Jon Bradshaw & Peter Harris
Join hosts Jon Bradshaw and Peter Harris as they dive into the world of venture capital with a candid discussion on the "Bad Moves VCs Make." In this episode, they share war stories and shed light on questionable tactics employed by some venture capitalists.
Bad Moves VCs Make
Join hosts Jon Bradshaw and Peter Harris as they dive into the world of venture capital with a candid discussion on the “Bad Moves VCs Make.” In this episode, they share war stories and shed light on questionable tactics employed by some venture capitalists.
From last-minute deal changes to questionable negotiating strategies, Jon and Peter explore scenarios where VCs may not always have the best interests of founders and startups at heart.
Throughout the episode, Jon and Peter provide valuable insights into the dynamics between VCs and founders, offering perspectives on when certain actions cross the line and become detrimental to the startup ecosystem.
With a mix of real-world examples and thought-provoking analysis, they aim to empower listeners with the knowledge to navigate the sometimes murky waters of venture capital.
Whether you’re a seasoned entrepreneur, an aspiring founder, or simply curious about the inner workings of the VC world, “Bad Moves VCs Make” offers engaging discussions and practical takeaways to help you better understand the complexities of startup funding and investment.
Tune in for an insightful conversation that explores the nuances of VC decision-making and the impact it can have on the success of startups.
Episode Transcript
Jon: War stories. Bad news this is make in the next episode will be bad moves that bad moves that founders make. All right, All right. If you like this podcast, you can leave us a review. Six stars where we're ready to roll.
Peter: Let's do it.
Jon: All right. So bad VC moves. Yeah, that's the name of the podcast.
Peter: Okay.
Jon: So we're not going to give any names, but I think people should know tricks that could happen. So if they happen to you, you're not like floored.
Peter: Okay?
Jon: And we want we want your deep secrets. Peter.
Peter: I thought you were coming with a bunch of stories that I wanted to react to.
Jon: But I want you to, like, also share stories.
Peter: All right, we'll see.
Jon: All right. So the names have been removed to protect the innocent and or guilty.
Peter: I.e., the names have been removed to protect our reputations.
Jon: Our reputations. Now, I’ll be fine with the mentioning names.
Peter: But Peter's reputation.
Jon: Okay, Peter's. There was a company that was going to exit and had a good offer on the table. According to what one of the investors at the table thought, to be fair. Right. So we're not misinforming them. But the most recent investor wanted a better return. So they threatened to veto the deal unless their class of shares got a big dividend.
Jon: Okay. And so they were going to blow up the whole deal if they didn't get something that they wanted.
Peter: And you think this is bad acting.
Jon: Potentially the the the person who submitted this story thought it was a bad that this VC was a bad actor. Do you think they're a bad actor or No, What's the context?
Peter: So, all right, have.
Jon: You done this?
Peter: This is like totally a scapegoat, but, like, it depends.
Jon: Okay, think about.
Peter: It this way.
Jon: Where have you done this move?
Peter: I have not done this move.
Jon: But what about doing this move?
Peter: No, because in large part because this is not the kind of games we play, but so. But it has happened to me. but okay, so, so here's the issue. The issue is what happens if the founder comes to you and they're like, they lay out this big vision, they're going to build this thing into $1,000,000,000 company, right?
Peter: You sign up for and you say, Great, we'll put in money. And then six months later, an offer comes along that's at like, you know, basically the same valuation at which you just invested. And the founder's like, let's sell and all the early input, all their employees, all the early investors, they're all going to get like a great return on this, right?
Jon: Okay.
Peter: Yeah. And you're like, frustrated because you're like, Look, I put this money to work in this company. I chose this company versus other places. I could have put the money. And now six months later, you're telling me that like you're throwing in the towel and I'm just going to get my money back? Like, the opportunity cost is really high.
