How VCs get a false sense of security with their investments

Over the last 4 years as a VC I’ve been consistently surprised by how often VCs get a false sense of security with the investments they’ve made.

Having seen other companies succeed in seemingly similar situations to their ‘own’ companies, they develop the feeling of being safer than they really are in the investment.

They take edge cases and use them to rationalize a situation they are in without taking the time to understand the details on what made the edge case, well….an edge case, and why it probably doesn’t apply to them.

The issue here isn’t just with the VC’s internal thought process, but that they rationalize it for the entrepreneur as well, which just perpetuates things.

This has certainly happened at Arthur Ventures and I know from first-hand conversations that each of the great firms we have co-invested with have been there too.

As an early stage VC, here are four examples where I see this happen most often:

The proven entrepreneur will ‘figure it out’
Proven entrepreneurs are great.  Some have had multiple grand successes.  However, many have also raised way too much money right out of the gates with essentially zero traction based on nothing but their reputation.  It has worked before, but often times the company never gains enough traction to warrant their overpriced valuation.  When this happens, expect a VC to overlook the facts and say the proven entrepreneur will once again ‘figure it out’.

The business won’t get valued off a revenue multiple
Some markets have repeatedly demonstrated that large outcomes can occur in the absence of material revenue (social, open source, life sciences, etc.).  When working with companies outside of these sort of markets with some sort of ‘proprietary’ technology, it is really easy to overlook and rationalize glaring revenue misses by the uniqueness of what is being ‘built’.  When this happens, expect a VC to say that this isn’t the sort of business that will get valued off a revenue multiple at exit.

Revenue in one market is more valuable than another
Some markets are just harder to sell into than others. Healthcare is a great example.  There are something like 6,000 hospitals in the country while there are millions of small/medium sized businesses.  It is inherently harder acquire 1 hospital than it is 1 small/medium sized business.  When companies in these more challenging markets are doing well, you’ll never hear about how hard it is to sell into their market.  However, when they are not, expect the VC to rationalize the long sales cycle and repeated unimpressive financial results by saying that revenue in this challenging market is more valuable than another.

A company’s market is a ‘land grab’ right now
There are special times when a macro-event occurs that causes a market to suddenly open up and become what many call a ‘land grab’.  I see this the most with compliance software reacting to recent regulation (think electronic medical records, etc.).  However, this term is used way too loosely by both entrepreneurs and VCs, usually right after a big financing round, as an excuse to sustain a burn rate that is not supported by any sort of productivity ratios.  When a startup is burning a clearly inappropriate amount of cash, expect a VC to say that their market is a ‘land grab’ right now.

All of this rationalizing of situations and getting a false sense of security comes from a good place.  VCs and entrepreneurs never work together with the goal of losing.  They always want to win.

However, sometimes the less safe you feel, the more successful you end up being.

get in touch: Arthur Ventures; patrick@arthurventures.com

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