Power shift tests VC-entrepreneur relationship

The honeymoon period between entrepreneurs and venture capitalists is long
gone. Without provocation, each party reels off a laundry list of complaints
about the other. And friction is unavoidable, since the VCs are more intimately
involved with their portfolio companies than ever, spending more time on site,
asking more questions, demanding that performance milestones be met. Separate
beds aren’t an option here.

By Scott Kirsner, Globe Columnist

Can this marriage be
saved?

The most obvious change
in the VC-entrepreneur
relationship is the
180-degree power
reversal. In the late 1990s,
entrepreneurs held all the
cards. When raising
money, they could play
one venture firm off
another, and hold out for
the best possible deal
terms. Now, says Bob
Fleming, a founder of Prism Ventures in Westwood, ”the power has swung the
other way. The entrepreneurs took advantage of it when they could, and the VCs
are taking advantage of it while they can.”

Entrepreneurs gripe that when they are offered a shot of venture money these days,
the investors want the bulk of their company in return. Investors require the top
executives to cut their salaries and reduce their bonuses. They drag negotiations out
until the supplicant company is on the verge of collapse, with no other options but
to take the money on whatever terms are offered.

And more than a few entrepreneurs believe that venture capitalists unfairly expect
today’s investments to compensate for their bad bets of the dot-com era.

”In a lot of cases, [venture firms have] lost money on lots of deals from the late
1990s,” says Ron Elwell, chief executive of Octave Communications, a maker
of audioconferencing gear in Nashua. ”They’re putting that pressure right back on
you. It’s like, `We’ve got to really make money on this thing now.”’ (Octave has
raised a total of $33 million, including a round of $4 million last month.)

Fleming calls foul on that accusation. ”I don’t think that’s the case,” he says. ”But I
do agree that venture capitalists are ultra-sensitive about not overpaying” for their
stake in a company. ”There’s little motivation to do a deal unless you can get it for a
low price,” Fleming says.

Universally, venture capitalists grumble that the founders of tech start-ups still hew
to an irrational belief that the Nasdaq’s nose dive shouldn’t have any effect on how
their companies are valued.

Some of the strains between venture capitalists and entrepreneurs, observes Matt
Harris of Williamstown-based Village Ventures, have arisen because many of
the relationships started in much rosier economic times.

”When you did a deal in 2000, both of you had vastly different expectations than
you have today,” Harris says. The expectation was that both parties would see
their champagne wishes and caviar dreams come true overnight. The reality is a
daily grind with no end in sight. ”A big question is: How are you going to get along
now?” Harris says.

Getting along is a challenge, especially given that the two parties are spending so
much quality time together at close quarters. Call it ”The VC Who Came to
Dinner.”

Les Yetton, the chief operating officer of Softricity, a Boston-based start-up that
raised a third round of $14 million late last month, says that board meetings last
much longer these days, with investors interested in much more operational detail.

”In some ways, it feels almost like an [acquisition], and they now own the company
and are going to come in and run it,” he says. (Prism is one of Softricity’s investors;
the latest round of funding valued Softricity at significantly less than its previous
round – a down round – which isn’t unusual.)

”I do hear a lot of people complaining that the VCs are micro-managing things,”
says Harry Hanson, head of the technology practice at law firm Choate Hall &
Stewart. ”Their investors want to sit in on management meetings, and are really
being a pain in the neck. That doesn’t happen when everyone’s doing well and
making money.”

Entrepreneurs say venture capitalists have lost their stomach for risk and slowed
their pace of investing to a crawl; VCs say they’re just conducting more due
diligence than they did in the heyday, and are gravitating toward companies that
have built an early version of their product and begun testing it with customers.
Entrepreneurs contend that VCs are forcing reductions in budget and staff to the
point that a company may survive, but isn’t well-positioned to succeed; venture
investors reply that leanness is the new look for 2002.

Also producing tension are the milestones that venture capitalists lay out as a
condition of further funding. Sometimes, these relate to the development of a
product, but more often, the milestone is a set number of customer deals or a
revenue figure. ”It’s definitely more formulaic now,” says Vijay Manwani, a
founder of Bedford-based BladeLogic. ”They say: `Here are the gates you gave
to go through to get the next round, and to get a higher valuation.”’ But sealing
customer deals in the current stagnant market feels about as easy as opening a ski
area in August.

There are few possible exits from the relationship – and none of them are appealing.
Shut the company down and try to sell the assets into a moribund buyer’s market.
Merge it with another tech start-up suffering from a similar lack of momentum.
Angling for a public offering is unrealistic, as is praying to be bought by a larger
company.

Is there anything that entrepreneurs and VCs agree on? Only that it’ll take
incredible fortitude and focus to survive a tech-buying slowdown that shows no
signs of abating.

And even there, they shade things slightly differently:

”It’s Darwinian in the extreme,” moans Ron Elwell at Octave.

Bob Fleming’s take: ”Welcome to entrepreneurship. If it was easy, everybody
would do it.”

Scott Kirsner is a contributing editor at Wired and Fast Company magazines.
He can be reached at [email protected] .

© Copyright 2002 Globe Newspaper Company.

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