The Hobbit and Silicon Valley: Beware of VCs who get Dragon Sickness

I recently watched part 3 of the Hobbit, the final portion of Peter Jackson’s adaptation of Tolkien’s beloved book.  While there are many aspects of the Hobbit I could write about (it's one of my favorite books of all time), I’d like to explore one that caught my eye and applies particularly in Startup-Land:  Dragon Sickness.

I’ve often compared embarking on a startup journey to be a mythical adventure, not unlike those of Bilbo Baggins and his dwarvish companions. Though startup adventures usually last longer than Bilbo’s journey (which was a mere 13 months!), there are a lot of valid comparisons to be made.  

Like many mythical adventures, startup journeys are fraught with peril; each twist and turn can have life-changing implications; they bring out odd traveling companions and bedfellows (not to mention enemies and advisors); and there is often a seemingly unattainable golden treasure somewhere near the end of the quest!  More importantly, startup adventures can push you out of your comfort zone, and as Bilbo so aptly complains in an earlier part of the Hobbit, adventures can “make you late for dinner”! 

In a previous entry, Gandalf the Venture Capitalist, I focused on some of the positive aspects of having an investor/advisor who is wise like Gandalf with you on your journey.  Having the right investors, particularly those who have personal qualities like Gandalf can be very helpful on the startup journey, and get you out of many a scrape.

In this entry, I’d like to explore the opposite: when an investor turns out to be someone who’s extremely selfish, difficult to work with, valuing money above all else, and causes great difficulty on the startup journey.   

While you can easily get rid of an unhelpful advisor or employee, it’s not so easy to get rid of an unhelpful investor, particularly if they are a VC.  Moreover, many investments in Silicon Valley begin with convertible notes, which have their own special characteristics and once you’ve entered into them with an investor, you may be stuck with that investor until the end of the journey.

Believe it or not, I’ve seen investors (VCs) in Silicon Valley contract something that looks a lot like the “Dragon Sickness” in the recent film.  

In the film, the leader of the company of dwarves that Bilbo is traveling with, Thorin Oakenshield, falls prey to this sickness when the company finally achieves the quest they set out on: to reclaim their homeland in the Lonely Mountain, and more importantly the gold and jewels that it contains.  Their main obstacle is of course, the Dragon Smaug, who is a selfish but formidable figure and who has claimed the treasure for his own.

When Thorin finally achieves the Quest, in many ways because of the contributions of others (Bard from Laketown actually kills the dragon, and Bilbo Baggins rescues and saves the life of Thorin and the company more than once!), he starts to see things differently.  He starts to see himself as “entitled” to the gold, and won’t part with any of the treasure, in the process, forgetting every promise he had ever made to people along the way.

It’s called “Dragon Sickness”  because, as Bilbo tells us in the prologue, “…for dragons covet gold with a dark and fierce desire …”   And it leads to a certain kind of self-centered madness.  As the first the dragon say and later Thorin finds himself echoing:  “I will not part with a single gold coin.”   

It's usually typified by someone whose only goal is to “possess as much of the treasure as possible” without any context or caring how their relationship with others are impacted can fall pray to this sickness, just as Thorin does when he finally takes over the gold. In Thorin's case, it was his relationship with his companions, the residents of Lake-town, and even the elves.

Let’s summarize revisit what happened to Thorin and see if this might apply to anyone we know in Silicon Valley:  Achieve a treasure, largely through the efforts of others, claim as much of it for yourself as possible, and refuse to give up any part of it, ignoring previous agreements about sharing.

While some entrepreneurs definitely fall prey to dragon sickness themselves (I may do another entry on this another time), I personally have seen it more with investors in Silicon Valley than in founders.  They often forget whatever agreements were made in the past and decide to find a way to maximize their “take” right at the end.  

Since I moved to Silicon Valley in 2007, I have seen this first-hand several times, usually when a company is about to be sold.  I’ve had VCs say they want more of the gold than they are currently entitled to and want the founders to take less.  Of course, they don’t say it that way, like a sneaky, experienced dragon they speak in sweet tones and make it seem like what they’re proposing is “the right thing to do” even though it benefits just them and hurts others.

Moreover, while a company is not a zero sum game at the beginning, when a purchase price has been negotiated to sell a company, it does suddenly become a zero sum game – i.e. each dollar that goes to someone else, doesn’t go to you.  

