Marc Andreessen (who is an investor at Pando, in a personal capacity) took to the Twitterverse recently to outline the latest threat to peace and joy on Earth. That investors from outside the Valley are looking to come in and invest in late stage companies to the detriment of those companies.
Yes, it is possible to be a tad cynical about the interests of a VC guy warning other VCs off his patch but there is something of substance there as well. The basic point is that there’s a form and a style to Valley negotiations, one that’s rather different from how they are conducted elsewhere:
Marc Andreessen and his firm Andreessen Horowitz are advising their portfolio companies to be “highly skeptical” of high-valuation offers from growth-stage investors from outside Silicon Valley.
The reason? Increasingly, these investors are engaging in a practice that is considered “unethical” and “abusive” in Silicon Valley, Andreessen said in a series of tweets, republished by the Wall Street Journal.
That practice is usually considered rather differently elsewhere, being called “good negotiating” more than anything else.
What Andreessen is pointing to is that there’s a form, a norm, for how funding decisions are made in the Valley. The terms of the deal are hammered out first: What is it that we think you’re doing, what is going to be done next, what are the equity options, who gets what, how much money and so on. In effect, all of the negotiating is done upfront. Then investors have, once such agreement is reached, a more thorough look at the company, do their due diligence and then pay up. Or not, if that due diligence shows that there are issues that haven’t already been addressed or are at odds with what was said.
Elsewhere in the economy this isn’t quite the way it’s done. Everything is up for grabs all the time. Anyone can (and does) come back and try to renegotiate any part of an agreement at any time. Nothing is final until the total agreement, after that due diligence, has been signed (it’s a little different with quoted companies but this is how it happens for private ones). And what is being warned against is thinking that you’re going to negotiate by Valley standards and then find out that you’ve actually been using some other set of norms.
The danger should be clear: most companies looking for finance have some idea about when they’re going to run out of their current round (those that don’t know probably don’t have accounting systems good enough to get more finance). So they start looking early perhaps, or maintain a constant conversation about it all. But imagine that an investor outside the circle of social (or contractual) conformity offered some wonderfully high valuation, said we just need to sort out these last details, and by the way would you give us an exclusive on your next funding round? You know, just while we sort out the jots and titles?
In the world where anything is always up for negotiation that’s rather dangerous for anyone who knows when they’re going to run out of money. For due diligence will reveal it, even if the opening conversations haven’t. And the Valley way is, well, yes, we know you’re going to run out of money, that’s why you’re asking for more. And competition between funders means that no one strings it out. But what about that investor that has the exclusive rights? As that time you are going to run out of money comes closer and they’re still arguing about whether the company should have business or first class travel (for, of course, no reason other than it’s a very important point, not a method of simply prolonging the negotiation, oh heavens no) then as that deadline looms the likelihood of early investors being forced to hold the lube and bend over when it comes to discussing price is going to increase.
That different industries or locations have different negotiating and contractual techniques shouldn’t come as a surprise but it often does to those who who start working across the boundaries of either an industry or a societal group. Cut flowers are sold at auction by descending price, paintings of flowers are sold at auction by ascending price. Negotiations to sell steel are very different from those to sell tantalum and the trading process for stocks is entirely different from that to trade beer. It might be that these differences are there for good logical reasons it might just be path dependency and historical happenstance. But knowing that everyone involved is using the same system is pretty useful.
If Andreessen’s point had only been “local investors for local companies” then I’d be one of those looking askance at the attempted protectionism. For fewer outside investors would lower the valuations at which the locals could get into deals. But the point I take him to be making is that you’ve got to understand the negotiating norms, the societal expectations, that the other guy is bringing to the valuation and investing event. And these might well not be the same we’re all used to when that investor is coming from outside our cosy little world.
[image via thinkstock]