The Toxic Entrepreneur –

Stewart Alsop, a venture partner at New Enterprise Associates in Menlo Park, has worked with a number of ball-busters in his career, and he has become convinced that in frustratingly many cases the harder an entrepreneur is to like, the more ruthlessly successful he or she becomes. “I call it my asshole theory,” he says. “The bigger the asshole, the better they do,” he laughs.

Like many VCs, one of Alsop’s first run-ins happened soon after he entered the business-and he didn’t see it coming. Investing in an infrastructure company, he remembers that “the domain was something I knew about, my partners were very enthusiastic about the company, and another well-regarded investor with whom I’d always wanted to work had done the Series A, so I had moved quickly to get in it.”

Just as quickly, he’d regret it. Feeling increasingly frustrated and threatened over the appointment of a new CEO by the board, the founder started building barriers between the tech staff and the rest of the team. More dramatically, he began boycotting the office and refused to give anyone, including the new CEO, a schedule for delivery of the product. “We rapidly realized that he was a real piece of work,” says Alsop.

NEA and its co-investors sold their stakes shortly afterward.

Alsop’s experience is nearly universal, and for unsurprising reasons. Most venture investors are willing to tolerate some craziness in exchange for genius. Many see the two as linked, in fact. Says Dino Vendetti, a general partner at Bay Partners in Cupertino, Calif., “This business is filled with interesting personalities. The dichotomy is that some of the most wacko founders have the same characteristics that you look for in your great entrepreneurs.”

Truly bad seeds-or Toxic Entrepreneurs, if you will-may be few and far between, but in today’s climate, the danger of not identifying them is real. The stock market is rebounding; sexy deals, particularly within the consumer space, are becoming hotly contested again; and exhilarated VCs are writing checks in alarmingly short order. That’s to say nothing of Sarbanes-Oxley, which doesn’t appear to be giving the industry as much pause as it should, considering that its passage seems to be auguring an escalation in director lawsuits. (See “Epinions,” March issue).

In short, the brisker the deal making, the greater the risk. Says Managing Director Heidi Roizen of Mobius Venture Capital, who once launched an electronic clip art company: “What I never understood as an entrepreneur but now get as a VC, is the importance of letting a few months pass between the first time you meet an entrepreneur and the time you make a decision to invest.As an entrepreneur you think, Hey, I made my pitch; if you get it, invest.’ But as a VC, you want to take time to have numerous interactions with the entrepreneur, to get to know him or her and the company he or she keeps, as well as how that person deals with bumps in the road and whether they do what they say they will.I don’t know how to gather that data without the passage of time.”

Alsop says that his big regret in funding

the technical founder was that in rushing to close the deal, he relied on the due diligence of the lead investor. “I might have gone ahead with the investment,” he says, “but at least I would have known that [its founder] was a handful. These can be very long-term relationships. You need to know as much about a company and its management team when you invest as you’ll know a year or two later.”

The most destructive characters tend to fall into three camps: entrepreneurs who are arrogant, those who are greedy, or those whose ethics might otherwise be generously considered challenged. Of course, sometimes, they are all of these things.


Conceit appears to be the most prevalent trait among entrepreneurs and the investors who loathe them. Art Berliner, the founding partner of WaldenVC in San Francisco, readily admits that, “I’ve been accused of not funding someone who’s very arrogant.” What he tries doing, he says, is to decide whether or not a person is too much to handle based on the team that he or she puts together. “Someone can be very arrogant and over the top, but if at the same time they’re smart enough to surround themselves with people who are complements to them, then I don’t care.”

Longtime angel investor Ron Conway-who has backed many entrepreneurs, like Google’s founders, who famously play by their own rules-agrees that intellect can trump arrogance. It’s when arrogance borders on narcissism that Conway clamps on the brakes.

Conway says that he is still scratching his head after a recent meeting with one self-important founder who he had agreed to meet at a restaurant in Menlo Park. “I went at the appointed time, and not finding this guy, I called him on my cell phone. Half an hour passed before I called again, this time saying, Look, I’ve been waiting here for 30 minutes. I’m leaving.'”

As Conway briskly strode back toward his car, he says that the “guy grabs me by the arm, explaining that he’d been seated in the back, that he hadn’t seen me, that he couldn’t hear his phone.” Though some contrition about the mix-up might have saved the meeting-in part because someone in his highly prized network recommended the entrepreneur to Conway-it was soon clear that his lunch date wasn’t sorry at all. On the contrary, he says, “When we finally sat down, the guy was clearly exaggerating every single point he was making. Worse, when I questioned him about things, he would say, I’ve got this piece of the business under control.’ In other words, I don’t need your help; I just need your money.'”

The entrepreneur wasn’t given a second meeting. “If you want money,” says Conway, “you ought to sit at the front [of the restaurant], answer your phone and act interested in what I have to contribute.”