They often, though not always, imply that they won’t go along with the sale unless they are "satisfied".  Now, many investors have vetoes over selling the company, and while VCs don’t like to use vetoes explicitly, investors can cause plenty of harm when a sale is happening.  This is doubly true if the company is being sold, or even if the company is not doing well and is about to run out of money, and needs to raise money quickly at whatever valuation it can get.

I had one entrepreneur tell me that he thought that what the VC was doing was basically extortion. While I wouldn’t call it that, I would say that someone whose only desire is “purely financial” or "purely transactional" will do whatever they can to make sure they get “as much gold as possible”, no matter what.

There are of course many ways that a bad investor can be destructive to a startup, but this is one of the most frustrating ways.  It’s like a serpent that you've let into your house, which starts to eat the company and the team from the inside.  This usually happens in two instances: when the company is doing really well financially (and everyone is getting greedy), and when the company is not doing well and the company needs to either do a fire-sale or raise money quickly.

This is why it’s important for entrepreneurs to vet investors in the same way that VCs vet entrepreneurs.  Many entrepreneurs are so happy to be getting “money” that they don’t consider the ramifications of who they’re bringing into their adventure.

I’ve often said that it’s pretty easy to tell if a co-founder that you don’t know well is easy to work with in a place like Silicon Valley.  Because people here usually start multiple companies, you just see if that person’s co-founders started another company with them. If they did, then that person is probably relatively easy to work with (or at least acts reasonably when things get tough).   Of course, if their co-founders didn’t start another company with them, it doesn’t absolutely mean they are hard to work with, but it’s a pretty good indication.

Similarly, you can do the same kind of research on VCs by interviewing founders of companies they have invested in before.  Of course, you have to interview more than one – preferably one whose company was financially successful and one whose company failed – you will probably learn much more about the investor from the failed company than you will from the successful one! Each situation provides a ripe environment for the dragon to come out, even when they seem entirely reasonable and on your side when you’re getting your financing.

So, how can you spot an investor who’s likely to fall prey to “Dragon Sickness” well before you get to these stages?  It’s not easy, but here are things to look for in both your own company and others founders experience with investors.

•       Look for investors who are looking for an advantage over everyone else.  I’ve seen some investors who not only want to invest, but they want a better deal than the other investors they are investing alongside them.   Now, don’t get me wrong, if an investor is doing services for you beyond just the money, it might make sense to give them more (perhaps warrants or just pay them for their services).  But when an investor, at each juncture, co investing with others, tries to get advantages over the other investors in his round, asking for rights they don’t have, that’s a sure sign that they may turn out to be slimy when push comes to server.
•      Every discussion is like a zero-sum game.  When startups first get going, they are not a zero sum game.  That's why it makes sense to take investors in the first place, by giving up shares of the company, you are theoretically expanding the pie for everyone. When every part of the negotiation to do a deal feels like they are playing a zero sum game - not willing to give in to anything, you're starting to see their personality seep out.  If they are like this when there's plenty for everyone, what will they act like upon a sale of the company, where it really does start to look like a zero-sum game?
•  Doing what’s right for them vs. what’s right for the company.  I’ve seen many investors push companies to do deals that are right for them but not right for the company.   On the flipside, I think having board members who are on other boards in the same industry can be extremely helpful, but the key is whether they “insist” on doing things their way even if it doesn’t make sense from the founders and other investors perspective.  It’s more about the way they do this – again speaking in sweet tongues and making it seem like something is “best” for the company when it’s actually “best” for them.
•  Not Participating.  If a VC Fund puts in money at the beginning, or while the company is doing well, but are unwilling to support the company in any way financially when the company is not doing well, this is a sure sign that they will be a tough investor to work with and will try to manipulate events so that they get “more out” than their fair share by withholding consent.  Like a "fair-weather" friend, the a "fair-weather investor is the worst kind to have.  Now, VCs have obligations to their general and limited partners, so they can't always put in more money when they personally want to without their partners consent.  But any serious VC Fund, which has set aside money for follow ons, should be willing to put in their pro-rata into subsequent rounds, even if  they aren't investing a lot. When VCs don't do this, it scares off new investors and actually hurts the company's chances of raising more money.  The new investors start to think, there must be something seriously wrong with the company.
•   Beware of well-known investors with big egos.  Sometimes, an investor, because of their firm or reputation is known as a "big wig" and has developed a big ego.  There’s of course nothing wrong with bringing in well-known investors, it is often a benefit to your company, but sometimes their reputation and how much money they’ve made in the past belie the specifics of how they acted behind closed doors.  Most hollywood stars, for example, are nothing like their public personas in private.  Many comedians aren't funny and many super-likable TV stars are not really nice guys behind the scenes.  The same is true with VCs.

