Creating value through smart money

Throughout the past few years, the venture capital market grew exponentially to become a 200+ billion dollars market in 2021, attracting attention from even the most conservative investors, whose risk aversion opened an exception to the curiosity of how this industry boomed in such a short time span. Although many entrepreneurs struggled during the pandemic when investors froze their investments and capital became scarce, such shortage ceased as abruptly as it began, and 2021 is ending differently than we saw last year. Today, oversupplied capital makes investors compete for the best deals, and founders have become picky about who will become their next venture capitalist partner. Amid this new reality, valuations spiked, and good deals became harder to be found. With resources availability not being an issue anymore, entrepreneurs are now looking for something else: smart money.

Despite how well investors have convinced founders that their hands-on approach will make a difference for the startups, most of the time the smart money seems to be false advertising most of the time. Indeed, Forward Partners reported that, while 92% of investors offer value-add initiatives, 59% of founders feel duped with what was initially promised, with 49% reporting that these initiatives had no impact on their businesses. This issue is double-faced in the sense that there is a relevant part of investors whose initiatives were underdelivered and an even more significant part of investors whose efforts were well-intended but failed for any reason.

With that in mind, it’s fair to conclude that just a small number of investors are indeed successful in somewhat offering value creation initiatives and properly delivering them according to what was promised to their founders. It would be unfair to overlook those whose well-intentioned efforts were unsuccessful. Still, the hands-on approach depends on experience, well-structured processes, and persistency to succeed and will hardly work out without one of these.

In our history, we were able to help approximately 20% of our portfolio companies expand to Brazil and several others in increasing sales, hiring key executives, securing follow-on funding, and making strategic decisions. Like most other learning processes, consistent value creation initiatives are preceded by uncountable hits and misses. However, unlike other learning processes, venture capitalists have a limited number of misses before their reputation becomes jeopardized in the market, so learning quickly is a must in this space. Looking back at everything we got right and wrong in creating value for our startups, here are the key learnings we have had so far:

Create a dedicated team

Starting with a dedicated value creation team may be a too-long step to be taken at the beginning for any venture fund. However, as the business grows and value-add initiatives become numerous, having someone to centralize them makes an enormous difference. It doesn’t mean the initiatives must change or the rest of the team shouldn’t be involved anymore. On the contrary, contributions are always positive, if they are centralized and processed by a dedicated team, who will be responsible for defining what the best steps to be taken in this field are, hitting more than missing, and taking the company to another level faster than it would otherwise.

Know how far the team can go

Although it seems obvious, many don’t follow this rule. One shouldn’t promise the world if it cannot be delivered. There’s no problem to start small, but failing to keep the word may jeopardize the investor’s reputation and relationship with the founders. Our first smart money offer consisted in helping our companies expand to Brazil, which we knew we were capable of, and succeeded in doing so. Our scope of offers (talent hiring, mentoring, introductions to potential customers on an international level, and so on) gradually increased throughout the years only after we felt comfortable ensuring we could fulfill our invested companies’ expectations in each of them.

Assure everyone is on the same page

One of the habits that we developed is to regularly communicate to the entire team all efforts made on the value creation front. Sometimes, it may feel like consuming valuable time from the team with matters not necessarily within their job scope. However, this is an effective way for everyone to think about ways to provide the support that might not have been on the value creation team’s radar yet. In addition, it also helps make sure that no projects are being left behind and that the value that was initially promised to the companies will be delivered.

Connect the startups with the LPs

Keeping a close relationship with the LPs is one of our pillars. Therefore, their engagement whenever we need a hand finding connections in a specific industry is substantially high. For the same reason that the founders expect their investors to bring more than money to them, LPs expect venture capital managers to provide them with more than just returns. In this sense, exposing them to circumstances in which they can also learn about the market they are investing in is one of the best ways to deliver what they expect. Not surprisingly, many of these circumstances emerge whenever an introduction is made.

Not all startups need help

Despite the smart money’s importance for most founders, some startups may accept investors for reasons other than their capacity to offer frequent support. As the portfolio of a venture capital fund grows, equally helping every company becomes simply impossible, but not all of them will request the investors’ assistance. Some may thrive without any need for help, others will neglect the importance of the investors’ support, and other startups, unfortunately, will bankrupt before the investor can help with anything. Offering support (as long as it can be provided) is helpful, but forcing it is detrimental.

Receiving support may be game-changing

Among the tens or hundreds of companies within a portfolio, for some, receiving support may signify an increase in value greater than for others. Ideally, the investor should identify the companies that will benefit the most from his support and dedicate special attention to these startups. As time goes by, circumstances change, so keeping track in real-time of which companies will benefit the most from it is crucial.

Quality is more important than quantity

Although investors might think that value is measured by how many different supports or introductions they have made to the companies, understanding how much the action impacted them is far more relevant. For some firms, being introduced to one large customer that really sees the value in their solution and decides to close a contract is more important than dozens of “blind introductions” that, even if converted into one or two small contracts, will hardly justify the time consumed from the startup’s sales team. Also, it is crucial to notice that, for some businesses, a small support initiative may mean much more than investors think. Pre-negotiating deals with third parties on behalf of the startup to provide a reasonable discount on software tools, for instance, will positively impact its burn rate projections and increase the company’s runway.

Engage the team in homeopathic doses

Encouraging all the team to spend a few minutes looking for ways to contribute to the support provided for a particular startup is helpful, as long as they are not overwhelmed with something our of their job scope. Asking them for small contributions frequently generates more significant results than asking for immense contributions every so often.

Organization is key

More than any other activity, properly organizing the processes behind value creation efforts is crucial. It is hard to imagine one being successful with initiatives in this field without creating organized processes, keeping all interactions up to date, and maintaining a plan with all the parties involved in adding value to the startups.

Even though the venture capital industry is cyclical like any other market, meaning both excess and scarcity of capital will continuously interpolate each other, value creation initiatives became a clear trend. They will eventually be required for any investor to access competitive deals independently on whether the capital available for investments is scarce. With that in mind, any fund willing to compete for the best deals should give the proper attention for value-add structured efforts. More than ever, founders are looking for much more than just money to accept new investors into their cap tables, and smart money has already shown signs that it will last as the new practice for years to go.