Mitchell Kertzman, a partner at Hummer Winblad Venture Partners in San Francisco, found himself in a more conflicted position involving an arrogant founder last year. As he tells the story, he “loved” the technology, the product, and the market that an entrepreneur was trying to disrupt, but the CEO thought he had nothing more to learn about any of those things. “It was an application development company bootstrapped by the founder, a former engineer,” recalls Kertzman. “I really wanted to fund this guy, but he didn’t want oversight. He didn’t want advice. He didn’t want a board of directors. He actually said, after a number of meetings with us, It isn’t obvious to me that you guys add a lot of value.'” Kertzman, who was a software CEO for 30 years before joining Hummer Winblad, calls the ruined opportunity “tragic.”

Because of his experiences with know-it-all founders, Mike Kwatinetz, a general partner at Azure Capital in San Francisco, says that he now challenges people intensely early on during the due diligence process to avoid wasting anyone’s time. “You really need to question their ideas to see how they react. Are they trying to learn or are they highly defensive? When we meet with a company, we try to gauge how collaborative the sessions are. We throw out ideas and if they’re quick to dismiss them, we have all the clues we really need.”

It is the same advice that Bay Partners’ Vendetti offers. “When you begin to sense that you have a problem, act, don’t wait. It always gets worse.”

In fact, Vendetti says he recently pushed to oust two arrogant founders at one of his firm’s wireless portfolio companies, and he insists that the startup is flourishing as a result. “I was dealing with two guys who came out of Microsoft, and they were, like many Microsoft-type engineers, phenomenally delusional. They thought they had something to do with Microsoft’s success.”

Bay Partners was willing to join the startup’s Series A because of a personal relationship between one of the founders and a partner at Bay. Over time, however, it became clear that neither of the founders “presented well” (a euphemism for “they were immature”) and that the CEO in particular had lousy executive skills. “He didn’t listen well. Also, though the guy could hire engineering talent, he wouldn’t know a good marketing or business development person if they hit him on the head.”

Bay and the firms it attracted to the startup’s B round-on the condition that it would install new management-asked the team to leave shortly after its close.


VCs say that greed is just as insidious and that it often translates into an unwillingness to listen-another reason why getting to know an entrepreneur over time is so important. For Hummer Winblad co-founder John Hummer, at least, it is only during “repeated negotiations with someone that trust and respect are formed or they aren’t.”

Though you might not be able to point to any one thing, says Hummer, “Watching how someone handles a discussion about price valuations, salaries, reporting structures and so forth is very instructive and gives you a sense of someone. It’s why I always walk through line by line of a term sheet with someone to gauge their reaction.”

Bo Peabody, the managing general partner of Village Ventures in Williamstown, Mass., looks for similar tip-offs. “If I sense in a meeting that an entrepreneur is only interested in getting the highest price possible for their company, I probably won’t even do a second meeting,” says Peabody. “Greedy entrepreneurs-even if you’ve got the deal done-don’t tend to value anyone’s input, and people who don’t listen tend to get in trouble.”

Peabody-who years ago founded the website publisher Tripod and did some individual investing after Lycos bought it for $58 million-recalls two times when greedy entrepreneurs in the go-go market of the late 90s had him pulling out his hair. “In one situation, an entrepreneur who I’d given a term sheet said, My cousin passed away, so I won’t be able to get back to you for a week.’ Meanwhile he was shopping around the deal.”

On another occasion, a group of investors including Peabody was vying for a stake in an interactive media company that was raising a $10 million Series A. Five firms were willing to give the founder term sheets. The founder, aware of his position, said that only those investors willing to commit to a second round of another $10 million would be considered. Two, including Peabody and the venture firm with which he was working at the time, said a wide-eyed “no thanks.” The other three firms said yes.

Peabody was glad to be cut from the deal. “You don’t want to fund someone whose primary focus is on getting rich.”

Kwatinetz also avoids greedy people whenever possible, largely to avoid the frustration that an ongoing relationship would compel. He tells the story of two young founders who were recently developing “a new Internet infrastructure that would get groups of consumers to collaborate.” Though pre-product, it was a “very interesting” technology and like most entrepreneurs trying to raise money, the founders were “on their best behavior” initially. “Unfortunately, when we started talking about valuation, there was an enormous gap between our respective expectations.”

The founders thought Azure Capital was being miserly. Kwatinetz says the founders were being avaricious. “The valuation should have been in the single digits and their vision, of a post-money valuation of $25 million, was to me, bubble-like.” Azure passed, but two other venture firms funded the founders. “Maybe they’ll be successful,” he says. “We just weren’t willing to pay two to three times what the company was worth.”

Thankfully, avoiding greedy types doesn’t require a degree in psychology. “Someone can be smart and likeable, but [over the course of a negotiations] it can become obvious that they aren’t interested in the long-term future of their own company but rather the payoff,” Hummer says.

Ethically Challenged

There are always, too, those emotional train wrecks who do dangerous and sometimes criminal things, sometimes with their venture money. These entrepreneurs are the rarest but most dangerous breed of all, say VCs. They also make the strongest case for why thorough due diligence is necessary.

