Invest in Relationships, Not Transactions

Why founders should want VCs (and vice versa) who treat investments as relationships, not as transactions

Oct 20 · 8 min read

As I prepared for our annual LP meeting at Aleph, I wanted to reflect on our investment strategy in this era of weaponized capital, or capital as a commodity. A quote from an article my friend Sam Lessin penned a few months ago stood out in my mind:

“You will know you are doing real venture capital when you aren’t competing with other investors to finance a deal but are instead offering to invest in people, industries and ideas that don’t yet have access to capital. That is where money can be most useful, and also where returns can be the highest.”

Sam’s framing is what I would call “new versus obvious.” New or untested entrepreneurs don’t have access to capital. You obviously back repeat entrepreneurs. New ideas or industries are out of most investors’ comfort zones. At this point, most SaaS software, for example, is not.

Aleph’s mantra since inception has been “different is better than better.” For us, it is always more important to think and act in different ways rather than just improve on existing constructs. “Better” is always compared to existing models or experiences and generally delivers a linear outcome. “Different” stands out and provides non-linear results.

In contrast, the speed and alacrity with which Tiger moves to issue a term sheet is what I would call “better than better.” It is not different, but it is “better,” faster and more seamless than other funding routes. Perhaps it is even significantly “better than better.” They move faster and with more capital and higher prices into prime assets, leaning into commoditized capital deployment with more speed and heft. They almost create a self-fulfilling prophecy, achieving the results of the financial model they built for a company by anointing the winner, pulling through ever more capital at higher valuations and accelerating growth. “Better” or “better than better” seems to be working for growth capital.

But venture capital (as distinct from growth capital) has never been about “the model,” “pulling the model forward,” or accelerating the winner. Venture capital has thrived in uncertainty: uncertain technologies, uncertain market trends and uncertain capital availability. The stress, unlikelihood and massive opportunity size of a string of low percentage possibilities occurring is what can create outsized outcomes and returns as well as transformational companies. The unique insight, innovation and execution of a set of entrepreneurs who set out to fix a problem, create technology or transform an industry is the magic of venture capital.

Lessin’s “newness” observation certainly applies to new industries, or what I call “pre-industries,” which is either an industry not yet created (think private space exploration before SpaceX) or an existing full-stack industry still unspoiled by tech innovation (think Airbnb, Daisy in building management or Lemonade in insurance). Pre-industries obviously also have uncertainty.

In addition, many early-stage founders and companies do not fit the model/extrapolation approach because great entrepreneurs are breaking existing models and behaviors or creating them almost ex-nihilo. They are tinkering their way through uncertainty. Think about the early stages of Square. It had a little cube through which cab drivers and others swiped a credit card. It then pivoted. Imagine the uncertainty in Tesla where an entirely new design, premium product approach, battery innovation, precision manufacturing and a new business model had to come together in a string of stunning successes to birth an industry. There had been previous electric vehicles, but nothing that was entirely reconceived like Tesla.

Expectations by commodity capital investors to pull the model forward in either of these cases would have led to disaster.⊃1; Lemonade, where I was fortunate to invest, was really tough to model as it took real time to get the loss ratio under control and prove you could sell multiple products to the same customer over time. Moreover, they completely innovated the business model of insurance, a model that was unproven. Initially, Google had no business model that you could pull forward; their first one — selling search servers — flamed out and then… boom. And what of Airbnb?

Ergo, while “newness” is certainly one form of uncertainty you can invest in, I think there is another non-obvious but more salient one that today sits at the nexus of what I call scarce and proprietary.

In an era of transactional investing, relationships are both scarce and proprietary. They are “different.” As an investor, relationships provide access to entrepreneurs who are looking for a combination of support, insight, brainstorming and assistance in building teams that have real chemistry. Those relationships are critical for pitching A+ executives to join these nascent startups as well.

Today, many entrepreneurs are taking easy capital without developing relationships, which I believe may come back to bite them when times get tough. They may have already felt it when they can’t find recruiting help or a fund to pitch in when the model is not exactly right. Relationships are also proprietary. If you invest time, energy, your network and wisdom with the right people, they will want to keep working with you even when a faster and better transaction comes along.

