Jon: On today's podcast, we are going to talk about the red flags of a toxic VC.
Jon: And so I guess my first question is like storytime. What personal experiences have you seen in the space of just toxic red flags?
Peter: So I think the conversation today is we want to talk about some of the things that if you're an entrepreneur, you should be doing your due diligence on the VC. Right. Like, so often, like the perception is like the VC should be the one doing all the due diligence, but the entrepreneurs should be doing their diligence as well.
Jon: Why would you do due diligence on ABC? They're not going to.
Peter: Because you're going to be tied at the hip for a long time. And if you read your docs closely on that round, you just closed. You just gave up a ton of control and rights over to those investors. So that's fine as long as you have a good relationship with them and there's somebody that you can trust, which means you got to do your due diligence.
Jon: Personal story. One time we had it was an angel investor. They were they're a VC, but they wanted to do an angel investment and they kept saying they were going to invest. And we had this round of traction. We would blow through the round of traction and then they'd be like, They'd keep moving. The goal line.
Jon: And so then finally, one day, this person's like, Well, let's have our third meeting. And it was a lot of a long ways away. I'm like, Look, I'm just not going to go there and meet a person. But they said, they're going to invest. And I'm like, Look, I don't feel comfortable with a person who's kicked the ball three times.
Jon: Like, it doesn't seem like they're going to follow through with their commitments. Yep. And I said no, like, let's not take their money. But then I thought about I said, Well, let's to meet you in the middle. Let's do due diligence on this VC And the person on the other phone, my business partner screamed at me and said, Why would you ever do this?
Jon: And I'm like, my gosh, Like, this is super toxic on both sides.
Peter: Yeah, Interesting. Well, and then there's also this question of like, there are VCs that are toxic and there's red flags, and then there are VCs that just aren't that interested in you, right? And like, there's some nuance there, right? Like a VC is incentivized to never say no. Right. Because, like, let's say in your case, right?
Peter: It's like, no, no, no. And then you absolutely, like, you landed some massive contract and then all of a sudden it became super interesting. If you had said no earlier on or she had said no earlier on, you're like, well, he's she's just not interested in what I've got to offer. I'm not going back to them ever again.
Peter: And they would have missed out on that deal. Right? So like your incentivizes VC to always kind of like kick the can down the road as much as you can until with hopes that maybe it turns out interesting so that you always have optionality.
Jon: So I think it's also tricky because there's a local person here in Utah who this person's motto is, I'm going to be extremely honest, tell you what happens. But I feel like it has literally come back and haunted that person when they said, Hey, I'm not investing in you because I'm uncomfortable with this person on your team. Or, you know, I don't think your space is that that that attractive.
Jon: And I feel like it has created a really negative cloud that has followed him.
Peter: Yeah, that's fair. I mean, it's an art. It's it's totally an art. Right. One of the skills that good VCs have to do well is saying no.
Peter: You say no a lot. But you got to be able to say no in such a way that it doesn't ruin the relationship. And if and ideally, that keeps the opportunity open without being that toxic person, that's like, he's just like li like kind of leading the entrepreneur on without ever without having any intention of ever closing the deal.
Jon: What is your approach, Peter, on this?
Peter: I mean, I tend to be fairly direct in terms of like why we're passing, but I draw the line if it's like if it's like, I don't like somebody on your team, I won't tell them that I don't like that person on their team, right? Usually that's not the only deal killer. Right. I think there's a matter of like being able to separate.
Peter: Hey, this isn't a fit for our fund. And that's really like where I try to focus. And I think you and your baby are ugly, right? That. That's. That's offensive, right? And people remember that. They don't like that. Right. But if you say, hey, look like I think you've got some interesting things here. It just doesn't fit for us and our strategy.
Peter: Right. I think that's a way to, to not attack people personally is totally a fair reason to pass on an investment. And the other thing is, oftentimes, if it's a deal where I'm like, Hey, I want to leave some optionality here, I'll do two things. I'll tell them, one, Hey, how can I be helpful in the meantime?
Peter: Right? Here's some ideas of ways I could be helpful. And the other thing is, I'll say to your example earlier on, like, if you meet these milestones, I would love to reengage because once you've hit those milestones, all of a sudden you move from outside of the box inside of the box, and we can have some more productive conversations.
Peter: I think like that's the kind of VC that you should be looking for somebody that can like get you to ideally a fast yes, but if not like the next best thing is a fast no without being like a total jerk about it.
