Rajat Bhargava and I have been working together since 1994. We’ve been involved in creating seven companies together (the most recent ones are MobileDay and Yesware) and, while most have been successful, we’ve had a huge number of positive and negative experiences along the way. We’ve mostly had a lot of fun and, when we haven’t, we always made sure we figured out what went wrong.

Minda Zetlin just put up an interview with us on the Inc. Magazine site titled 4 Signs You Should Say ‘No’ to a VC which I thought was excellent. She explores the entrepreneur – VC relationship and suggests four warning signs for an entrepreneur when interacting with a VC.

1. The VC isn’t fascinated with your product
2. He (or she)’s just not that into you
3. You can’t be completely honest
4. The VC doesn’t treat you like an equal

The paragraph on “you can’t be completely honest” is a seminal moment in my relationship with Raj. It also was a key point in my work career where, upon reflection, I completely and totally grokked the importance of being honest in the moment, clear about my reasoning, and willing to change my perspective based on new information, rather than feeling stuck in simply delivering a message. The section from the article follows:

“The important thing is to be completely transparent,” Bhargava says. “It’s very, very difficult to be transparent about your business, but it goes a long way toward building that relationship. ‘Here’s what I’m going through; here’s what I’m struggling with; here’s what I need help with.’ You have to know if that will spook the investor or if they’ll want to dig in and help you.”

That ability to be honest was a great asset in Feld and Bhargava’s relationship when they worked together on Interliant, the only one of their ventures that did not survive. After some politicking by a different executive, Feld removed a part of the company’s operations from Bhargava’s oversight. Bhargava took a few days to calm down, but then he explained forthrightly how disappointed he was and why he believed Feld had made the wrong decision. “Being open and directly confronting the issues, you get through it,” Bhargava says now. “I felt hurt, but I think our relationship is that much stronger.”

As for Feld, he recalls returning to his hotel after discussing the matter over dinner and feeling physically ill. “I knew I had completely screwed up,” he says.

I count Raj as one of my closest friends and trust him with my life. He’s had an enormous influence on how I behave as an investor and how I interact with entrepreneurs. Raj – thanks man – I look forward to many more years working together.

I spent most of the day yesterday at TechStars Boulder. Demo Day is a week away and I did my annual “talk about how to finance your company” thing which included meeting with each company and giving them advice on where they were in the process. As I walked to dinner, I felt incredibly energized – once again there is a great set of companies coming out of the program and it’s awesome to reflect on the progress that they’ve made in 90 days.

My “near the end of the program” talk has become a ritual for a few of the programs – I just sit around and answer questions about the financing process for an hour. This lets me tune the discussion specifically to what’s going on and what is top of mind of everyone at this stage in TechStars. Since everyone in the program is in the room, they get to hear specifically what their peers are going through and how things are being addressed. This is obviously not a steady state phenomenon from year to year as while some of the issues and dynamics around fundraising stay constant, the environment is continually changing.

I woke up to an email this morning from Isaac Squires of Ubooly which said “Best Analogy Ever: I think it went something like – “VCs are like D&D players – I’m the psi mage, and Jason is the barbarian…”  It was part of my rant about VC archetypes.

One of the biggest mistakes entrepreneurs make is to assume “all VCs are the same.” Over and over again I hear questions like “how do I raise venture capital” or “how do I approach a VC”, or “what does a VC want to see in the first meeting”, or “now that I’m going to pitch a VC, what should I show them?” The answer – generically – is “I have no fucking idea – WHO are you meeting with?” This usually gets the person’s attention, at least a little.

The point I go on to make is that there are dozens are archetypes of VCs. Yesterday I listed half a dozen quickly off the top of my head using one line descriptions. I then paused and used an analogy that occurred to me in the moment and caused all the nerds in the room to smile. I said something like:

“Think about D&D, or Magic the Gathering, or any other game like that. The VCs are individual characters in D&D. Each character has a different set of skills, weapons, money, and experience points and over time develops more. A firm is a combination of different characters – at Foundry Group you might have a mage and a barbarian – and the combination is what you have to pay attention to.”