Peter: Like, again, I could have put it into something else that would have generated a two, three, five, ten tax return. Right? And now I'm just going to get my money back. And so like, yeah, if, if I'm going to go through with this deal, then you got to give me something to help compensate me and my investors for the opportunity cost, right?
Peter: Of like, I can't just take that money and recycle it into another deal in many cases. Right. Some funds can, but a lot can't. So I don't know. I can understand the frustration, but I don't know enough context to know, like if they came to them, they're like, Yeah, you're going to get like a2x return. And then they were like, Well, it's not enough.
Peter: Where, where, where? We need more dividends.
Jon: Let's just assume six months. I don't I don't personally know the time frame on this, right. I just know the names.
Peter: Right.
Jon: Like let's say it's been six months. Yeah. You get it to every return.
Peter: Yeah. Like if I got a2x return in six months, I'd do that all day long. Right. But I also have a different investment criteria than most. I mean, the IRR on that is like phenomenal, right? It's like 180% or something crazy like that. but if somebody like we had a deal like this happened not too long ago where the company got acquired for basically, it actually got acquired for less than the valuation at which we invested in.
Peter: But fortunately we had liquidation preferences that protected our investment. Right? And so that happens sometimes. and that's, it's a little bit frustrating in this particular case, like I thought it was the right move and supported it. And that's again where it's just like, it really depends.
Jon: So when is it a bad move in this context?
Peter: I think like I think the bad move is when there's an offer on the table or the entrepreneur clearly wants to take it. and it's unclear whether or not there's a lot more like headroom for the company to grow and the VCs come in and block And then the company struggles because the founders not into it, there wasn't that much headroom for more growth.
Peter: And then the company collapses. And that does happen. Like I have seen that where like the founder VCs should have taken the deal on the table. this is like on a side note, why the meme account praying for exits. Like I just loved the name so much because like as a VC you put money in and then you just, like, pray every day that like, somebody will buy that thing and then you get liquidity because it just doesn't happen that often.
Peter: It's like my mom always said, she's like, it's always easier to buy than it is to sell. and so I don't know. I think sometimes VC is, I don't know. It's challenging because the VC, right? It's like you got power lock on and, and you're like, Hey, this is one of my winners. And we, we don't want to sell it too soon.
Peter: Right. And miss out on all the upsides.
Jon: But when was it a bad move when you think the company has no more upside.
Peter: Yeah. I think when the company has limited upside and when the founder really wants to sell because honestly, like founders have the ultimate liquidation preference here. The ultimate like, you know, because like kids, they can just be like, well, screw you, I'm walking. Or I'm not going to put down all my, you know, blood, sweat, tears and do this anymore.
Peter: And then you won't have a great business, right? So I think VCs like unilaterally blocking and a sale that the founder really wants to do. I think that's usually a bad move.
Jon: You know.
Peter: That comes back to bite them.
Jon: Got it.
Peter: But I think you can sit down with the founder and like, think it through. Right? Like there is another example where the founder was like, hey, look, we have an offer on the table to be acquired, like we could sell. I don't think that's the right move. I think we should keep growing it right. So it kind of cuts both ways.
Jon: Okay. Ready for the next scenario?
Peter: All right. Tell me the next one.
Jon: All right. So again, a report is that there's a V.C. who is known for this, who will agree to terms, have a term sheet created.
Peter: Yeah.
Jon: The day of signing or we were supposed to find, like the sign, the final agreement, we'll just throw in like one extra term.
Peter: Like at the 11th hour, 59th minute.
Jon: When everything's been agreed to verb, you know? Yeah. Hey, I don't know, like this, this, this VC comes back and he or she says, Hey, you know, I've thought about it. I don't know if I can do the deal anymore. Hey, to give me over, I need X.
Peter: Yeah. Now that's totally shady. Yeah.
Jon: Okay. Why is it shady? Because they should have known before that.
Peter: Well, here's here's the big problem is. Well, because they did know before, right?
Jon: Okay. Yeah.