As we saw back in the early 2000s, founders should also beware who they get into business with because, at some point, markets turn. When that happens, you really want someone in your corner who treats the investment as a relationship, and not as a transaction.

Relationships yield networks, insights and access, all of which can help navigate startup uncertainty and improve the odds of big outcomes. They also help an investor overcome the uneasiness inherent in jumping out of his or her investment comfort zone. I had never invested in healthcare before our investment in Healthy.io four years ago. However, years of relationship building with Yonatan Adiri, Healthy.io’s brilliant and inspiring CEO, as well as the people around him, not only gave me access to invest in this transformational company, but also helped me overcome my reticence to invest in healthcare. I think, if you ask Yonatan, he will tell you that the deep relationship came in handy during challenging times and critical junctures. It also helped with recruiting talent, which is perhaps the most scarce resource of all.

Successful early-stage investing is based on relationships. I would even say cherished relationships. Like familial relationships, the VC/entrepreneur relationship enables a company to grow out of early childhood and through the ups and downs of adolescence. It accelerates the learning process, product-market-fit and early customers who take a risk on the new company. In contrast, growth investing is about maintaining growth rates through speed, scaling a playbook and capital availability.

The scarce and proprietary nature of relationships should give unique access to early-stage entrepreneurs. My Benchmark partner and mentor Bruce Dunlevie has often remarked that venture capital is a “low market share” business, but that is exactly why you need to reach and persuade the small number of great entrepreneurs who give the low market share explosive returns.

In the current bull market environment, many have forgotten that this is an iterative game both between founders and investors as well as between investors. The ability to rely on relationships when times get tough or to share good deals is fundamental. In an era of information abundance and commodity capital, relationships are the only scarce and nearly proprietary item. That makes them different — and different is certainly better than better, at least for early-stage venture capitalists.

The Founder Checklist

I prepared the following checklist for entrepreneurs thinking of raising capital in this environment and seeking a relationship-driven investor:

Does the VC partner…

1. Bring insights and relationships that can help accelerate product-market-fit? Provide introductions to early customers?⊃2;
2. Have the relationships and network to help recruit key product builders (scarce resource) and early management?
3. Provide access to good ongoing capital — either through relationships, proprietary insights or networks? (see above about iterative games)
4. Take time to understand the long-term strategy and provide unique insights or breakthrough ideas?
5. Question founder assumptions respectfully but firmly?
6. Have the ability to spend real time working with a founder to accelerate their learning?⊃3;

Other questions to help check whether an investor is transaction-driven or relationship-driven include:

1. Has he or she invested with founders repeatedly?
2. Do the investor and their founders sit on other boards together?
3. Have their founders invested alongside the VC in another company?
4. Did their successful founders invest in the VC’s fund?

Endnotes:

[1] The macro trend of a 12-year bull market and commodity capital does not mean that YOUR company is going to succeed. My grandfather used to say that YOU are a statistic of one. Therefore, in my mind the principles of very early stage investing actually remain remarkably similar despite the fact that post-product and post-revenue growth investing has changed dramatically.

When you pour money into a company before it is ready, it causes the company to be less scrappy and less iterative. My partners at Benchmark used to say that “more companies die of indigestion than die of starvation.” Moreover, it is far from clear to me that this macro environment will persist. A wealth manager who represents 12 VCs told me earlier this month that all of his clients think the tech market is over-valued — except for their portfolio.

[2] It follows that founders should “date” early-stage investors to see whether they become smarter through the interactions and whether investors can grok the potential of the business and its core challenges. Unfortunately, I see too many young founders today just taking the first fat check they’re offered.

[3] Accelerated learning is the key attribute of a successful early-stage entrepreneur. It is also the most important trait for an early-stage investor. The investor needs to support or help the founder figure out his business as fast as possible and as strategically as possible, helping to build moats and ever faster learning along the way. An investor who does not want to get commoditized out of the market by weaponized capital must prove that he or she can accelerate the founders beyond money, in addition to accessing talent and follow-on capital. This is actually super time intensive for the investor. It is a real investment in the relationship and not a transaction.

Founders should ask for proof of ability to help recruit engineers and talent. Does your investor significantly expand your network? Does he or she accelerate your learning? Is there a high signal-to-noise ratio in feedback and questions?