Why VC’s need to preserve their reputation in company referrals to other investors

It’s been over a year since we made our first investment at Aslanoba Capital. As a result, several of our startups are nearing the stage where they need to look for follow-on funding to continue their operations. The fortunate few have shown such great performance that they have already secured new rounds from us and outside investors. There are also many that are either cash flow positive or still have ample runway before they will require a new round. However, there are also a few that, at their current burn rates, will require additional funding in the next 6 to 9 months. As these startups begin to look for follow-on funding, they naturally request that I refer them to potential investors.

When the company is performing well, this is an easy decision. I’m very glad to introduce the founders to investors with an interest in the company’s business, geography, and stage. But what happens when a company isn’t performing well, or is growing but has fallen short of meeting the targets which would make it deserving of follow-on funding? This is a tricky issue.

On one hand I have a responsibility to contribute to our startups’ success. This requires helping our startups secure the funding necessary to continue their growth. On the other hand, I have a responsibility to other investors to refer them companies that are worth investing in. While I could refer them companies that, based on my experience working with the company since we funded them, have questionable fundamentals and future prospects, and the investors may even decide to support these companies, this would be short sighted. The long run will eventually become the short run and the company’s questionable performance will become clear to the new investors.

The result will be that the company will have survived a while longer, but I will have damaged my reputation. I will lose the trust of the new investors. This will make me less likely to be successful in referring to them those companies that are performing very well and do deserve their funding. I’ve been at the receiving end of such short-sighted referrals and am now skeptical in evaluating opportunities arriving from these sources in the future.

Because of these reasons, although it may frustrate our entrepreneurs, it’s my principle to not refer our companies which aren’t performing well to other investors. But you may ask, “What if you’re wrong? What if the company is actually going to be successful in the future?” Since there is a chance that my evaluation is wrong, while I don’t refer a company that I believe isn’t performing well directly to the investor, I do help the company brainstorm which investors could be interested in their business. This approach ensures that I’m not harming the company’s prospects in the event that my evaluation is wrong. However, it is the entrepreneur who will ultimately be responsible for reaching out to the investor, and I will provide my objective view of the company’s performance when the investor gets in touch with me.

Ultimately, building a successful startup requires trust on multiple levels. Although trust between founders and investors is most important, trust between existing and new investors is also key. If investors don’t play the long game in their relationships with other investors, not only do investors lose, much more importantly entrepreneurs lose. It’s my responsibility to our entrepreneurs to not make this happen.