Jon: Okay, What are some actual red flags that you've seen or like or the back stories.
Peter: Like these are trying to do things that are outside of what's market. That's always a big red flag.
Jon: So what would that mean?
Peter: Like, so that could be yeah. It would be like valuation terms, like they want a, you know, three X participating preferred liquidation preference, right? When market is like a1x NONPARTICIPATING preferred or maybe they're saying like, Hey, I'll invest, but you got to personally guarantee my investment, right? Like that doesn't happen super often now, but it used to happen a lot, a lot more frequently in the past.
Peter: So another one is like you meet with a VC and they say like, yeah, I'm an investor, but they're really like an analyst or associate and they don't have check writing ability. Yeah, and then they just like lead you on for a long time and you think you're having a really great like conversations, but like the partner level has never signed off on it.
Peter: They don't care, they're not interested and like that VCs just kind of wasting your time. I think the other thing is like VCs that show up late to all of your meetings and like, don't care or respect your time is.
Jon: Not standard in VC land.
Peter: I mean, it's very common.
Jon: I used to work with one angel investor on several deals, and to this day I will send allocations almost anywhere. I'm going. Yeah, because I found that I picked up those same habits and I felt like it was disrespectful. So I know that if I'm sending my location, I want to be honest. But yeah, that's site tangent.
Peter: But if an entrepreneur of a VC is really excited about your business, this gets back to like, is he really into you or not? He like he or she will be there and they will make you a priority. Right? And that's that's usually the best sign that, like you're getting good traction is if you become a priority in their eyes.
Peter: When Josh James raised money for Domo, the partner that from Benchmark that led that round, like he texted him and was like, Hey, I'm going to raise a round. And the guy like, left his dinner, got on a plane and flew out here. Right. Like, that's commitment. So one of the things I recommend you do is ask them what the process is to get through due diligence with the firm.
Peter: So for us, I'll tell you, our process. Our process is I meet with an entrepreneur. I hear the pitch, I make it decision. Is this something that fits with us or not? If it's something that doesn't fit, usually I tell the entrepreneur, like right in that meeting, like, Hey, probably not a fit. Here's some other ways I might be able to be helpful.
Peter: Here's some things that I'd love to see you achieve before you are fit. And then, like we call it good. But if it is something that's interesting, then I'll ask for a data room and I'll ask for a follow up call. Then I assemble my team and the team digs through the data room. We do a follow up call, we ask questions, the team packages up all the due diligence that they've done.
Peter: They pitch it all the other students, the students vote on it, they approve it. We take it to our investment committee. Once the investment committee approves it, we're good to close, right? That's our process. And I, I explain it to people in that first meeting. If it's something that, like we want to move forward with other friends, are might they may have some varying level of that same process.
Peter: Right? Maybe it's like, well, the next step is we bring you in as an entrepreneur and we have you pitched all the partners and then we have a discussion and then we'll we'll dig into our due diligence and then we bring you back for a final investment committee meeting with our partnership.
Jon: I really like that because I hadn't thought of that approach before to say, What's your process? We can know if we're following it or if, Hey, they're just not that into me. Is it a red flag? If a VC has not done a deal within six months, 12 months?
Peter: Not necessarily, but yeah, the longer amount of time has passed, the more of a red flag, that is.
Jon: How do I find that out to look for? Or should I just be pitching everyone because someone could be a connection? I mean, I assume if they're raising the new fund, they're just going to tell you.
Peter: Yeah, I mean, so good questions ask through diligence is like how much money do you have in your fund? Where are you? Like, when did you close that fund? Right. So how much dry powder do you have? How many more investments are you planning to make out of this fund? What size checks do you typically write like? I think those kinds of things are important.
Peter: Asking the process question will also give you insight into like how the firm makes investment decisions, which then will inform you, at least to some degree, how much sway that partner you're working with has through that process, Right? Yeah. One of the toxic things as a VC that claims to be like all of that, you know, like have tons of influence within the firm and then in reality, like, can't get a deal done by him or herself.
Peter: Right? So, you know, you want to watch for those kinds of things, but knowing their process can be helpful to like, figure that out.
Jon: How do you handle a VC who thinks he knows he's all that? I mean, I would say just walk like maybe not everyone has the choice to walk. I feel like one of the challenges with with VCs is they think they're exceptional operators, they're great marketers, they're visionaries. And a lot of times.
Peter: There's a lot of ego and.
