The Case of the Compromised Capital

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HEIDI: Welcome to The Startup Solution and "The Case of the Compromised Capital." I’m Heidi Roizen from Threshold Ventures.

A former student of mine, that I’ll call Athena, is pursuing a renewable energy breakthrough that she developed while earning her PhD at Stanford. Athena wants to commercialize her technology as quickly as possible because she thinks that it’ll have a hugely positive impact on climate change – and the sooner, the better. So far, she’s hired a handful of people and raised a seed round from the venture arm of a large corporation in the energy space that I’ll call OilCo. While OilCo currently makes the bulk of its money from oil and gas, its CEO believes that the future lies in renewable energy. So, OilCo is funding a number of leading-edge startups to bring that future into reality, including Athena’s.

The company is still very early, so Athena spends most of her time in the lab. But on this particular day, she was spending it on the phone, dealing with a crisis.

. . .

ATHENA: Hey, Heidi, ugh, help. A climate activist with a huge online following, because of course, that’s just my luck, just wrote about me and my company, saying that because I’m funded by OilCo, it makes him question whether I’m truly trying to help solve the climate issue, or just being paid off to greenwash OilCo’s image. I need to respond, but I don’t even know how to think about it. I know you’re super busy, but can you give me a call as soon as possible? I’m kind of dying here. Thank you.

. . .

HEIDI: There seems to be more interest nowadays about where a startup’s capital comes from. This seems similar to the rise in ESG investing, where investors care not only about how a company performs financially but also about how the company performs through the lenses of environmental, social, and governance considerations – which is where the E, S, and G in ESG come from.

I guess it’s not surprising that some company stakeholders might look for values alignment not only with the company itself, but also with the investors who’ve backed the company. And when I say stakeholders, I don’t mean just the entrepreneur, or the other shareholders. It may matter to employees, suppliers, customers or even the broader community that the startup operates in.

Which is what Athena has now painfully discovered.

. . .

So, if you’re raising money for a startup now, it’s probably a good idea to consider how your prospective investors might be viewed by your various stakeholders – before you take their money.

Let’s use Athena’s situation as our first example because it involves a strategic investor. Strategic investors, which I’ve talked about in past episodes, are typically large corporations, and they not only invest in startups that may be adjacent to their lines of business, they sometimes even invest in companies that may prove to be disruptive to them.

For example, if you look at the website for the venture arm of Shell Oil, you’ll find that they’re seeking to invest in companies that lower emissions and innovate in renewable energy. Strategic investors can be great partners in deploying a startup’s innovations more widely and quickly than the startup could do alone. They often have infrastructure that a startup could never afford, huge customer relationships to take advantage of, and a deep understanding of the ecosystem they, and now you, operate in – all of which can turn out to be even more valuable than the money they put in.

However, in the eyes of some stakeholders, money from Shell may be seen as compromised capital because of the activities that generated that money in the first place. And as Athena is now finding out, that may lead to reputational fallout.

. . .

While I want to spend the bulk of this episode on reputational considerations, I do want to at least mention that sometimes strategic capital can present even more of a compromise for you – if it comes with unusual control elements or even a board seat if handled inappropriately.

If you want to know more about strategic investors, check out an episode from season one called The Case of the Strategic Sucker Punch. Overall, I’m a big fan of strategic investors, and many of our portfolio companies have been helped by having them involved.

But remember that while we VC investors only make money if your stock goes up, a strategic investor also makes money – and often more money – if their stock goes up as a result of their involvement with you.

Because of this, conflicts can sometimes arise with strategic investors. While the vast majority of strategic investors make great partners, I’ve seen a few use an investment as a defensive move, giving them power over your future fundraises, who you can partner with, or even who you can ultimately sell your company to. Again, in my experience, this is super rare, but it’s something to look out for if you’re negotiating with a strategic investor.

. . .

Luckily for Athena, the entrepreneur with the oil money for her renewable energy startup – OilCo has been a great partner and nothing but helpful so far.

Nonetheless, she's still being judged by the broader community for her association with OilCo.

And let’s face it, strategic investors aren’t the only investors who might create reputational issues for you. Any investor could potentially become the source of unwanted attention by virtue of their bad actions. For example, Jeffrey Epstein was reported to have been an investor in a couple of startups, as well as having been a donor to a number of nonprofit entities, including MIT’s Media Lab. While it would be hard to fault someone for having taken Epstein’s money before any accusations were made public, some entities were called out for having taken his money after he was charged and plead guilty in 2008. Some even ended up returning the money, including MIT’s Media Lab. In fact, I’ve included their apology statement in the show notes – and it’s an educational read.

At a minimum, I think a simple Google search is probably a good idea before you take anyone’s money to make sure there isn’t already something bad hanging out there. And it never hurts to ask them directly, at least in my experience.

Now, in Athena’s case, we’re talking about a direct investor – but that’s not the only kind of investor you probably have – and when it comes to investors, what you don’t know can still hurt you in terms of reputational risk.

. . .

