What value add?:  Readers respond

Last week I wrote about an email a colleague had sent me, with a frustrated critique of cleantech VCs.

Since that post, readers have been emailing me their thoughts and reactions.  Some agreed with my take (disagreeing with a couple of key points in the email), and some came back with strong agreement with the email (one reader’s reply, which was provided for background only, went so far as to argue that the email understated the problem).

One Boston-area entrepreneur, Scott Rackey, had a very thoughtful take, one that he was gracious enough to let me share with everyone:

As with most statements of this tone, it is partially right.  At some point all funds focus on later stage deals (fad or no fad) with good reason.  Most funds have a fixed life.  As funds get older, a VC’s focus appropriately shifts to later stage deals.  This is analogous to an individual gradually getting out of high growth equity investments as they approach retirement.  There is nothing inappropriate in this. 

But what about those funds that still have plenty of runway?  They don’t have the same excuse. 

I would argue that VCs are not trying to anticipate irrational investing fads - they are creating them.  It starts by VCs honestly trying to anticipate fundamental industry change, “inflection points”, (insert your management buzzword for big shift here).  This is a strategy that helps save time because it frees the investor from looking at every deal on its individual merits.  There are “sweetheart” deals in every industry regardless of how slow the larger industry itself may be.  However, finding and vetting these deals takes too much time.  So, investors instead try to identify investing “spaces” that are about to boom.  The thought is that “a rising tide raises all boats”.  They place a few bets within the target investment space and then hope they guessed right.  The thing is, VCs all talk to each other - a lot.  (Life gets easier if someone else does the legwork to identify a promising investment space.)  Add in a fear of looking stupid for passing up a great opportunity plus a general herd mentality, and before you know it,  you have an investing fad.  Nobody tried to make it happen.  It is just an emergent behavior of the crowd.  Some people make money while others pay too much because they are too late.  Nonetheless, the behavior is stable and these cycles seem to keep happening.  Examples are fuel cells, distributed generation, solar, biofuels, demand management, carbon credits, etc. 

This strategy of picking the opportunity before finding the company is pervasive.  When VCs are interviewed, they are typically asked what sectors they are targeting and why.  They usually do not say “we look at every deal individually” without winking because they cannot be experts in all industries.  Instead they say something like “we are very excited about the (XXX) sector because we believe that growing shortages of (YYY) combined with an industry shift to (PPP) and/or increasing regulation of (ZZZ) will create unprecedented opportunity.  We are quietly looking at several excellent deals in that space right now!” 

I see this as a CEO all the time.  Investors have already emotionally decided whether or not they like my deal before they even hear it.  I either fit in one of their target investment spaces or I don’t.  This is especially problematic for my company which is in the fuel cell space.  I even had one VC (who was new to the Cleantech space) say “we are not considering fuel cell deals - we heard they didn’t work out.”  Clearly, the investing fad for my sector is past - for now. 

I should hasten to point out that this fad-creating behavior is for new investments only.  Once a VC has taken the leap, I believe that most are extremely loyal and supportive partners in the effort to build a successful company.  I personally have not seen VCs that are deliberately engaging in some kind of “pump and dump” strategy.  What I have personally seen is that my VCs work very, very hard to make my company successful.  For the most part, these are honorable people doing the best they can with a hard problem. 

So what is a CEO in an out-of-favor space to do?  You have to find the right VC.  There are VCs out there that have the resources, reputation and fortitude to lead the herd.  They are the ones trying to identify the next industry shift that will create opportunity.  If you have a good enough deal, and you can convince that one VC, you can be the deal that all the later ones try to copy. 

What is my advice for the VC?  Try to be that right VC that can see a little further and does not care what your peers think.  Hell yes, it is risky for you personally rather than just risky for your fund, but if you don’t take risks…