Jon: VC How do you handle that? Is that an issue or is it just something you it's just you have to deal with?
Peter: Honestly, I think it's kind of something you just have to deal with. Okay, well, think about it this way. Like both entrepreneurs and VCs are incredibly arrogant and that's not necessarily a bad thing. You kind of have to be right. You are as an entrepreneur. You're saying like the current status quo sucks and I've got a better solution, right?
Peter: Like that takes a massive amount of ego, right? And then on the venture side, the VCs like, I believe that the current status quo sucks. And this guy, of all the guys out there, the women entrepreneur, like whatever, that's the one. And I'm going to plow millions of dollars into that one company because they're going to disrupt everything like that requires a ton of guts.
Peter: I think the what happens is you get a lot of ego at the end of the day, because of ego is also driven by insecurities. I mean, think about it this way. Like in venture capital, this partner at Lightspeed made the point which to this day I just think is is a great point is like venture is like one of the few industries where you can be wrong 70% of the time and still be like viewed as just an absolute like money maker.
Peter: Right. But think about it that way. Like every day, 70% of what you do fails. That's like kind of insecurity driving in a lot of ways. Right. And so when something really works, like you get really excited and okay, so I don't think like egos are necessarily all bad. I think there are obvious reasons why they exist within this industry.
Peter: I think they do become a problem when they become an impediment to whatever it is you're trying to accomplish. Right? Like I've seen deals where an entrepreneur turned down a V.C. and then the VC was like all hurt and their ego was hurt. And then like, they went and did like some retaliatory things.
Peter: Invested in a competitor or started up a competitor, right? And or tried to block one of their other companies from working with that company and like that kind of stuff. That is toxic. Right.
Jon: Okay. Can we talk about a recent discussion with a look? Obviously, I do want to mention any names, but there's a local a local V.C. who for whatever reason, didn't really push one of their investments, just had an IPO and they're on the board and they didn't let their founding team come through. Is that a red flag that I should look out for with that fund?
Peter: I think that is a red flag.
Peter: I think it's a red flag. But it doesn't mean that you that just because a VC replaces the CEO it's always a bad thing. Right. Like you think about Google. Right. Google was started by two guys in college and as it started to grow, the VCs came in and said, hey, we think you should really bring in some adult supervision.
Peter: Right. Somebody that's kind of been there, done that brings some passion right to the C-suite and they brought in Eric Schmidt and that was arguably the right decision. Like he helped fundraise, he helped bring legitimacy to what they were doing. He up closed deals like he helped mentor Larry and Sergey and like eventually he he moved aside and Larry stepped in.
Peter: But that was that was the right move. And it wasn't just the right move for the company. It was arguably the right move for Larry and Sergey because they ended up making a lot more money because of Eric. Right. So, like, it can be like a benefit. Like what you want to see is you want to have an investor that says you've maybe hit this plateau.
Peter: Let's find somebody together that can take you to the next level, right? And let's move you into a role where you're happier, whether that's within the company or maybe we help you start another company. That's one investor and that's the kind that you want. Even if they have a history of replacing people, the opposite is the VC that, like from day one is like, Wow, that guy is a train wreck.
Peter: We're going to get rid of him as soon as we can. Right? And maybe, maybe as I'm thinking about it here, right. You want to see that empathetic. Right. And not just driven by short term monetary gains, Right? You want at the end of the day, you want to see that it takes the long view. So my belief is that what if found like a good founder brings to the table is the vision.
Peter: They become the torchbearer of that vision.
Jon: And not the operator.
Peter: And not the operator. And the best companies, the biggest companies are incredible torchbearers that can also execute. So you think about meta and and you think about Microsoft and Bill Gates. You think about Amazon and Jeff Bezos. You think about Steve Jobs and Apple. Right. Like these people, they may not have been the best. They definitely weren't the best at everything that needed to be done in the business.
Peter: Right. That's not why they were CEO, but they were really good at like holding that vision and and managing the teams that could actually execute against it. And so as a VC, I would almost argue like you should be backing that type of entrepreneur, right? Not the type of entrepreneur that can get there. And you should probably pass on the deal if it doesn't have the right type of entrepreneur and the CEO see it rather than invest.
Peter: And then Canham. But that's my perspective, right? Like there are other ways to think about it.
Jon: So this is the end of the Venture Capital podcast. Like and subscribe. Thank you so much, Peter. We'll see you again next week.
