Ask A VC: When do you know that it was a mistake to invest in a company?

by Adam Koopersmith
May 16, 2013

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Question: When do you know that a mistake has been made in an investment, and what next steps do you take?

In venture capital, we’re in the business of balancing risk with reward.  We do our best to uncover, and mitigate, any risks prior to making an investment. That being said, in many instances, it doesn’t take long to realize we’ve made some kind of mistake during our due diligence process.  In fact, we often learn about these mistakes immediately after closing an investment, during the “fearful first board meeting.”  With an open dialogue between management team and investor, and a decent set of key performance indicators (KPIs), mistakes are often relatively easy to identify.  The key to fixing mistakes is to identify the problem, not just the symptom.  For example, the fact that sales are short of plan is a symptom, not the problem.  Your problem could be that you have the wrong people on the sales team, or it could be that your product lacks the features your customers want, or it could be that the market you’re selling into isn’t as mature as you expected.  It is vital to identify the actual problem, before developing and implementing a solution.

Well, what do you do once you realize you’ve made a mistake?  I think the first question to ask is…”Is the mistake/problem something within the company’s capabilities to fix, or not?”  The steps you take may be very different depending on the situation.

For example, let’s say a company has a technology deficiency in the management team (problem). The solution may be that the company needs to hire a new CTO.  While it may not be easy to recruit a new CTO, it is generally something within the company’s control.  Someone on the team should own the solution and should make sure the time allocated to solving the problem is commensurate with the problem itself.  If hiring a CTO is the #1 priority for the company, that means whoever owns this task should be spending significant time on this solution and leveraging the skills of folks around the table (e.g. make sure your VCs are helping to identify candidates).  Solving big problems require real time and attention.

On the other hand, let’s say the mistake/problem is that the market the company is selling into is not as mature as originally thought.  This problem is outside of the company’s control.  Regardless of the great marketing campaigns a team may be able to dream up, or the great salespeople hired, it’s nearly impossible for small companies to move markets.  As a result, it makes sense to take a more holistic view of the company while addressing the problem:  Do you need to reduce operating expenses to give the company more time to let the market develop?  Do you need to adjust the company’s focus to a different market that is more mature?  Answering these questions will require input from all key team members, investors and key advisors, and the answers may have a profound impact on the company going forward.

In either case: (1) collect the data you need to identify the real problem (not just a symptom), (2) determine if the solution is something within the company’s control, and (3) allocate the proper resources to construct and implement a solution.

Each week the team at Pritzker Group Venture Capital answers your questions about startups, raising capital, technology, and entrepreneurship. Submit your own question and see more answers here.

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