How do Investors Handle Failure?

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Liveblogging a panel led by Adriana Gardella (NYT), with Esther Dyson (EdVenture Holdings), Cindy Padnos (Illuminate Ventures), Manu Kumar (K9 Ventures), and Guy Hirsch (SayHired) at Failcon:When you found that one of your entrepreneurs was failing, what did you do?Esther Dyson: How do you recognize it? Acknowledging that what you were doing was wrong is hard to see, and a hard call to make. The people problems are harder, subtler, and more difficult to fix than the other problems. You don’t want to undercut someone you like…  There is a grieving process as you start to notice that there are problems. it takes a while, you ask other board members. You need a board who will take action. it often takes longer than it should… In a couple of cases, it takes years. You will always find a reason to excuse it taking too long. In one case, the CEO never talked to more than one person in the company at the same time… But in that case, I wasn’t the person closest, I wasn’t the lead board member.What’s the process for failing?Guy Hirsch: When you know you need to shut down operations, you are now optimizing for how much cash you have left, letting go of employees. Get your investors to be proud of how you’re handling failure. In this case, optimize vendor management, letting people go, etc. You don’t want to get to bankruptcy. For a while, you’re the black sheep, but you can turn into a hero if you land the plane safely.Esther: Emeritocracy had a user commenting/ranking tool. It was really great, but didn’t get traction. He gently closed it down, came back to me and the other big investor, and did a debrief. He called us instead of us having to call him. I would hate to be involved in a company where you have $50k in debt, have to negotiate with creditors. He came to us, and I would invest with him again if he came up with something reasonable. The other one was Facebook on a cellphone 10 years ago; that beautiful company got no traction. He closed it in a classy way, and that really matters.Cindy Padnos: We were working with a company who wasn’t going to be a suceess. $2MM in funding, no traction, milestones not being met. We talked with the founder, and sold the company back to the founder. He strongly believed in the business, but he had intellectual property. We could have said “no”, but we thought it was the right thing to do. We sold it back to him for $10k.Manu Kumar: I was advising a company last year out of UC Berkeley. Built an awesome product, and I was asking them “what do you need?”  The day before we ended up signing the termsheet, they ended up getting sued in a frivolous lawsuit. In this case, the event destroyed the fundraising round. The founders can’t represent the company in court, and it had to shut down. The way these guys handled the situation was so impeccable, that they have a blank check from me. If these guys want to start something new, I’d fund it. The moment they found out, they called up all of the investors, and told us beforehand that they had been served. They could have sat on it for 12 hours, and we would have signed the termsheet, and we would have invested in a lawsuit. They were very upfront, and the way they handled a bad situation showed their true character. I would totally back these guys again.Cindy: What is important to me is “no surprises”. They will call me proactively, even if the board meeting is the next morning. They will call or text me ahead of time. When I was a first time CEO, I didn’t know that my job was to manage the board. I didn’t do it properly at first, but the second time, I was much more proactive. The surprise situation is what you want to avoid.Esther: 20 years ago, I was on the board of a company run by a geek. It was clear this guy had to resign, and no one on the board wanted to deal with it. I went to the CEO, and said “I don’t know how to do this, but the result has to be that you resign as CEO, and this other guy takes over. I want to end up friends afterward.” If you focus on what you are trying to achieve and work backwards from the result, that will work.Question: anyone have a story of closest you’ve seen a startup to hitting the mountain, and then pulling up?Manu: That happens with every startup. Every startup is close to death before it succeeds. My startup had $1k in our account, and $35 payroll tomorrow. That is the closest one of my companies came to hitting the wall. We made it work by calling everyone who owed us money, and asked them to wire it so that we could make payroll. You beg!Cindy: How well can your team deal with the peaks and valleys? You might have to protect the rank and file from this, once you’re over a dozen people. But the early people have to LOVE the highest high, and can live with the low and not be demoralized, and see the next peak ahead.Guy: You cannot go up if there is no fuel. You don’t need to think about failing when you start, but you can avoid signing longterm contracts. You should arrange things so that you could shut down within 15 days if you need to. On the execution side, if you raise money from a big VC who has a lot of portfolio companies, you can push your vendors to waive money you owe to them. Sometimes you have that buying power around if you raise money from big VCs.Esther: FedEx: Fred Smith went to Vegas to raise payroll. The reason failure is so valuable is that it gives you courage. Once you shut down a company, you know you can survive. You think it’s a fate worse than death, like cancer. But there is life after this… Someone who has completely failed, you don’t clutch next time it happens.Question: can you have too little fear of failure?Esther: You can be too careless, you can refuse to say it isn’t working.Manu: Company was doing OK, exit would have been 3x in two years. But the founding CEO made one big blunder. He showed all of his cards to the potential acquirer. He showed how much cash he had in hand. You need to have multiple potential acquirers… The acquirer now says “the company is almost out of cash; I’ll wait a few weeks until they run out of money.” The return was .3x. You always want to create the market, and have 2 or more people at the table.What do you look for when companies are pitching you? Traits in a CEO?Manu: I ran an experiment. What works better… A founder who is great at sales, or who is super technical? I went on two ends of that spectrum. What I found it that none of them work. Need a technical founder who understands business. Need to have a balanced perspective of being able to build the product, and understand the business side of things.How do you handle it if the founder is ready to throw in the towel, but the investors want to keep going?Cindy: Founder was approached by M&A, and everyone would have done well. Founders looked at it and wanted to grab the deal. We brought in investors who would show what next funding would look like, founders were able to get some of their cash off the table, which made them happy. A year later, there was another M&A offer for 3x more, and everyone was very happy.What if the board doesn’t want to sell?Esther: It depends. It’s that same old magic. if I look at all my investments, one out of 10 is a big success. But the others end up getting bought, sometimes for right around what you invested. You end up being a body part for someone else.How have companies who have lost money for you done down the road? Have there been rebounds?Manu: the company we sold for .3x, they are still around today.Have you seen the “hit by a bus” scenario? How has that affected the investment?Esther: yes, it does happen. I have a company where one of the two co-founders started a company called “sunshine client”, and changed his name to “sunshine client”. He’s clinically mentally ill. It’s been a problem.Manu: I dealt with that in my first company. One requirement for the financing was to have a $3M key person insurance policy. I was worth more dead than alive.Anyone have a monetary gain, but considered it a failure?Esther: haven’t got the financial gain, but the guy sued someone he should not have sued.Guy: Even if it was a failure, I ended up with more money than I started with. I don’t think that’s the measure.Is there anything in terms of culture that invstors look for:Cindy: I look for an environment where the customers is king. How do we build and deliver something that delights the end user? I haven’t seen that kind of focus fail, ever.Manu: I look for a culture of capital efficiency. How do they manage their personal finances.Guy: investors don’t know what they want. They think they know, but they might not know. they make judgement calls based on same drivers that are there when you try to find a spouse. a lot about hthe chemistry. what your network says. a alot about the soft things, not hard data.How does it go with other partners in your investment firm when an investment goes bad?Cindy: The answer is that we ALL step up to do anything and everything we can to help that company get to a reasonable exit. Everyone has to help out. There is no finger pointing. When there is an issue, it is all of our money, and all of our responsibility.Esther: That’s why I invest only my own money.(panel ends)