Peter: And they did know before and they're using it as a negotiating tactic to get what they want. And some VCs will play this game where not only will they do that, but they'll also string the company along, allowing the company to burn up capital so that it's in a more desperate situation. Yeah, and it has they have to take the deal because if they don't take the deal, they'll they don't have any money to start the fundraising process over again.
Peter: And it's also like the VCs know this, like if a deal falls apart at the 11th hour, it can be really hard to raise a can. Right? Because all the other people that looked at your deal the first time are going to be like, Well, why did it blow up the 11th hour? What's wrong with this deal? Like it's like red flags all over the place.
Peter: So, like, it's a really, like, crappy thing to do because it definitely puts the founder in a real tough position no matter how you cut it. Right? Like it's just not going to look good to have to go back out to market either. You won't have the cash to sustain it and or you've got all these red flags you now have to explain.
Peter: It's like anytime you're explaining, you're losing. So yeah, now that's a crappy thing to do. But here's the thing. Like you do that once word gets out and then nobody trusts you, right? You become the funder of last resort.
Jon: Finally, this person is well trusted in the space.
Peter: Yeah, well, I know other people that have done this that are not well trusted in the space. They built this crap and they are the funder of last resort. And their firm, frankly, struggles to get access to the very best deals because of it.
Jon: I think in the same firm I'm thinking of.
Peter: I don't know who you're thinking of. All right.
Jon: Let's go to the next one. So this one a friend was raising. They had a convertible note and the convertible, no support. They felt that their I mean, they felt that their investors were purposely not putting more cash in. Now because it would change the valuation and they wanted to convert to the lower at the valuation that is in the term sheet in the convertible note.
Peter: Right.
Jon: And then they would invest. Do you think that's just, hey, this is part business tactics.
Peter: So.
Jon: So like let's say there was a cap on the convertible note like 3 million and they're worth more. Right. But they have they know they haven't raised I think the founder thought that the they were looking for some sort of signal to other investors that the earlier investors would like come in again. Yeah. And they felt earlier investors were like why?
Jon: Because if we invest if we wait, we get a much better valuation, then let's play the second inning.
Peter: They were like, let's just put more money in the convertible note.
Jon: Not like a verbal note. They wanted the convertible note to hit hit at its maturity and it had a pre fixed valuation there. Yeah, that was lower than the supposed valuation that they may be able to raise that. And so they'd get like a ten or 20% discount and then after it converted, then invest again.
Peter: To me this just sounds like sloppy structuring.
Jon: Okay.
Peter: On the part of like the founder and their attorney, okay, because they should have just had like a very clean like cap. And so it shouldn't really and a cap plus discount and so it really shouldn't matter.
Jon: Yeah, the cap plus discount was lower than what they could have raised at. Yeah.
Peter: So but then why does it matter. Right.
Jon: They felt that the VCs were specifically waiting to get that advantage before putting cash in again. They said, let's hit the cap, then invest at the market.
Peter: Like, were they sorry, I'm just trying to follow this because it doesn't quite add up to me.
Jon: So I don't have I So.
Peter: Let's put some numbers on it. Like, I.
Jon: Mean, I can share names, but then I would have to edit out.
Peter: Now. But let's just put some hypothetical numbers on it.
Jon: Okay?
Peter: So, so the convertible note was what? Give me some numbers.
Jon: I don't know. Let's just say three and a half.
Peter: Three and a half cap.
Jon: Okay.
Peter: And 20% discount. And what was the issue?
Jon: What It was issue, I think they were trying to raise at a five or six after that.
Peter: Okay. Or higher. And the found and gassy in that. Right. These are all just we're just putting numbers to make it more concrete. And the other investors, the earlier investors.
Jon: Wanted them to not raise supposedly so that they would get it. They would convert at the three and a half cap.
Peter: But why when it converted the three nav cap, if they're raising it five it, then it should automatically convert it to three and a half cap.
