Why Investors Won’t Talk to Competitors

Posted: August 1st, 2012 | Author: | Filed under: Startups | 8 Comments »

Whenever I’ve been involved in fundraising, I’ve hit a frustrating rejection: “Sorry, but I have an investment that could be competitive.”

As an entrepreneur, this drives me nuts. I always marshal the same counterarguments:

  1. I know what they’re doing, and we’re COMPLETELY DIFFERENT!
  2. Let’s have an initial conversation.  I won’t disclose any ‘secret sauce’, and you can be better informed and decide whether or not there’s a real conflict.
  3. I don’t mind if you invest in both companies.  I trust you to keep information confidential.

I didn’t actually grok what was going on until I sat on the other side, looking at investments.  Now I understand the problems with each of these, and the real, underlying problem that I missed completely.

Objection 1: We’re not conflicting

I always said (and felt) this with such  conviction!  But in truth it’s just a stupid assertion.  You only know as much as their last press release.  The company may be planning to enter your market next week, for all you know.  Telling an investor that there’s no conflict  is like telling them what they should eat for dinner – no matter how much you know about the situation, they know more.

Objection 2: Let’s have an initial conversation

It’s a common misconception that investors are looking to thoroughly evaluate startups so they can make the best decision about each one.  In fact, most investors are looking for reasons to say no.  A typical angel has many competing priorities for their dollars – their existing investments, other new investments, their stock portfolio, their mortgage, a new car.  If you’re unlikely to be an investment because of what they suspect is a conflict, they’d rather spend the time on one of those things instead.

A typical VC is going to say “yes” to between 1% and 0.1% of pitches; that means they need to triage opportunities aggressively, and guess what? You Just Got Triaged.

Objection 3: I don’t mind!

Yeah, but what about the established company they’ve already invested in?  They mind!  Good investors feel a strong obligation to their existing portfolio, and they don’t owe you squat.

Super Top Secret Reason

The previous three point nonwithstanding, there’s a fourth reason that most investors don’t bother to explain.  It’s simple: investing in conflicting companies is a huge risk.  Here’s the scenario:

  • Jane Angel is an investor in Cantaloupe.ly, a promising cantaloupe vending machine startup.  Cool, crisp cantaloupe on every street corner!  The mind boggles at the opportunity.
  • Jambalaya to Go pitches Jane Angel on their investment opportunity.  Their secret sauce: bundled napkins with every bowl.  Jane thinks this sounds really cool, but doesn’t invest because she’s already invested in the messy-food-dispensing vertical with Cantaloupe.
  • A month later, Cantaloupe.ly announces that they’re expanding in to the soup business with their own napkin-dispensing technology.

Now, Jane didn’t leak JtG’s napkin breakthrough to C.ly.  It was a good idea, and C.ly came up with it independently.  And she had no idea the soup pivot was coming.  But now she’s in a crappy position.  JtG is going around telling everyone that Jane forwarded their pitch deck to C.ly, because – hey, look at what happened, and what are the odds?  (pretty good, actually, that two companies will wind up doing the same thing, and that they will have both talked to the same person about it).

So through no fault of her own, her reputation suffers.  C.ly even gets caught in the smear, because they’re accused of blatantly ripping off JtG, even though they’ve had an ongoing napkin dispensing research project since before the Cantaloupe guys graduated from college.

And thank goodness Jane didn’t actually invest in both companies.  If she did, she could be an easy target for a lawsuit.  Or even worse, she could wind up in a bind: sitting on the board of Cantaloupe.ly, listening to a discussion of napkin dispensing technology, in possession of material information about a competitor, but uncertain of whether she is obligated to keep it secret (because of confidentiality) or obligated to disclose it (because of her fiduciary obligation as a board member).

So the big thing is this: your investor chose their horse because they thought it could beat all comers, including your horse.  Placing a second bet jeopardizes them both legally and ethically.

“Conflict” is a subjective label.  Different investors have different levels of tolerance for it.  Companies pivot to become competitive, so this kind of mess is sometimes unavoidable.

But this kind of conflict is unpleasant and uncomfortable, so don’t be surprised if the answer to your pitch is simply, “Sorry, I already have an investment in your space.”

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  • http://www.hypedsound.com jonathanjaeger

    Great post! I have to say, also my favorite tagline for a blog (quite possibly ever).

  • ruchitgarg

    Here is a response i received yesterday “Thank you so much for the note. We are involved with xyz so this wouldn’t be a fit for us, but great opportunity and good luck on making it awesome! ” 

  • http://www.danshapiro.com/blog Dan Shapiro

     Clear, direct, and professional – hard to argue with that.

  • http://www.danshapiro.com/blog Dan Shapiro

     I hope no other entrepreneurs start blogs, or I may have to change it.

  • http://twitter.com/adamloving Adam Loving

    I’ve had a couple friends complain about pitching VCs who were involved with competitive companies, but didn’t tell the entrepreneur until after the pitch (or maybe at all). I don’t know if that’s actually true – or just the entrepreneur’s impression of your super top secret reason. Regardless, I agree that both companies having the same idea is pretty likely.

  • http://www.danshapiro.com/blog Dan Shapiro

     Very true!  I wrote about the situation where the investor is a straight shooter, and declining to put themself in a bad situation.  There are certainly some investors who will “pick your brain” with every intention of using the information to help your competitors, from the start.

    At a minimum, I always ask if they have any investments or term sheets out to competitive companies.

  • David Kurkov

    Hey Dan,

    I haven’t thought of it this way before. Thanks for writing this.

    What if you as a VC hear a pitch for a startup that is similar to one you already have ties with, but better. Is there anything you can do to uninvest and reinvest? Or do you let it go?

    Thanks!

    -David

  • http://www.danshapiro.com/blog Dan Shapiro

    You let it go.  And some people would then share the “better pitch” with the company they’re already invested in, although this is ethically questionable.