incidentally those are the same firms who were at the top of my wish list before I met with them.
There's a reason they are at the top of the list, and it's not just for the deals where they said "yes".
Posted by: Wil Schroter | Nov 21, 2005 4:29:03 PM
It seems to me that a VC's customers are the investors for the next investment round, including other VC's, larger companies (in the case of an acquisition), and investment banks and public markets (in the case of an IPO). Entrepeneurs are suppliers to, not customers of, VC's. A startup is the VC's product, to which a VC must add value sufficient for someone else to purchase it. So, like any business, a VC must cultivate its suppliers (entrepreneurs) so that it gets a steady stream of product of sufficient quality. The biggest difference with other industries is that post-investment the VC and entrepreneur effectively become partners, which complicates the relationship and requires the VC to treat the entrepreneur more carefully than another company might treat its suppliers.
Posted by: Phil Askenazy | Dec 9, 2005 5:30:16 PM
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