Jon: So I'm just saying this is a move of a founder claim that ABC ran against them. I don't have enough of the data to know where they're raising, trying to raise it at ten. They just felt that the views that they could they had the ability to raise another round. Right. But they needed the initial investors some of the to pony up and to carry the momentum and that those initial investors wanted to wait for the their notes to convert at the pre to define valuation in the note versus doing it.
Jon: Now coming out at a higher valuation because they thought that invested so it would give them a lower valuation. Supposedly the investors thought it would be worse for them.
Peter: So what would make sense to me in this situation is if the insiders were like, We're not going to price this, we're just going to put more money in the convertible. No. And the founder was like, But the company's grown a whole bunch. Not like it's no longer valued at three and a half. So why would I take your investment at three and a half?
Peter: And they were like, Well, we're not going to pony up money unless we get a three and a half million dollar valuation. And the founder is like, But if you don't pony up, nobody else is going to pony up at the like 5 to 6.
Jon: Should we should we phone a founder and find out what the actual terms are or.
Peter: I mean, if you want or we could just cut this whole section because.
Jon: All right, we'll cut the section.
Peter: Yeah, it's been rough. I don't really know what's going on there next.
Jon: So number three. Okay.
Peter: Yeah. Is this number three?
Jon: Yeah, number three, because that was three you're going to cut it to. All right. Number three, VC's bribing founders to let them in on the next round or for them to choose their deal or for them to acquire the company.
Peter: So when you say bribing, what, what constitutes bribing?
Jon: So I get.
Peter: Like literally, like cash exchanging hands.
Jon: If I look at my text message, I believe. So to me, they wanted me this VC specifically want to be ask you the bribing question. Okay. But they didn't give me more context.
Peter: Okay. Is it okay for a VC to bribe a founder.
Jon: To accept their deal?
Peter: To accept their deal for the next round of the current round you either.
Jon: Sell or for the current round. All right. What what examples of bribing have you seen?
Peter: well, I mean, there's lots, but usually they're not that overt in terms of like, here's cash, right? Well, actually, that's not even true. Okay. All the ways in which VCs bribe founders, they fly them on their private jet to courtside seats with the, you know, the warriors game, the jazz game or the, you know, pick your game.
Peter: Right. Okay. that's not a bribe.
Jon: Or is that cost a business?
Peter: I don't know. That's what I'm saying. Like, what constitutes a bribe, right.
Jon: Okay.
Peter: so they'll do all kinds of things like that. They'll invite them to retreats at the Yellowstone Club and, you know, like, super swanky, blah, blah, blah, or or different, you know, heli skiing or whatever. Right? So they do a bunch of I've seen VCs do stuff like that.
Jon: Is that a bribe or networking?
Peter: I don't know. Depends on how you define bribe, Right.
Jon: Are you calling these bribes?
Peter: I think. Well, what is a bribe? Right. A bribe is some sort of person.
Jon: It's a symptom of a benefit the individual receives that the rest of the people at the table don't participate in.
Peter: Right? Right. So of the v-c, I mean, does a VC provide that same benefit to everybody else? Every other founder? No. Right.
Jon: I think the benefit is because that I mean, it's at the same time, it's not a sure thing.
Peter: Sure.
Jon: And the founder in this case is.
Peter: Well, no bribe is a sure thing. Well, no.
Jon: Bribes, a sure thing. But in this case, like, let's say courtside tickets to your your like an NBA playoff. Yeah. In this scenario, the founders also trying to work to get a deal for the company. Yeah I think in an example that I think they gave which to me doesn't make complete sense.
Peter: Okay yeah it says.
Jon: That if there a 25 I've got a picture of that my computer screens not on a pull it up. Da da da da.
Peter: Da da da da doo doo doo doo doo doo doo.
Jon: Where is this text message?
