It’s a new year – and in the spirit of new year’s resolutions and efforts for self-improvement, I’ve decided to put down on paper the code of conduct by which I try to operate as a VC – in the hopes that others will add to it where it is lacking and, perhaps, adopt parts of it that they find helpful.
The venture business is a complex one – and the relationships between VCs and entrepreneurs are sometimes fraught with tension. Experienced VCs have seen thousands of companies and dozens of financing rounds. Most entrepreneurs are working on their first company, or perhaps their second or third. There is, often, an experiential advantage that VCs enjoy relative to entrepreneurs – when it comes to the VC-entrepreneur relationship, we VCs have simply been around the block many more times. Because of that, I think it’s important that VCs act decently at all times. But “decency” can mean many things, and I wanted to try to set down on paper what I think it means for a VC to be decent.
To be honest, this post has also been sparked by my travels around Europe. I have met too many founders in London, Edinburgh, Berlin, Belgrade, and beyond that have been (pardon my Americanism) screwed by unscrupulous or unprofessional VCs or angels. In far too many of these cases, the situation is basically unrecoverable: the cap table, legal terms, and investor base of the company have become so toxic that no new investor will be likely to go through the pain of rescuing the situation – and things typically just unravel from there.
So here it is: my crude attempt at a VC Code of Conduct. Like everything else in this business, it is a work in progress, it’s subject to change, and it needs the feedback and insight of the community to make it better. So please have a read through, and let me know what I’ve not included.
- I will do no harm.
I think this is sort of goes without saying. There are many ways that VCs can unintentionally harm a company: saying the wrong thing to the wrong person, giving really bad advice, dragging things out too long, etc. The core principal that underlies all of the rules below is that VCs should do their utmost to ensure that they don’t cause any damage. Startups are fragile things. Entrepreneurs are trusting us with their time, their energy, their plans, their life’s work – and we owe it to them to act thoughtfully and carefully so as not to cause unintended harm.
- I will respect your time.
None of us have enough time – but we VCs have a tendency to think that our time is a bit more valuable than that of everyone else. I do my best not to be late for meetings or calls – especially when someone has travelled across town or across a continent to meet me. Invariable, I am late occasionally. When all you do is meet companies back-to-back five days a week it is inevitable. But it’s unforgiveable, and I try avoid it at all costs. Similarly, I try never to allow an entrepreneur to travel too far just for a meeting with me. No need for a meeting when a Skype call will suffice.
- I will not ask you for material I don’t need.
I try to be very careful before asking an entrepreneur to provide me with any material. Raising money may be an important corporate objective, but entrepreneurs have a lot of other more important things to do, and putting together slide decks and fancy excel sheets in response to VC questions is not a good use of time, especially at early stages of a process. I try to ask for material that already exists, or for the “real” data that a CEO is using to manage the business. No need for a customer pipeline analysis in PowerPoint when you can just export something from Salesforce.
- I will not string you along. I will be straight-forward and transparent about the likelihood of an investment. VCs can easily waste tons of entrepreneur time by not being honest about the likelihood of an investment, or by the all-too-common “it’s interesting, let’s talk again soon.” The reality is, we don’t invest in the vast majority of companies we see – and we should be honest about that. By not saying “no,” VCs run the risk of an entrepreneur turning down another investor or jeopardizing a round by delaying it too long. It’s better to give a quick “no” and then re-engage later than create a false sense of momentum.
- I will let you know about any competitors in our portfolio.
This is a no-brainer. Sometimes, it’s not clear that there might be a competitor in the VC’s portfolio until halfway through a meeting, but if it becomes clear to the VC that this is the case, the VC must flag this immediately. It doesn’t necessarily mean that the investment shouldn’t happen, but at the very least all parties should be aware of any potential conflict.
- I will be transparent about any conflicts of interest between an entrepreneur and myself.
Often, what’s best for the company, what’s best for the entrepreneur, and what’s best for the VC are not in full alignment. For example, when a company wants to raise more money than it needs in the early stages, a VC can end up with a large holding at a great price, and the entrepreneur can end up with a big signaling problem on his hands if the VC isn’t committed to further investment. It might, however, be better for the entrepreneur to raise less money from the same VC (or from angels) in order to prove out a concept before raising a larger round later at a higher valuation. This can give him or her more freedom to operate, less dilution, and – especially when a near-term low-value exit is possible – a much better personal financial outcome. I think as a VC it’s my duty to expose these conflicts of interest honestly so that we can get to a true win-win: the right investment from the right investors at the right price at the right time.
- I will not sign an NDA, but I will act as if a reasonable one is in place.
VCs often get asked to sign NDAs by entrepreneurs who are not aware that the vast majority of VCs try never to sign them. We don’t sign NDAs for two reasons: First, we deal in confidential information all the time and trying to specify the precise rules in each case is next to impossible. Secondly, even if it was possible, the administrative overhead of an NDA per company when we are sometimes meeting twenty companies a week is just prohibitively onerous. That said, entrepreneurs have a reasonable expectation of confidentiality when they approach a VCs. And VCs need to be sensitive that much of what is discussed in their presence is not public. Often, we will meet five companies in the same space in the course of a month or two (even unintentionally – innovation happens in waves – a future blog post). Each of those entrepreneurs has a reasonable expectation that we will not divulge anything specific and non-public to a competitor or, frankly, to anyone. My test is simple: is this information that someone could garner from the public internet in five minutes? If not, it’s confidential.