Let me ask you this – have you ever thought about where venture capital money comes from? When I ask entrepreneurs this question, a surprising number say that VC money comes from rich people. And yes, some of the money in VC funds does come from wealthy individuals. But most VC money comes from large institutions – entities like pension funds, university endowments, and sovereign wealth funds. In VC terms, all these investors are called Limited Partners, or LPs, in part because they have both limited rights and limited responsibilities when it comes to their positions in these funds.

Many entrepreneurs feel that they don’t need to know who the LPs are in their VC funds – it doesn’t seem relevant to them. However, similar to direct investors, sometimes those LPs can end up in the news for things you don’t want to be associated with. And even though indirect, some stakeholder of yours might still draw the line from them straight back to you and call you out on it.

Take sovereign wealth funds. Some of these are among the biggest funds in the world, with a few weighing in at over a trillion dollars under management. They often take large positions as LPs in other investment entities. Countries with large sovereign wealth funds include, for example, Norway, Saudi Arabia, Iran, Russia, and Libya. And while Norway doesn’t make a lot of headlines, a few of the others have ended up in the news – not in a good way.

Take, for example, an incident in 2018 that dominated the world headlines for weeks. Dissident journalist Jamal Khashoggi was murdered, and Saudi Arabian government operatives were almost immediately implicated in his death. Shortly before this, Saudi Arabia’s Sovereign Wealth Fund had become one of the largest investors in Softbank’s Vision Fund. So, when the news hit, some entrepreneurs who had taken Vision fund money were publicly called upon to give it back. And a number of entrepreneurs who took Vision Fund money after this all happened were also taken to task publicly for doing so.

. . .

Now, I’m not going to comment on whether I personally think any of the decisions that entrepreneurs made were right or wrong because I think every situation has nuances and details that may be unknown to the public – and every case is unique. I’m just bringing these up to show how you, as an entrepreneur, can end up in the spotlight for who your investors are, even when they’re LPs and perhaps not even known to you until they make the headlines. In the Vision Fund case, the identity of its largest LPs had already been widely covered, so I doubt that any entrepreneurs were caught off guard by the association. But in other situations, I know of entrepreneurs who were surprised to discover that those people in the news were also their investors.

Of course, you can’t know in advance who’ll become the subject of future scandal! But you can make some educated guesses. And certainly, you can find out which ones have already been in the news about stuff you wouldn’t want to be associated with and weigh that in your decisions.

In terms of finding out who might be in your VC’s funds, I think, again, it doesn’t hurt to ask. Some funds are bound by confidentiality with respect to the identity of some or even all of their LPs and will have to honor that. But even in those cases, you could at least ask them whether, to the best of their knowledge, they have LPs who might become a reputational risk to you. After all, any information is better than none.

. . .

Before we get back to Athena, I want to cover what I hope is the biggest consideration of all when you decide who to have as your investors. And that is how you yourself feel about taking capital from any of these individuals or entities.

Some entrepreneurs I know have turned money down from entities that had been in the news for things they found objectionable. Others that I know have taken money from less desirable investors because they believed that they were still accomplishing a greater good by getting their company off the ground. And frankly, for some, they didn’t have any other offers to choose from.

As for you, you get to decide what you’re willing to take. But just make sure that you can live with the decision you make, even if someday it’s called out by a stakeholder, like the situation Athena is facing.

. . .

Speaking of Athena, let’s get back to her situation and what I think she should do about it.

In cases like hers, I think it’s hard to respond to an attack on social media – because the first vitriolic headline gets all the attention, and your reply usually never gets as much air. Then again, if your response does get traction, you can also sometimes end up in a dumpster fire far worse than what started it. In this case, I suggested to Athena that she not engage with the activist directly. This particular person had a new grievance seemingly every day, and I thought this attack would die without doing any significant damage to Athena or her company. Her employees already knew about OilCo’s investment, and she wasn’t in market yet, so there weren’t any customers to consider either.

I said all this to Athena, but she still felt strongly that she needed to respond. So, I suggested she put out a post on her company website and on LinkedIn, owning the relationship with OilCo and explaining why she was working with them. She highlighted OilCo’s new mandate to help the world move to renewable energy and explained that their vast position in the energy market would accelerate her ability to achieve impact faster. She even added that she sincerely hopes to drive OilCo’s current business out of business with her company.

. . .

So, Athena put out her statement, turned off her media notifications, and got back to work in the lab. The activist who first made noise about this issue moved on to something else, but I expect this won’t be the last time Athena will have to deal with the OilCo connection.

Ultimately, she still believes working with OilCo is the best way for her company to have a large and fast impact, and that’s far more important to her than any public blowback she’ll have to weather, now or in the future.

And in my 25 years of doing this, I’ve seen that these types of tradeoffs are the norm, not the exception. You have to use your judgment as an entrepreneur. And no matter what you decide, someone’s probably going to be unhappy with your decision.

And that’s okay.

. . .

And that concludes “The Case of the Compromised Capital.” For the record, this situation is real, but Athena and OilCo are composites. And no startups were harmed in the making of this podcast.

Thanks for listening to this episode of The Startup Solution. We hope you’ve enjoyed this episode, and if you have, please share it with someone who might benefit from it. I’m Heidi Roizen from Threshold Ventures.

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