I played a lot more D&D than Magic (D&D was my junior high school game of choice) but the analogy holds exactly for Magic or even in simpler form Werewolf. One you realize you are dealing with many different archetypes with different skills and skill levels, and the configuration of these archetypes into a firm are similar to how characters combine and interact in a battle, you realize that there is no “generic VC.”

I moved off the analogy to make the point that you should do your research on the person and firm you are talking. It’s easy to do today via the web and the power of all the network connections between people. If you understand who you are talking to, what motivates them, and what they care about you can both target them better as well as have a much more effective conversation with them.

I expect I’ll use this analogy again and again – it’s better than saying “there are lots of different VC archetypes.” I need to think a little harder about the specific archetypes at Foundry Group since right now we all appear to be 3-D printed bobble-heads when you look at our website. At least there’s the consistent theme of beer in the background.

I discovered Josh Breinlinger’s blog this morning via a tweet from @stefanobernardi. I added it to the Ask the VC blogroll, read carefully through his post  VCs are liars. And so am I, and declared it the VC post of the day.

And – Josh is right – it’s super hard to say “you suck” or “your team sucks” as a reason for passing. Most VCs aren’t willing to do this as they either don’t want to deal with it, don’t have the emotional constitution for it (it’s hard to say no constantly throughout the day, every day), or don’t recognize that’s the actual reason they are passing.

At Foundry Group, our most common reason for passing is that what you are working on doesn’t fit within our themes. We try to pass on these companies in less than 60 seconds. If you assume that you are one of the 1,000 or so companies a year we see that fit within our themes, we quickly narrow it down to about 100 companies that we spend real time on based on one of three reasons.

1. We don’t like the team
2. We aren’t excited about the business
3. You are too late stage for us

We usually figure this out in the first meeting. You’ll rarely get past interacting with one of the four of us if one of these three is the case. I’ll come back to this, especially point #1, in a minute.

If you end up in one of the remaining 100 companies a year we look at, recognize that we’d probably like to invest in your company. So by this point we like the team – that’s the not the reason we end up passing. Nor is it the business. Our challenge is that we can only invest in a dozen companies a year. We’ve purposefully constrained the number of companies we invest in a year to 12 +/- 2  (our fund is $225m, we have four partners, and have no interest in ever growing bigger.)

100 companies a year we love? 10 – 14 potential investments a year. How do we choose? At this point it’s completely qualitative. We just spend time going deep, individually and together, on every company in this set. We dig into the people and the product. It’s usually pretty obvious when all four of us are off the charts excited about investing. If we aren’t, then we don’t.

The toughest cases are the ones where we are excited, but something qualitative is holding us back. This is always either people or product. But it’s not because we think the people (or the product) suck – we are way past that point. Rather it’s something that just doesn’t catapult it into our “we are out of our mind with enthusiasm about investing.”

So – in our case, the equivalent of “the people suck” happens early – as we narrow from 1,000 to 100. In those 900 that we pass early in the process on, often people issues are the drivers. It’s not necessarily that the people suck, but it’s often the team doesn’t inspire us, we don’t click with them, we think there are weaknesses somewhere that are significant, or we just don’t get the right vibe. We are often wrong on this, but if asked will be blunt about it. It’s hard, so it’s more “reactive” when someone asks rather than “hey – we’ve decided to pass because you suck”, but we try to never hide behind something else when someone asks for feedback.

Having now done this for 18 years (eek) and said no to people about investing somewhere between 10,000 and 100,000 times, it’s really hard to tell someone the reason is them. But, when asked, I try. And I’ll keep trying.

At the HBS VC Alumni event I was at last week (no – I didn’t go to HBS – I was a panelist) I heard a great line from a wise old VC who has been a VC about as long as I’ve existed on this planet.