Peter: So other ways in which I've seen VCs bribe is by allowing the founder to do secondaries. So they'll come in and be like, Hey, look, if you take RDL willing, we'll include buying out $1,000,000 of your secondaries. Right? And that's actually like cash going in their pocket. Now, technically, they're also buying shares. So, you know, they'll couch it in all kinds of things.
Peter: They'll say, well, you know, we we want to invest $10 million because we need to own 20% of the company. And we but we also know the company only really needs like 5 million in order to, to hit its goals and so will buy $5 million of shares from the founders. Right. And and that's how they they justify themselves and how the founders justify them to themselves.
Peter: but I would argue that in a lot of ways that could be construed as as very much a bribe, right? It was like, well, yeah, I'm going to put millions of dollars in my pocket. Yeah, I'm going to go with these guys who are going to give me that deal versus those guys who aren't. Right.
Jon: Have you seen other examples beside that or those are the main ones.
Peter: And I think those are the main ones.
Jon: I think the example they gave is they said it'd be like holding back 25% of the sales price as an incentive for management to stay out after the acquisition. But if I see, I don't see that as a bribe. So if they had just how.
Peter: Is that a bribe like holding back 25%?
Jon: Yeah, we're going to replace that one. We're going to have to have a go at this one.
Peter: But I think it's a good question. Here's the question for you, John.
Jon: That's a little bit final.
Peter: Here's a question for you on the bribery. Yeah. Is any of that a problem?
Jon: Do you I think if you if you look at what's happening for the overall the shareholders of the seat or the founders going to the next games.
Peter: Yeah.
Jon: And they're wining and dining them and it's perhaps setting everyone else up for a better return than.
Peter: Yes. But what if it's what if it's like here's a VC fund that is not a very good partner, is not the right partner for the company. And the founder only goes with them because they got caught sight tickets when they could have gotten a much better VC, there would have been more value add. I think that is a problem and I think I think the reality is like the funds that have to play the like courtside seat tickets don't have like anything more interesting to offer.
Jon: Right? I mean, I look at when you pick a VC you're looking at who can help you get into your next round of funding or your acquisition.
Peter: And does this court side tickets help you do either of those things or not?
Jon: So I think that would be a separate issue. Your point, I think.
Peter: About it like is that the is the benefit being shared broadly with shareholders or is the person who's making the decision getting some sort of benefit that other shareholders aren't getting? Right. I think that's where it becomes like this gray area.
Jon: Are you saying a lot of founders will pick the the the ride in the jet versus the the Sequoia or the university growth funds of the world?
Peter: I don't know. I don't know if they will or not. But, you know, it is ways in which VCs try to quote unquote bribe, cajole, convince, I mean founders to go with them versus somebody else and let to your earlier point, is it just a cost of doing business?
Jon: Maybe you're trying to you need to get people's attention. You need to get them the room. Yeah. People do business with people they're friends with going to basketball games. It's a good way to develop friendships and relationships. Yep. Yep.
Peter: I think it's I think it's a definite gray area.
Jon: Yeah.
Peter: Right. Because it could to your point, it could be, like, totally legit.
Jon: I would like all good reasons.
Peter: It could also be like, you know, like think about if you're a co-founder, but you're like a junior co co-founder and the CEO just, like, got whisked off to Aspen. Right. And you're, like, toiling away, working hard, and you don't really like the the the guy that the venture fund that's coming in because they're like, pushing like, you know, harsh terms or whatever, They don't have as big of a of an option pool or what have you.
Peter: Right? But the founders like, yeah, now we're going with them, right? Because they're good guys, right? And you're like, well, yeah, of course you think they're good guys. You just spent a week in Aspen on their bill, right? Well, I was sitting here toiling away for sure.
Jon: I mean, I think a better example maybe of the bribe scenario would be, hey, take our deal and we're going to give you equity as part of this deal. But again, that would be disclosed and everyone not. And I guess if the founder had the ability to accept that deal or another deal.