One need only remember the case of Michael Fenne, who founded streaming-media startup Pixelon and spent a much-publicized $12 million on its lavish Las Vegas launch party before admitting that he was a convicted embezzler and a fugitive from the law (as well as that his real name was David Stanley). William Michael Bowles, the founder and chairman of iBEAM Broadcasting Corp., is another entrepreneur who investors would sooner forget. He pled guilty to using the Internet to solicit sex from a teenage boy-after the “child” he arranged to meet turned out to be a police officer.

“There are certainly entrepreneurs who’ve made money who also happen to be pretty sketchy characters,” says Heidi Roizen. She says that she is able to evaluate people in fairly absolute terms, though. “The biggest thing when dealing with someone you don’t already know is references. If someone I really trust tells me that a person is a nightmare to deal with or if I see a history of litigiousness or a string of ethical violations, I keep our checkbook locked away. My view is that life’s too short.”

Roizen doesn’t say whether or not she has learned the hard way how difficult some people are to make out, but many VCs have. Michael Greeley, a managing general partner at IDG Ventures in Boston, is big enough to admit that he has backed a couple of entrepreneurs who’ve spent their financing on all the wrong things. One was hiring pricey prostitutes with the venture financing that he had received. On another occasion, many years ago, Greeley invested in someone he describes as “an incredibly earnest guy from Ohio who seemed not to have a bad bone in his body” but quickly proved otherwise after he had sewed up some funding. “During our first audit meeting, we learned that he had purchased a company plane. A plane! We couldn’t believe it.”

Looking back at both, Greeley, who stopped funding both companies, recalls that he was disappointed to have made “such bad judgment calls,” but through the experiences he discovered how quickly people can change.

One way to get a better sense of someone is, unsurprisingly, to ask probing questions. WaldenVC’s Berliner has found it useful to learn as much about how someone thinks and reacts across a wide range of circumstances and situations. His process in trying to understand how someone thinks? “To find an entree to the person’s life that’s not directly related to his or her business.”

Another option: hiring a private investigator. Indeed, according to Wendy Schmidt, the principal in charge of business intelligence services at Deloitte & Touche in New York, the unexpected is often worse than most people might imagine. “Even people you think you know really well can have issues or problems in their past that you really need and want to know about before you close the deal.”

Schmidt, who does background checks for dozens of “well-established, prominent” VC firms, says that her unit has seen cases where “a job candidate for a CEO post had committed murder. We learned that another prospect had been arrested for indecent exposure in a public park. We’ve turned up government sanctions, felony records for forging checks, the illegal transfer of technology from country to country-you name it.”

Deloitte & Touche charges anywhere from several hundred dollars for a basic background search to $5,000 for a more extensive investigation, involving public records searches, calls to schools, and interviews with former business associates. “We cross-check everything,” says Schmidt.

The process doesn’t end once you hire a private investigator to dig up dirt. Sometimes you need to dig even more. Bill Burnham, managing director of newly formed Celsius Capital and formerly a managing director at Mobius Venture Capital, tells of one of “just a couple” of cases where Mobius hired an outside firm to gather intelligence. It was looking to merge one of its portfolio companies with a small, Midwestern outfit about whose founder the partners knew little.

The investigator brought back information about the founder, but in hindsight, Mobius should have “peeled it back a layer or two,” Burnham says. To wit, though the firm read in a local paper of the founder’s exit from a prior business, it didn’t drill down to look at why he left; it relied on the founder’s representation of events. “As it turns out,” Burnham says, “There was a big blow-up and he’d threatened to sue his investors, which was serial behavior. The guy had a history of threatening-though not filing-litigation, which is almost as effective as suing them and almost as disruptive.” By the time Mobius realized its mistake it was too late. The sale had gone through. Burnham declined to say exactly how things turned out except to say that the individual in question ended up causing trouble.

Beyond Diligent

Finding top-notch entrepreneurs is never easy. Finding top-notch entrepreneurs who are solid both emotionally and ethically can be even more challenging. The inescapable fact is that the distance from willful to controlling, from ambitious to greedy and from visionary to downright arrogant is fairly short, especially when the pressure is on. Observes Vendetti of Bay Partners, “You have to be supremely confident and tenacious to be a successful entrepreneur. You have to figure out and develop new technologies, assess markets, attract the best talent and the best money and still sometimes, to reengineer your product. It’s so insanely competitive that it’s little wonder that some founders are, well, not entirely normal.”

Because the VC industry is at a pivotal moment, the danger of teaming up with a potential headache is stronger than it’s been in years. Competition in core areas of investor interest like the digital home is blistering, and in the race to close deals quickly, some VCs are likely ignoring subtle hints about company founders that may come back to haunt them once the ink on their term sheets is dried.

Key to countering the problem is conducting thorough due diligence, then doing some more. As Alsop suggests, to the extent possible, VCs need to know as much about a company under serious consideration as they will know two years later.

Relying on instinct alone is clearly not enough, but paying attention to one’s gut is a good idea, too.

Says Burnham: “If a VC can’t get comfortable or has enough concern about a person that he wants to hire [a private investigator], then he should probably rethink the investment.”