How to Deal with Skeletons in your Closet

Posted on Nov 12, 2009 | 51 comments


This is part of my series with Advice on Raising Venture Capital.

skeletons closetI recently wrote a post on how to Deal with your Elephants in the Room during your VC meetings.  Elephants being big issues that the VC will be thinking whether you bring it to his/her attention or not. My advice with Elephants was that you need to take them head on in your first VC meeting because the VC is already thinking about the issue whether you bring it up or not.

But what about issues that might have a slightly negative connotation that the VC couldn’t know in advance?  Skeletons in the Closet are these types of issues.  They are issues, though, that your VC would certainly find out during due diligence or at a minimum you’d be ethically obliged to tell them.

Some examples:

  • A large company has told you that you need to change your brand name or they’ll sue you for trademark infringement (this is a real world, recent example)
  • A company has just filed suit against you for product patent infringement (obviously more serious)
  • Your CTO and leading technology visionary has just announced he’s quitting
  • You’re not happy with your existing investors
  • Your largest customer just cancelled its order
  • Large parts of your tech system are going to need to be rearchitected
  • You have a prior record as a felon (yes, this has happened)

These are all things that you know you’ll eventually need to tell your VC and ethically you must tell them before they fund you.  But when in the process should you tell them?

I’ve had this debate several times with VCs – sometimes they agree with me and sometimes they violently disagree.  In this particular case – I’m right.  Here’s my advice: Don’t reveal your “skeletons” in the first meeting but you need to tell your sponsoring partner before the full partner meeting.

Why shouldn’t you tell them up front?  Is it displaying a lack of ethics to avoid some of these facts?  I don’t think so.  I have often said that fund raising (like any sales process) can be related back to human instincts and therefore explained via dating analogies.  All prospective partners say that they don’t like to “play games” yet it is human instinct to do so.

Some VCs would tell you that you need to lead with all of your dirty laundry – but in reality this way they won’t fund you (whether they admit it to themselves or not).  So here’s my analogy:

snoringLet’s say you’re in your late 20’s and you’re in a bar trying to meet your prospective future partner.  You wouldn’t reveal the first night you meet girl / boy of your dreams that you snore like a bear, would you?  I guarantee the night would stop there.  It is important that he/she sees your positive attributes first.  She loves a man with a great sense of humor.  That smile!  He’s so kind to people.  He likes kids! Did you hear that he was an entrepreneur?

So eventually it will be known that you snore.  By then she has at least seen your good points for what they are rather than being biased by some smaller issue that she eventually would realize isn’t that big of a deal.  Or if it’s a big deal to her, she’ll abort just as a VC would.

BUT (and there’s always a but) … you need to reveal your snoring habits to your sponsoring partner before the full partner meeting.  Why?  Because that individual is your champion within the VC firm and is going to bat for you with his/her partners telling them how great you are.  You can’t send them into battle without the full details or you’ll lose a supporter.

It’s ok to not admit to snoring on the first meeting but it’s not okay to ask somebody to champion you without complete information.  If they back you in the full partner meeting and then later have to reveal your secrets to his/her partners you’ll not only lose the deal but you’ll lose a friend and contact (along with your reputation).

UPDATE: @BSierakowski wrote to me on Twitter and pointed out that I didn’t really deal with how to begin to reveal your Skeletons in the Closet.  This is a tough one because every VC process will go differently depending on how hot your deal is perceived to be, what the general market conditions are and whether that partner has other deals in his pipelines.

But let’s assume a standard pace.  Let’s say it takes you 3-4 weeks to get from your first meeting with a single partner to get to the full partner meeting.  Let’s assume that you have 2-3 one-on-one meetings with the partner and several phone calls.  My suggestion is that you get through the first 2-3 meetings and feel out whether the partner is comfortable at some point putting you in front of his/her partnership.  If the answer is “yes” then before the full partner meeting is scheduled I suggest the following process:

  • Call the partner to say you want to sit down to go through some final details before the full partner meeting is scheduled to be sure you’re all on the same page
  • Ask that this meeting be 1-on-1 (e.g. no principals, associates or analysts) because you have some sensitive stuff you’d like to go through before the partners’ meeting
  • ALWAYS have this discussion in person – even if it means jumping on a plane and flying 5 hours
  • Sit down and have a 1-on-1 discussion.  Lead with the information early in that meeting.  Make it clear that you wanted to reveal the information before asking that partner to sponsor you in front of his other partners
  • Make sure you walk the partner through the details of how and why you believe you’ll be able to overcome this issue
  • If the partner grills you on why you didn’t tell him sooner you can answer in two ways.  A) you can explain that you felt it was important that people judge your business for its positive attributes that you are passionate about and your commited to making sure your Elephant won’t harm the company – OR – B) tell them you read this post and followed my advice and you won’t let that happen again ;-)

  • http://openswipe.com/ Casey Allen

    “It is important that he/she sees your positive attributes first…Did you hear that he was an entrepreneur?”

    Nice. Love it.

    Truthfully, I avoid the e-word like the plague because chicks assume that I'm independently wealthy. Little do they know. I'd actually pay extra to be able to filter out “daughter of an entrepreneur” on Match.com.

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