Series on Trust: Partners and (or vs.) Non-Partners

This is the fifth and last blog post in a series on trust.  I’ve written in the past about trust between a VC and an entrepreneur (“When Entrepreneurs and VCs Break Up”), between a VC firm and its investors (here and here) and among Partners in a VC partnership (“When VCs Divorce”).

Today, I’ll write about trust between Partners and non-Partners.  Regarding the latter, I’ll focus on members of the investment staff who are not Partners.

Non-Partner titles vary by firm, but the more common ones include:

  • Associate
  • Principal
  • Vice President
  • Venture Partner

When a firm has a good track record, it can raise more funds.  With more investment capital comes a management fee, which can be used to hire more people to the team (for more details, read “How VCs Are Paid”).  That is why a firm hires non-Partners.  They have more capital and need more people to find investments.

Trust isn’t an issue initially, but it can be over time.  Here are some common scenarios:

1. The non-Partner who wants to be promoted.  New staff are hired mainly to source new opportunities.  There is a very tight hiring screen, and the ones who make it are always bright, energetic, and engaging.  And, incredibly ambitious.  They want a promotion to the next title.

Since it often takes eight to nine years (or more) from the initial investment to an exit, it takes a long time to know if an Associate’s sourcing is making the firm money.  So, the most obvious metric for evaluation is this: how many investments has that Associate sourced?  To get promoted, she needs to source and shepherd through a VC investment committee multiple opportunities.

Normally, this isn’t a problem. But, if the Associate is also doing most of the diligence on a new company, then the Partners have to trust that Associate. Is the person being objective, or is there bias there given the Associate’s incentive to get the partnership to a “yes” answer?

2. Attribution.  Attribution, or credit for an investment, is huge in VC.  A VC with a strong personal track record has the flexibility to switch firms. When a VC leaves his firm, there can be a prolonged and painful negotiation about attribution.

This dialogue is also complicated.  When an investment does well, a lot of people want to claim credit.  If an investment fails, others run away.  As the old saying goes, “Success has many parents, and failure is an orphan.”  So, when a VC leaves a firm, there may be a dynamic where other Partners want to take credit for that VC’s good investments, and let her take all the blame for the investments that failed.

So, deciding attribution is critical for VC firms and individual VCs–and, it is tricky.  Who gets credit for an investment?  The Associate who finds the opportunity and does all the diligence, or the Partner who sits on the Board?  What if there are two Partners on a Board?  Is credit given 50/50 to each Partner?

Here’s a painful example.  A friend at a large VC firm approached me with a conundrum. He sourced an opportunity, did all the diligence, negotiated the terms and sat on the company’s board.  At the last minute, there was another board seat available, and the VC firm decided to take two board seats.  The VC firm’s founder took the other seat.

After some ups and downs, the startup eventually did well and went public.  After the IPO, this VC friend of mine heard from another VC firm that the Senior Partner was claiming credit for the investment in the marketplace. Behind his back.

My friend asked: “What should I do?  Can I trust that guy?” He was shaken. I didn’t know what to tell him.  How does he negotiate credibly with a Senior Partner, who controls the firm, can cut his pay, and/or fire him?  That felt like an unfair negotiation.

That friend is now making plans to leave his VC firm. He no longer trusts the Founding Partner.

3. Transparency (or lack thereof).  As I’ve written previously, some Partners are kept in the dark about the firm’s financial statements and are not involved with major hiring and firing decisions (see “Top-Secret VC Economics and Power Unveiled”).  That can make for an awkward dynamic, as this anonymous Quora post mentioned:

Never have I more felt like a second class citizen than when I (and several other “partners”) were not invited to certain meetings around firm governance.  Also no transparency into the firm’s hiring/firing/financials

What’s being discussed on those meetings? How much money are the senior Partners really making? Who is “on the bubble”? What are the firm’s growth plans?

In closing, trust is critical at a VC firm.  As my friend learned, broken trust is very hard to re-forge.

When there’s a great deal of trust, a firm is very stable and can get through ups and downs. When trust is gone, a firm will experience a great deal of turnover. Turnover at the Partner level creates complications for everyone:

  • For the VC firm: As Partners leave, the remaining Partners have to take over the board seats.  This contributes to board seat overload and a literal case of VC indigestion whereby experienced investors may each be on 12 to 15 boards (see “The VC and Super-Angel Digestion Problem”).  Partner turnover is also a huge red flag for investors.  They’re committing 10 years’ worth of funds to a VC firm, but who will be there to manage the capital in the end?
  • For the entrepreneur: If that sponsoring Partner leaves, someone else will take over the board seat.  This may be a Partner who believes in the company, but usually isn’t.  It may be another Partner, but often a non-Partner is appointed to the seat.
  • For the Partner: If he definitely thinks he is leaving, how can he ethically sponsor new investments?  Start-ups take so much time, and is it fair to invest in a company when you know you’re going to quit your VC firm?

I hope you’ve enjoyed this blog series on trust and that the posts have been helpful.  At Kepha, we think trust is everything and we try to shape our behavior through our values.

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