- I will not share your slide deck or any material with anyone unless you give me permission.
Needless to say, the expectation of confidentiality pertains to any materials provided by the company. Sometimes this is viewed as a grey area, however, because VCs are genuinely trying to help a company by sharing a slide deck with other investors or with experts in order to due diligence a company. But this is actually not a grey area at all. I never share a slide deck with anyone (VCs, angels, trusted technical advisors, etc.) unless I’ve received explicit permission to do so from the entrepreneur.
- I will not speak with your customers without your permission.
Speaking with customers is a natural part of any due diligence. That said, it can cause damage and needs to be done in the right way, at the right time, and with the entrepreneur’s permission. Sometimes when I have an existing relationship with a customer, I will reach out, but only when I know that my questions will not cause any damage. But I will never cold contact a customer without the entrepreneur’s permission. Startups are fragile things and two many VC inquiries can shake up a customer, especially in the early stages and especially if the customer is not expecting them. How and when to contact customers is something I determine on a case-by-case basis, but I usually try to wait until the end of the process when I’m reasonably educated on the business and very enthusiastic – as I know that speaking with me is, in a round-about way, part of the customers due diligence on their vendor.
- I will educate before I negotiate.
Often in term sheet negotiations, I realize that the experiential advantage is in my favor. For example, some first time entrepreneurs are not familiar with concepts such a “drag along.” Just this week, I came across a case where a VC had almost managed to convince an entrepreneur that drag along rights should allow a minority holder to force the company to sell at any valuation – effectively giving that minority holder a back-door majority control on any exit-related decision. My view is that it is my responsibility as a trusted partner to make sure the entrepreneur is fully aware of the meaning and implications of any subject we are negotiating about before the negotiation takes place. Often I find myself saying things like: “this is why I am going to push for founder vesting, this is why you might not like it, and this is why I am going to insist on it anyway – now let’s meet in the reasonable middle.”
- I will be honest about what standard terms are.
In my near-decade of VC experience, I’ve seen just about every possible term, condition, and provision thrown into term sheets and legal docs. I know what’s standard and what’s unique, what’s fair and what’s unfair. I think entrepreneurs deserve to know what standard terms are – and they certainly should not have to deal with VCs that are misrepresenting non-standard terms as the industry norm.
- I will not issue a term sheet unless my firm has made a firm decision to invest.
Every firm is different here, but my practice is to make sure my partners are on board with an investment before issuing a term sheet. This can mean longer due diligence and a bit more risk that I’ll lose the deal, but it means that when I negotiate a term sheet, I’m empowered to do so. It also means that the entrepreneur can take the term sheet as a very reliable signal that our business due diligence is completed, and we intend to invest. (Financial and legal due diligence typically happen post-term sheet as part of deal closing, but that rarely scuttles a deal. Needless to say, deals can still fall apart post-term sheet – but it’s very rare.)
- I will reflect the term sheet in the final legals.
VCs sometimes try to sneak terms into investments by writing a friendly term sheet and then inserting unexpected things into the final legals in the hopes that no one notices or, at least, that they don’t have the energy to fight and risk the deal. This is just bad practice. Term sheets should be an honest reflection of what the final agreement will look like.
- I will not seek an unreasonable equity stake in your business.
I’ve seen too many cases of VCs taking unreasonably high equity stakes in early-stage companies. In some cases, this is because the VC feels the risk is very high and, in other cases, it’s simple because he can. In any event, I’m pretty convinced that it’s wrong to do so because it makes it much harder for the company to raise money in the future. The majority of VC rounds (from seed stage to expansion rounds) are typically done at a total dilution of 20-30%. Sometimes a bit more, sometimes a bit less. A really high-risk company that’s super capital intensive might have to suffer up to 40-45% dilution. But when I see early-stage rounds in software companies being done at 60%, I know something is deeply wrong. More often than not, it’s the case of a naïve founder and a short-sighted VCs. My view is that entrepreneurs and VCs are building companies together and it’s our joint responsibility to build healthy cap tables for the long term. However, because an unhealthy cap table can kill a company, this is not just a business issue, and it’s ethical issue.
- I will avoid surprises.
As an investor and a board member, a VC has a fiduciary duty to every company he or she backs. Part of this, in my view, is that the VC must communicate honestly and early in order to avoid unpleasant surprises. This should be the case both pre-investment and post-investment. Usually, this has to do with delivering bad news in a timely way. If I think a company needs to hire a CEO, it’s my duty to say so early. If I think I’m unlikely to want to lead a future round, it’s my duty to say so early in order to give the CEO enough time to turn things around and/or plan appropriately.
- I will act in the best interests of the company at all times.
I don’t think this requires any detailed explanation, but it’s profoundly important.
- I promise to try not to look at my phone in meetings.
This is a matter of courtesy and respect more than ethics, but it’s important nonetheless. I’m not very good at this one. But I promise to try.
Gil Dibner is a venture capitalist at DFJ Esprit, part of the DFJ network. He was born in Boston, lived in Israel, and works in London, as you can tell from where this was first published: yankeesabralimey.tumblr.com.