Venture Capitalists (VCs) are smart. They look at hundreds to thousands of pitches from companies all the time. They invest in a very small number of those they look at. How they pick the ones to invest in is a subject of another blog post.
But when they invest, they typically join the board of directors of their investment. It’s a way for them to watch over and nurture their investment. And as the CEO you want their oversight and involvement. After all, they have connections and perspectives that can help you.
But not when it comes to buying another company.
VCs do two things really well, or they’re not in business long, and that’s 1) raising a fund so they can make investments and 2) investing in companies. They’ve seen an awful lot of good and bad ideas. They’ve been involved in various growth stages of a number of companies. They have probably sold a lot of companies, since that is the most likely liquidation event for any VC. But what they don’t do a lot of, and they don’t do it well, is buying companies.
How can that be, you may ask? I’m sure a number of VCs will take exception to that statement, but it’s true. Let me explain.
VCs have two priorities, and one takes precedent.
- Get a large return on their investment. The magnitude depends on the VC but their objective is generally in the 10x range.
- Support the CEO and their investment. They will use their connections and experience to provide guidance and direction, to steer the company through it’s phases to ultimately reach a liquidation event.
But understand, #1 takes priority over #2. And when it comes to #2 and acquisitions, they’re focus is still on #1. That may seem like that’s a win-win for the CEO but it isn’t always.
I’ve been told by a VC that they’re not interested in their portfolio companies making acquisitions. It typically dilutes their ownership percentage. So if growing through acquisitions is a part of your growth strategy, don’t look for support from your VC.
Furthermore, they’re not skilled at BUYINGcompanies. They’re skilled at SELLINGcompanies. There’s a big difference.
Here’s a real-life example. A small private company has the opportunity to buy another small private company. They’re both in the same space, focused on the social aspect of e-commerce. The buying company sees an opportunity to expand its service offering and the selling company sees an opportunity to tap into the buying company’s sales force. It seems like a natural fit, on the surface. The combination is apparently supported by the buying companies Board of Directors, which is made up of its investors, the VCs.
But if you take a closer look at the combination, and it doesn’t take much effort, you can see that the combination is a disaster and it will sink the buying company. Why? Because the companies sell to different buyers. Because the acquired solution’s business model is success fee based where as the buying company’s solution is subscription based. Because the buying company’s sales force isn’t going to be selling the acquired company’s solution because the compensation doesn’t work. And the whole reason for doing the deal blows up.
Why doesn’t the Board of Directors and the VCs see what I think is a very obvious flaw in this combination? I don’t know for sure and maybe I’m missing some point or perspective, but I think it’s because they don’t know what to look for, not having done a lot of acquisitions. It seems they’re willing to support the CEO in this deal, so they’re not opposed to growth through acquisitions, like the VC I mentioned earlier. But supporting the CEO doesn’t mean agreeing to the deal.
If they want to support the CEO and maximize their investment they ought to tell him (or her) to get some skilled expert to give some perspective on the proposed transaction. Too often the CEO will try to do on their own with the support of the BOD and the executive team. But there’s a problem with that, as I’ve written in We Can Do this Ourselves.
There are tough questions that need to be asked and answered if the VC is going to maximize its investment.