“VCs only need three rights: Up, Down, and Know What The Fuck Is Going On”

If you’ve read Venture Deals: How To Be Smarter Than Your Lawyer and Venture Capitalist, you already know that Jason and I agree with this statement. And even though a term sheet might be four to eight pages long and the definitive documents might be 100 pages or more, other than economics, there are really only three things a VC needs in a deal.

Up: Pro-rata rights. When things are going well (up) a VC wants the ability to continue to invest money to maintain their ownership.

Down: Liquidation preference. When things don’t go well (down), a VC wants to get their money out first.

Know What The Fuck Is Going On: Board seat. Beyond demonstrating that older VCs also swear in public, many people believe that with a board seat comes great power and responsibility. In reality it mainly gives one the ability to know what’s actually going on, to the extent that anyone knows what’s actually going on in a fast moving startup.

As I was writing this up, I remembered that Fred Wilson had a post about this a while ago. I searched his blog (using Lijit and the term pro-rata) and quickly found a great post titled The Three Terms You Must Have In A Venture Investment. He attributes this to his first VC mentor, Milt Pappas, and the three terms are the same ones referenced above. It’s a great post – go read it.

Entrepreneurs – don’t get confused by the endless mumbo-jumbo. If you haven’t read Venture Deals: How To Be Smarter Than Your Lawyer and Venture Capitalist grab a copy. Or read blogs. Or do both. And VCs – don’t forget what terms you really care about – focus on making it simple.

For all of you out there who are wondering, Amy is doing fine. We’re in Boulder, she’s happy, in some pain, but enjoying the delightful impact of Percocet, and making her way through MI-5 Season 8. Thanks for all of the support, emails, and kind words.

I’m about to head out for a five hour run (broken into three separate segments) in preparation for the 50 miler I’m doing in April after I help her take a shower (which ordinarily I would be excited about), but first I thought I’d write some thoughts about a call I had with an entrepreneur yesterday.

The call was about a potential financing he is considering. I’ve gotten to know him some from a distance over the past year and am impressed with what he’s created. He originally just called me for advice on his financing strategy but I started the call by telling him I was interested in exploring leading a round, would be willing to give him advice also, and would quickly tell him if I was dropping out so he could flip me into “advice only mode” if we weren’t going to end up being a potential investor.

We had a wide ranging conversation over an hour about the current state of the business and how he’s thinking about the financing. Several times over the course of the hour he sounded defensive about a particular issue – well – not defensive, but uncertain. He’d frame what he thought was a negative in the context of the way he’d heard it from a previous potential investor (let’s call them BucketHead Ventures) who hadn’t gotten to a deal with the company in the past.

One of these was around churn – he asserted that one of the clear weaknesses of the business was the high churn rate. I pressed him on what he meant and we went through some numbers. He didn’t have a high churn rate at all – in fact, his churn rate after a customer was paying for three months was minimal. The problem – described by BucketHead Ventures as “high churn” – was a combination of what happened in the first three months and BucketHead’s inability to do cohort analysis, so BucketHead looked at absolute churn on a monthly basis rather than on a cohort basis.

In my head, I thought to myself “bucketheads – they pretend to understand businesses like this but have a total miss at a basic level.” The entrepreneur understood the miss, but had internalized BucketHead Ventures feedback and was letting it color his view of his business. And, more importantly, it was making him gunshy. Instead of articulating a powerful story about low customer acquisition costs with minimal downstream churn, he lead with “the worst problem with the business is our high churn rate.”

I see this all the time. While some entrepreneurs think all VCs are bucketheads (they aren’t), other entrepreneurs think all VCs understand this stuff (they don’t). Even ones who seem to be experts, or should be experts, or claim to be experts. Especially the ones who claim to be experts. Often, they are just bucketheads. Listen to their feedback, but don’t let it make you gunshy if you think they are wrong.