Peter: Yeah, but like they're going to specifically give the founder equity. So they're they're saying like, hey, take our deal. And we promise that when we're voting to allocate more of the option pool to people, that you'll get a bigger chunk of it. That's the question.
Jon: That'd be much better. Like, hey, here's a bribe.
Peter: Yeah. That feels hey.
Jon: We're going to, we're.
Peter: Going to help that feel sketchy. We're going to.
Jon: Make sure you get, you know, more equity in.
Peter: Okay. Okay. So that feels sketchy, but talking out of the other side of my mouth here, it depends. It depends because like, let's say I come in and I'm like, look, we need to reprice this company, right? We need to reprice it at a lower valuation, but we still want to make sure you're having it. You and your team are heavily incentivized, so if you accept our terms, we're going to lower the valuation and we're going to bump up the option pool and it's going to hurt all existing shareholders because they're getting diluted by this bump in the option pool.
Peter: But you as a founder will get more so that you are still incentivized. And like I can see a very reasonable case for that. Right.
Jon: Okay. I had a friend who just raised and walked out with a $2 million check from her after the race and had a higher percentage of ownership of the company than he did or she did going in.
Peter: Well, good for them. They probably really good fundraisers.
Jon: That one. I want all the details on.
Peter: Yeah, well, I mean it sounds like it was either like the the fund that back then was kind of a sucker or there wasn't very much competition for the deal or they or sorry. No, there was a ton of competition for the deal and the founder could like name their price. Right. So now all's fair in love and war, right?
Jon: For sure. And I think that that case that the VC want to make sure the founders and it wasn't just the founder, I would think it was the initial founding team. Yeah. Was properly incentivized to run to run the whole way.
Peter: Right.
Jon: So it just surprised me.
Peter: Yeah, they had taken some chips off the table that clean up any of their like needs so that they could swing extra hard on the future. Yeah, it's a, it's a common, it's a common justification.
Jon: Let's invest and we'll give you more equity.
Peter: Yeah. Which I mean where did the equity come from. I mean it came from other investors or other shareholders that were not the founders.
Jon: Right. So I think in this case. So founding team.
Peter: The founding team came out ahead by basically taking value from all the other insiders common and preferred potentially. But now there's no other way to do it mathematically. Like you can't like give people money and increase their ownership and invest money in the company, like mathematically, you know, and not have anybody get hurt.
Jon: I haven't seen the docs. I understand your point. I'm just trying to say.
Peter: Yeah, it look, it's fine if that's what they all agreed to. But, but that's the reality. Like, like equity didn't just magically appear out of thin air right? A bunch of people got diluted. So this is why it's important to. So one of the things VCs do is a will put in a ton of terms clauses of the kinds of things on our preferred shares.
Peter: And sometimes people like, you know, they push back and they're like, VCs are like, so, so greedy and selfish and controlling and all these things. The reality is that if you're not at the table, you're on the table. And I would argue that the people in that scenario that didn't have protective provisions in place to keep this sort of thing from happening, we're on the table and just got sliced up in it.
Jon: And yeah.
Peter: So that's ultimately why VCs do it, because the further along in the company gets, if you don't have some of those protective provisions early, you end up being on the table, not at it. Right. But if you have those provisions now, all of a sudden you're negotiating standpoint because at a minimum you have to relinquish those rights, which gives you some power in the conversation.
Jon: Okay, So don't get in. Is this another quote from your mom? No quote from your mom or amazing.
Peter: Now, this is from, our good friend Ben Dahl.
Jon: Yeah.
Peter: Yeah. I don't think it's like, really attributed to him, but he's the one that taught me that lesson.
Jon: Sounds good. I love Ben. All right, guys, thanks for watching. And venture capital out of FM. Leave your reviews. You have a six star reviews, leave comments, things like that. We want to know how to make the show better. So thanks and join us next time for Bad Founder Moves.
