Sunday, August 9, 2009

Doubling Down - Good Money After Bad

This post by Fred Wilson certainly resonated with me, and caused me to reflect about my time with Sevin Rosen Funds. Via Doubling Down:
Like most VCs, I am guilty of sticking with our investments too long and putting too much money into the ones that are not working. It's an occupational hazard. As I've gotten more experience in the venture business, I've gotten better at this part of the business, but it is still a challenge for me and most VCs I know.

Bliss McCrum, one of the two VCs who taught me the venture business early in my career always said, "if you are going to put more money into a company that is not working, make sure to change the strategy, team, or cost structure, or all three." It's good advice. You will not get a different result doing the same thing.

During my time at Sevin Rosen Funds, I saw quite a few presentations made by existing portfolio companies looking to raise a Series C or Series D round of investment. As the "new guy", I didn't have the history of what transpired to get the company to this point -- I was just evaluating the business as it stood at that moment.

More often than not, my advice was that the company was not a good candidate for follow-on investment. Invariably, the company did receive their follow-on investment.

It wasn't until I fully understood a number of things about VC that this all started to make sense to me: The way that VC funds are managed, how VCs are compensated, how money is allocated for follow-on rounds in the fund, the timing intricacies of when a new fund can be raised, the details hidden within LP agreements on how investments can be made when multiple funds are being managed by the VC entity, and the psychology that comes into play once your investment in a company is a public one (on the Portfolio page of your firm's web site) and you have become emotionally attached after a series of dozens or hundreds of board and strategy sessions.

Needless to say, my comments to SRF must have been heard as "your baby is ugly". And, let's face it, nobody wants to hear that their investment did not turn out to be a good one. With money allocated in a previous fund, and the LP agreement of the current fund prohibiting new investments in prior funds, say, some VCs may in fact be conditioned to double down more often than you would expect.

I completely agree with Fred Wilson and Bliss McCrum. Doubling down only makes sense when you change something core to the business. All too often, the VCs will do too little, or nothing at all, when doubling down. Such a strategy amounts to nothing more than hoping for some external change ("the market will finally start to take off; the hockey stick is just about to shoot up!") to make your investment pay off. That's bad business. That's throwing good money after bad. And the LPs will not like that.

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