VCs don't say no.
If the VC is interested, you can expect a call and, eventually, a check. If the VC is not interested, you won't get an answer. Saying "no" encourages you to look elsewhere--that's not good for the VC, who prefers to have you hanging around rather than going elsewhere for funding. Fads change; the herd turns; your proposal may look better next year. In addition, the VC may want more due diligence from you--to add your ideas to a different start-up's plan.
If VCs think you have few alternatives, they will string you along:
"I love the deal, but it'll take time to bring the other partners along."
"We need more time to get expert opinions."
"We're definitely going to fund you, but we're closing a $500 million fund, and that's taking all our time."
"I'll call you Monday."
Once your alternatives are gone, they negotiate their terms.
VCs have pets.
The VC's version of a pet is the "executive in residence." Many venture firms keep a cache of start-up executives on staff at $10 000 to $20 000 per month (a princely sum to an engineer, but just enough to keep people in these circles out of the soup kitchens). Start-up executives, loitering for an opportunity, may collect these fees from more than one venture firm, since the position entails no more than casual advising. These executives have "experience" in start-ups. When you show your start-up to the VCs, they will grill you about the "experience" of your executive team. It won't be good enough, but not to worry, the VC supplies the necessary talent. You get a CEO. The CEO replaces your friends with cronies.
The VCs' pets are like Hollywood's superstars. Just like Julia Roberts and Tom Cruise, the superstar CEOs command big bucks and big percentages (of equity)--driving up the cost of the start-up--but are "worth it" because they give investors and VCs a sense of security.
Your idea, your work, their company.
The VC's CEO gets 10 percent of the company. VC-placed board members get 1 percent each. Your entire technical team gets as much as 15 percent. Venture firms get the rest. Subsequent funding rounds lower ("dilute") the amount owned by the technical team. Venture firms control the board seats. The VC on your board sits on 11 other boards. Board members visit once a month or once a quarter, listen to the start-up's executives, make demands, offer suggestions, and collect personal stock options greater than all of the company's engineers hold, with the possible exceptions of the chief technology officer and the vice president of engineering. The VC's executives control the company. You and the rest of the engineers do the work.
VCs take advantage...to maximize the return for the venture fund's investors. Engineers are getting short-changed.
One company I know got a good valuation a year ago. Over the year, it grew rapidly, developed its product, met or exceeded its milestones, and spent its money according to plan. When it was time to get money again, the funding environment had changed. Last year's main investor wouldn't "price" the shares or "lead" the new funding round. The "price" declares the number of shares and the valuation of the company. Think of the company as a pie. It is a certain size (valuation) and it is cut into a number of slices (shares). An investor "leads" by offering a specific price for shares for a large percentage of the next round. Other investors follow at the same price. Even though the company's engineers had executed flawlessly, the round came in at less than a third of last year's valuation.
As a part of closing this "down" round, the last year's investors renegotiated the previous round, effectively saying, "Since this round is lower, we must have overpaid in the last round. We want more equity for the last investment." If there had been fraud by the entrepreneurs instead of flawless execution, renegotiating the previous round might have been reasonable. Imagine the opposite scenario: "In light of market developments, it's obvious that your idea is worth much more than we thought, so we're returning half the equity we took for last year's funding." It's so ridiculously improbable that you can't read it without laughing out loud. That we accept the converse highlights the entrepreneur's weak position.
Values at variance
The VCs know money and they don't care about the technology; the entrepreneurs know technology and they need money. Money knowledge applies across all the start-ups; the technical knowledge is unique to each. The VCs don't care about any single technology because they spread their investments across the opportunities. Knowing money isn't the same as knowing value. A year ago, VCs were lining up to give money to Internet dog-food companies; this year, they wouldn't back an inventor with a working Star Trek transporter.
It's financial; it's not technical or personal. To the VC, the engineer and the ideas are commodities. The venture firm squeezes the technical team because it can. VCs believe that they are exercising their responsibility to maximize return for themselves and for the fund's investors.
Reducing the engineers' share of the pie is counterproductive, however: they become demoralized; productivity suffers; eventually, they leave. Engineers are not commodities. Replacing a chip designer one year into a complex design delays the project six months while the replacement engineer learns and then redesigns the work-in-progress.
VCs don't appreciate that the electronics revolution is built on the backs and brains of engineers, not of executives. Moore's law and engineering talent drive the electronics revolution. Tremendous market pull for its products builds momentum. The pull is so great that the revolution is indifferent to the talents and decisions of its executives (legendary blundering causes only ripples), but it depends on the talent and the work of its engineers. The engineers are the creators of wealth; the VCs are the beneficiaries.
Fixing the problem
The engineers building the future deserve a fair equity share in the value they create; today they don't get one. For them to get their share, wealthy engineers must fund start-ups. And they don't have to be Bill Gates to do so. "Qualified investors" can participate in pre-IPO funding. This means your net worth (exclusive of your home) must be at least a million dollars or you must meet minimum annual income requirements. These days, the millionaire's club isn't all that exclusive. Many engineers are qualified investors.
If you are a qualified investor, participate in start-ups as an "angel" investor. An angel investor participates in early or "seed" funding rounds. Don't do it with more money than you can afford to lose, however, because it is risky. To change the situation I'm describing, start-ups need your money and they need your advice. More money and more start-ups bring faster progress and create more wealth. Creating wealth isn't only about money; it's about quality of life and it's about raising the standard of living for everyone (but that's another essay).
Engineers should band together to form venture funds. Start-ups need more angel funding and they need better-organized angel funding. I'd like to see a dozen or so $100 million venture funds run by nerds. These nerd-based venture firms would work at the seed round and at the next funding round (called the A round). They provide initial funding and advice and they, with the benefit of professional financial advice, represent their start-ups in future funding negotiations with traditional venture firms.
Here's a third suggestion. I'd like to see an engineer-run start-up whose goal is to raise $100 million in a public offering. The money becomes a fund for sponsoring start-ups. It's a public venture firm and it sells shares to raise money. Investing in start-ups wouldn't be exclusively for rich people; anyone who could buy stock could be investing in start-ups. Ideally, the public VC firm would be managed and run by nerds with empathy for nerds in the start-ups.
I wanted to publicly thank more than a dozen people for help on this essay, but they all said "NO!" None can afford to have the VCs find out that they contributed.
