Sometimes I get the impression that a lot of entrepreneurs think VCs have a special formula for making investment decisions, and that they keep it a well-guarded secret like the recipe for Coca-Cola. Sorry to burst that bubble, but I can assure all the entrepreneurs out there who are looking for a VC partner that it’s actually pretty straightforward.
To better understand how VCs operate, and to prove my point, I’ve provided answers to four common questions about investing, the structure of VC firms, and, yes, decision-making. By the end of the post, you should have a better idea of how a VC works.
1) How does the firm make investment decisions?
Many entrepreneurs hear about “partner meetings” or “Monday morning meetings” at VC firms. It’s fun to picture these like a secret society meeting, but truth be told they’re simply centered around moving companies through the investment pipeline — from early conversations right through to investment decisions. Of course, I can only speak specifically about how we do things at OpenView, but a look at our process should give you a very broad understanding of how things generally work at other firms, as well.
Essentially, our selection process can be boiled down to a series of meetings we hold to decide which companies will advance to the next stage of the pipeline. Every Monday, we review our recent early-stage pipeline discussions and identify which companies we want to keep learning about. By this point, we’ve usually had at least one or two conversations with these companies. During the meeting we’ll figure out next steps and determine the appropriate deal team to tackle the opportunity.
Once we’ve reached a point where we, alongside the company, are equally excited in finding a partnership that works, we involve the investment committee. At OpenView, that’s the partners and vice presidents, and getting the committee’s buy in is ultimately how investment decisions are made. Our process is a unanimous vote, so effectively everyone has the right to veto or block. Prior to these meetings, we’ll often have companies give a presentation to the investment committee — their opportunity to basically sell themselves and the opportunity. After that, we’ll discuss the potential investment risk, the key diligence points we need to focus on, and whether we want to move forward (via a term sheet).
2) Where is the line between the investor and the Firm?
For starters, I think it’s important to get past one very common misconception — that a VC firm is really just the partners, themselves. In fact, there are typically three key components that make up the operating structure of any firm and that makes it who it is — the firm/its brand, the investors, and the fund. In the case of OpenView, there are actually four, but we’ll get to that later.
At some VCs, particularly ones with large investment funds, the investors operate like a mini-siloed business units, maybe with their own mini-deal team. They have a lot of autonomy and the firm is akin to a mother ship where they get funds to make their investments.
At OpenView, entrepreneurs are receiving an investment from the firm as a whole (i.e. everyone here has bought into the opportunity). In other words, we’re an all-or-nothing operation. We’re a small firm, we make few investments each year, and they’re very targeted and carefully considered (again, see the above point about unanimous investment decisions).
There are a few advantages to our model. Often when investors leave a firm, their investments can end up as an orphaned assets. But if an investor leaves OpenView, someone else here can more-easily pick up their companies given we operate more like a single entity. Our structure also allows entrepreneurs access to everyone on the investment team and their respective networks (vs. just that of the investor on their investment). The company is considered part of the OpenView family as opposed to a single investor’s portfolio.
That said, companies do have an assigned investor who serves as their main contact at the firm. And just as a company needs to do their due diligence on the firm, they should do the same with the individual partner(s) they’ll be working with — find out who they are, their background and investment history, experience, and what they’re like to work with post-investment (quick tip: go talk to companies they’ve worked with in the past).
Making sure that you partner with the right person in addition to the right firm is key. That’s why doing as much homework as possible before closing an investment is critical to creating a higher chance of success.
3) Where Does the Money Come From?
Basically, capital comes from an investment pool referred to as the fund. It is essential for entrepreneurs to know a fund’s mandate, what it can and can’t do, and what its investors were told by the firm and its partners. For instance, if the mandate is early-stage seed investing and you’re not an early-stage company, you should confirm that, a) the firm can actually make the investment, and b) your company fits into their model (and that they can be helpful!).
The age of the fund is also important because that can affect the availability and timeline of investments. As a company, you want to ensure that you’re early enough in the fund’s lifecycle so you’ll have time to develop. It takes time to build a great software company, and you want to make sure you have that runway.
Look at the size of the fund and the typical deal, how many investments per fund the firm makes, and how many they’ve made so far. This will give a good indication of the pace and bulk of their investments. If they do a lot of deals each year will you just be a number? If they haven’t done many deals, why is that? It might be market and/or fund dynamics, or something else. If there are deals being done that fit in their niche, but they’re not doing them, find out why. Don’t hesitate to bluntly ask — that’s often the quickest and best way to get straight answers (even still, you may have to read between the lines a bit).
Lastly, the fund is made up of investments from limited partners (LPs). It’s also a good idea to find out what their underlying philosophies are — both short-term or long-term — and if they have a history of investing in venture. The diversity of a fund’s LP base is also important. If it’s a single LP, the background and health of the LP is even more important. If they decide to back down from venture, then your company could be left high and dry.
4) What Do You Consider Value-Add?
As I mentioned, most venture firms are made up of three components: the firm/brand/institution itself, it’s people, and its fund — OpenView is unique in that it has four. At OpenView, for example, we offer our portfolio companies access to OpenView Labs, another branch of the firm that provides operational support and runs as a separate entity from the investment team.
We created Labs so the companies we invest in can benefit from direct access to and help from domain experts. Labs streamlines a lot of the processes of growing a company, and it also lets us add amazing value and contribute to that growth. The goal is to help companies grow and improve quickly, which translates into better investments for us.
Many VCs will also stress that they bring more than just capital to the table. It’s true that an experienced partner’s experience and network can be extremely valuable, but in some cases, VCs can offer more than just a “golden Rolodex,” as well, so understanding value add is incredibly important.
I hope that helps clarify how VCs are structured and function. Is there anything I haven’t covered you’d like more info on? Do you have other questions about how VCs work? Fire away in the comments below.