One thing you notice pretty fast if you compare what constitutes a big exit for a deal in one of the venture capital centers (let’s call these “Venture Center” deals) with what constitutes a big exit most everywhere else (let’s call these “Wilderness Deals” is that you need at least one extra zero at the end of a Venture Center deal to call it a home run. Is that because Wilderness Deal entrepreneurs don’t have ideas as big as their Venture Center counterparts? Maybe, but I don’t think so. It is, rather, at least partly because Wilderness entrepreneurs have seldom, historically, had access to the kind of capital that Venture Center entrepreneurs have access to. “Big” Venture Center exits are typically an order of magnitude bigger than “Big” Wilderness exits at least partly because Venture Center entrepreneurs have an order of magnitude more venture capital at their disposal than their Wilderness brethren.
But that – access to Venture Center-like venture rounds in the Wilderness – is something that is going to change over the next several years, at least in parts of the Wilderness, as, say, the Chicago-Wisconsin-Minneapolis region*. At least I think and hope so. And if it does, during the transitional period there is going to be an extra dollop of tension between some Wilderness entrepreneurs and Wilderness-based risk capital investors. Why? Because today’s “Wilderness Model” of risk capital investing is, essentially, invest $500k to $5 million and exit for $10 million to $100 million. Most Wilderness based investors have neither the capital – nor at this stage, the fortitude, connections, or patience – to invest in the “Venture Center Model,” which, essentially, is to invest $5 million to $50 million and exit for $100 million to $1 billion. They fear, and not without reason, that pivoting from the home run to the grand slam paradigm mid-stream is going to add new levels of risk – in terms of execution, time, and perhaps most to the point, the potential for being washed out by downstream mega investors.
As the Venture Center Model emerges as an alternative in select Wilderness locations – effected Wilderness entrepreneurs may find themselves caught in a dangerous dynamic with their early Wilderness investors. Early stage Wilderness entrepreneurs that see themselves as candidates for downstream Venture Center Model investments will need to be very careful in their courtship of local early stage Wilderness Model investors. More particularly, if an entrepreneur is thinking that he might have a Venture Center Model opportunity – and if it materializes he will want to take it – he should discuss his thoughts before taking early stage money from a Wilderness investor that, more than likely, is assuming a Wilderness Model exit.
You might think that discussing this kind of thing up front with a prospective investor is neither necessary (if the deal morphs into a Venture Center Model candidate, what’s the problem?) or appropriate (it might queer the deal). As to the first point, it may not be necessary, but, when the time comes to make the pivot, an early investment group that doesn’t want to make it can cause lots of headaches, and seriously jeopardize the chances of executing the pivot. As for appropriate, yes, it might queer the deal to put the issue on the table before hand. On the other hand, a frank discussion of possibilities between entrepreneur and investor can be an important bonding experience – or a good time to identify a relationship that will crack under any strain going forward.
Now, to be clear, I am not saying that the courting of early stage Wilderness investors should involve a deep exploration of alternative investment/exit paradigms. But the discussion of exit alternatives should, I think, at least touch on the potential that what everyone is likely thinking (at least the investor) is a Wilderness Model deal in terms of capital needs and exit parameters, could morph in to something bigger, and what the various parties might think about the choices that would need to be made in that eventuality. This should be an ongoing discussion post-financing as well. Pivoting from the Wilderness to the Venture Center Model mid-stream is never easy. It is much harder when the early investors think the entrepreneur is pulling a bait and switch on them.
*NEA’s recent announcement of a Chicago office is one very positive sign on this score.