How to Spot Subprime VC

Subprime venture capital, as I described in an earlier post, is easily recognizable  Here are some of my metrics. Run for the hills whenever an investor…:

1. Seems more interested in how it is built rather than what the disruptive business proposition is.

Innovation becomes successful when it marries macro-economic value with micro-economic (technology) execution. Technology risk is the least of our worries in Silicon Valley, yet fundamental disruption is crucial and should take up the majority of the discussion.

2. Seems more worried about cost of development than cost of greenfield customer acquisition.

Capital efficiency is a buzz-word investors love to throw around. In most cases they want you to be as cheap as possible. But capital efficiency is relative to the cost and value of customer acquisition. Not all venture capital deals start with a seed round below $250K — more disruptive innovation usually costs more to build well (think iPod, iPhone, iTunes, eBay, etc).

3. Talks about valuations before you’ve explained the value of becoming the market leader.

A favorite trick of investors is to value the company based on its present accomplishments and many entrepreneurs fall for it. Their companies become undervalued and underpriced which leads to early loss of control to investors. And when investors run a company, statistically the chances of success have diminished significantly. Early stage companies should be priced based on the value of the idea and accomplishments along the trajectory of market leadership. Your glass should be seen as half-full not half-empty.

4. Seems more occupied with categorizing the investment than understanding its unique business value.

When investors start categorizing investments in technology categories and subsequently base their investment decisions on them, that means they clearly missed the fact that you business proposition could have value regardless. Again, technologies are not the business, application of technology to a market segment is.

5. Talks about capital efficiency without probing market inefficiency.

Again, capital efficiency is a relative term. When a large market is extremely inefficient it probably means that the absolute cost to enter is high (otherwise someone else would have entered it before you). So, the cost to enter the market is a function of its current inefficiency. Many investors are less versed in inefficiencies than you and therefor misjudge the price it takes to enter. As the entrepreneur you will be faced with the inequitable consequences if you decide to bow down and take the investors’ word for it.

6. Doesn’t question market entry risk, but focuses on cost.

Investment risk is what should be top of mind to investors, but many of them think they have the operational experience to challenge the assumptions of the entrepreneurs. In many scenarios market entry risk can be mitigated by developing a better product, but a better product costs more money to build. At any time would I rather spend a dollar on R&D to make the product better, than spend a dollar on marketing expenses to try and make a “cheap” product land better. So, the right amount of money (not cost) is imperative to disrupt a market.

7. Doesn’t ask about the runway to profitability, but the initial round to get in.

Most companies require multiple rounds of funding. Those rounds are not there for you as the entrepreneur, but for the investor to establish milestones to make him more comfortable. An investor that does not allocate sufficient runway, is effectively selling short on the promise of your company and will cost you months of fundraising efforts at every round.

8. Asks you which other investors you’ve spoken to.

Investors are lemmings, and so you should not disclose who you talk to until you have all their term-sheet on the table. Force them to make their assessment of your company independently. Usually each investor has a different risk analysis of your company and last thing you want to do is add up all the negatives before there is a buying signal on all sides. Herd the positives.

9. Asks you to talk with his associates first.

Associates are graduates that should be used to perform due diligence, not to discover a black swan. Many investors will use associates as a way to offload the workload created by the noise inherent to our industry. The minute you get the associate, you have become noise.

10. Asks you more about your education than your work experience.

Building innovation that is truly unique requires an analytical mind and ignorance to anything else but bottom-line results. Education teaches you how to respond to prescribed scenarios, innovation requires the opposite; an ability to respond adequately to a myriad of circumstances that have never presented itself to you, in that composition before. Any investor that focuses on your (or his) business school accomplishments has a warped view of what innovation really is.

Never forget that a great entrepreneurial idea sponsored by the wrong investor yields nothing but failure. Keep searching for the right partner and don’t bow down to sub-prime investment tactics.

Georges van Hoegaerden is the Managing Director at The Venture Company ( ) in Palo Alto, focused on helping companies with technological and market insight, organizational development, team building, selling and managing growth. This post originally appeared on his blog.