In the film the Hobbit, to help break through Thorin’s Dragon Sickness, Bilbo, the "junior member" of the company,  does something to try to get Thorin to do what’s right for the Quest and to others that Thorin had made promises to.  He willfully gives up most of his share of the treasure!

I’ve often had investors ask founders to take less than their percentage of the company so that they could have “more”.  Usually this comes out of pure greed, which is pretty common in Silicon Valley investors (and even in some entrepreneurs).  But it also comes from ego, which is sometimes even more common.

Luckily, I and other entrepreneurs have seen situations where, like Bilbo, some founders are willing to give up a chunk of their piece of the treasure upon a sale, in order to make rogue investor or founder to go along with a sale that the founders wanted to do.   They are doing it not as a reward to the investor, but for the greater good - they want a deal to get done and no longer want to work with the investor inflected with dragon-sickness, so they're willing to give up something to make it happen.  This isn't necessarily a sign of weakness (though dragon-sickness infected people might think so) - it's being practical and thinking of others as much as yourself.

So, when talking to investors, do your own due diligence on them. Find founders of companies that they do not recommend you talk to, you can usually get to them through friends of friends.  

The real question you need to ask yourself is: are you getting a Gandalf, or are you inviting Dragon Sickness into your little startup?  I’ve had both, and it’s much more fun to have Gandalf!

Gandalf the Venture Capitalist: The Perfect Advisor for the Startup Journey?

Last weekend, the second part of the Hobbit trilogy of films by Peter Jackson, The Desolation of Smaug, was released and, as usual, I think there's great inspiration for entrepreneurs, venture capitalist and investors in the form of Gandalf the Grey.

I’ve been a big fan of the Hobbit since I was a little kid, and it’s gratifying to see my favorite characters brought to the big screen.  I feel like I’ve been journeying with Bilbo Baggins in my mind for as long as I can remember, from the soft meadows of the Shire to the warmth of the Last Homely House of Rivendell, through the depths of Mirkwood and Laketown, into the Den of the Dragon itself, under the Lonely Mountain.

In the second installment, Peter Jackson introduces a new scene that chronologically takes place before the Hobbit proper story began:  In the village of Bree, Gandalf convinces Thorin Oakenshield that he should try to go on a Quest to reclaim their treasure, setting up the whole adventure in the first place.  

This extra scene, and some of Peter Jackson’s commentary on the extended edition of the first film (The Hobbit: An Unexpected Journey) made me think more deeply about the role that Gandalf plays in this “unexpected journey” to claim the treasure: sometimes as an advisor, sometimes as recruiter, sometimes as a participant, and sometimes as a concerned stakeholder.  Gandalf’s multiple hats (pointy and otherwise) remind me of the roles that a really great investor/mentor or venture capitalist can play in our own startup journey.

For many, the startup journey resembles the Quest of Bilbo and the Dwarves: full of pitfalls, unplanned detours, hair-raising near misses, and unexpected appearances of both friends and foes.  Like the Quest in the Hobbit, while there is potentially a lot of real Gold at Journey’s end, a startup adventure is fraught with the perils of mastering our own emotions: fear and greed, courage and compassion, stubbornness and open-mindedness.

In these films we see Gandalf masterfully guiding the company, sometimes through persuasion, sometimes through sheer force, sometimes through cunning and guile, and sometimes through what seems like magic, through rough roads and challenges that could easily have waylaid the company and marked the premature death of their entrepreneurial journey.

If Gandalf was a VC, he would be the perfect “older and wiser” counselor to a team of adventurers (the startup team), stepping in when he needs to be hands on, and stepping away to let the founders spread their wings, always available to give advice when needed, all the while keeping his eyes on the “bigger picture” even as the founders are down in the weeds of the day-to-day challenges of running a business.

Here are some specific instances from the Hobbit to illustrate what I mean:

1.      Gandalf sees an opportunity and recruits a CEO. In the new scene, Gandalf meets Thorin in Bree ("this isn’t an unexpected meeting, is it?"), and convinces the Dwarf prince to go on the journey to reclaim his homeland.  Gandalf is seeing a bigger threat to Middle Earth – a broader market if you will, and he sees that Thorin's background would fit nicely, if he could be convinced to run this one adventure.  An effective VC or advisor keeps his or her eyes on the broader market opportunity, and really great ones will actually encourage entrepreneurs to start companies to take care of specific niches in this broad market.
2.      Gandalf sees something in Bilbo that others don’t.  Gandalf decides that the Company needs a burgler, an everyday sort who can get in and out of the Dragon's Den without raising suspicion and inviting disaster.  The others think that Bilbo doesn’t have the courage or werewithal to go on such a journey (neither does Bilbo himself!).  A good VC or angel investor or advisor can sometimes see things in us (or in team members) that we might not see in ourselves.  I've often thought that that people really knew how difficult running a startup can be (compared to the popular concepts), many would-be entrepreneurs would never start.  But as in Zen, not-knowing is a good thing, as it allows us to come up with fresh solutions to the problems that crop up, which is what happens with Bilbo before the end - all because Gandalf saw something in him that he didn't see in himself.
3.      Gandalf convinces people to do things that will help the journey, whether they know it or not.   In the movies, it’s clear to Gandalf that they need to go to Rivendell, though Thorin is resistant and doesn’t want help from the elves.  Gandalf also recognizes that if Elrond knew the true purpose of the dwarves journey, he might not help them at all.  Finally Gandalf realizes that if the dwarves ask the White Council for permission to go on the Quest, it will be denied.   In my opinion, this is one of the great ways that we see Gandalf’s age, experience, and knowledge of human (not to mention dwarvish and elvish) nature really shines through in the movies (even if it deviates slightly from the books).  He gets Thorin to go to Rivendell out of need, he withholds enough information from Elrond so that he helps to decipher the map (a moment that Peter Jackson says gets Thorin to “truly” trust the wizard implicitly), and then counsels the dwarves to leave before the Council can tell them no!   Sometimes in startups, people don’t see the whole picture – they just see their little sliver, and it’s necessary for someone (preferably someone older and wiser who can see the big picture) to show them partial views, until they are able to embrace their role and grasp the bigger picture.  
4.      Gandalf’s prior contacts get the company out of many scrapes and keep the Quest alive.  Without Gandalf’s prior contacts, ranging from Lord Elrond to the Eagles to his knowledge of Beorn, our heroes would have been toast – literally in the scene with the Goblins and Wargs setting the trees on fire.   It turns out that in a past life, Gandalf had helped out the king of the Eagles, and this brings the Eagles in to help the company get out of the frying pan and the fire! Whether it’s making an intro that leads to a big customer or to an acquisition, or bringing in extra cash to keep the company alive, a good VC or advisor utilizes their rolodex and previous relationships to help out the team in ways they couldn’t do themselves. 
5.      Gandalf steps away to let Bilbo and the company spread their wings.  At certain points in the adventure, Gandalf steps away from Bilbo and Thorin and the Dwarves, off on urgent business.  It’s during his time away that Thorin and the dwarves really develop confidence in themselves and particularly in Bilbo.  Moreover, Bilbo develops confidence in himself and saves the party several times.  It’s important that any startup founder or CEO or leader be able to deal with situations on their own, without always relying on their advisor, mentor.  Sometimes this leads to mistakes, but overall it builds the courage, character, and inventiveness of the team.  A good entrepreneurial team, no matter how they start up, should end up with much more wisdom, self-knowledge, and confidence in themselves by the end of the journey, whether he venture is a financial success or not.  A good advisor or board member knows when to step away, and when to engage more deeply.

These are only some of the ways that I think Gandalf brings wisdom, experience, contacts, perspective, and compassion to work in what might otherwise be seen as a purely selfish journey that ended in failure.  Even Bilbo, who doesn’t like “adventures” because they “make you late for dinner” ends up better off because of Gandalf’s role as an advisor and mentor to the company.  

Venture Capitalists, investors and advisors to startups would do well to watch these films again and pay attention to Gandalf the Grey!