I wrote a “Rules Post” a few weeks back recommending that entrepreneurs not use middlemen/brokers to fund their startups – and that has generated a few private comments via email. First of all, just to be specific, the rules are meant to be humorous, and this rule was specifically about brokers who are blatantly only after their “take”.
[As an aside - come on, guys, this is a COMMUNITY! Let's share comments so we can all interact - even if you need to make them anonymously - I have thick skin and you can't hurt my feelings.]
But I don’t want to hedge on this issue about brokers -
There are certainly cases where a middleman/broker model can work in the startup world – but they are few and far between. The startup I worked for here in Pittsburgh, FreeMarkets, is one example – we raised money early on via a broker; but that was the late 1990s, and the world has changed much since then. There are so many more avenues that disintermediate the middle man; they bring little value in a more transparent entrepreneur-investor world.
Have we seen good deals from brokers? Yes. Have we invested in any? No. Why? For the most part, the deals haven’t risen above the bar; I am afraid that we are prejudiced that if you need a broker, you likely don’t have a compelling idea/product, or you don’t have “what it takes” as an entrepreneur to be successful (i.e., raising money as a proxy for longer-term success across the business). But also, brokers tend to charge too much; pricing is out of whack with regards to value provided.
I believe the same thing is happening on Wall Street – investment bankers have added too little value for too long at too high a price, and their industry is shifting underneath them. This sort of disintermediation will happen naturally, just like it is happening in the entrepreneurial world – but it is exacerbated by the crazy fees this industry has been charging.
A couple other easy targets for disintermediation that come quickly to mind are real estate brokers (6% to sell my house? No way…) and TicketMaster (fees often nearly as much as face value of ticket?!?), to name just two.
I would love your thoughts… IN THE COMMENTS FIELD, PLEASE!
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Comments (6)
I couldn’t agree more, the web has enabled an increase in the “disintermediation” of brokers. But overall, I think it’s a natural progression.
I think this is the whole theme behind creative destruction. This is the time when the hogs get slaughtered… Too long these middle men could hold their connections & insider knowledge over our heads, but technology is becoming the great leveler. It’s not that they’ll go away, but their business models certainly need to change.
Alan:
While I agree with the context of your blog, as a strategist that focuses on dynamic thinking, I’d be very careful about taking a static stand against middlemen/brokers both the venture type, and the equity-type on Wall Street.
Things are in flux on a global basis. I just finished a major analysis for a White House Department on “what are some of the scenarios if China just decided to ‘go it alone’ on the global downturn. They could do that. They probably won’t. But, we don’t live in a vacuum. “How would it effect Wall Street, national security, the US Economy, science and technology, WalMart, the local retailer, new ventures, and so forth?” The What Ifs are many — including it having no impact.
Middleman/Brokers got lazy during the “good times.” They became order takers, slacked on the analysis, and built their branding-marketing-communications skills. They certified themselves as experts without accomplishing anything significant — but, rather pointed to their personal financial successes as if those really and magically extended to their would-be customers. As they became better at the skill-sets they became less and less valuable, until they had little value-added services they provided. That is the current situation — but after the fallout, it may no longer suffice to be the way to conduct business and hold on to a job.
If a middleman/broker can work with a entrepreneur to TRULY expand and transform a linear business plan and idea into something more complete and valuable, that one-on-one consulting and mentoring would change the situation and all would win — as this would pre-screen many loser plans, while also building entrepreneur and middleman reputable reputations. The shock to the economy, and the dynamics may shape this.
Thanks for all your comments, guys – I think we all agree that some degree of disintermediation or creative destruction is happening, likely at different paces in different industries.
Frank, your comments are very interesting – taken to the extreme, the best angels in the investment world function much like the “good brokers” you describe. They take a small equity stake in a young company, but more importantly, they do the guiding and mentoring that you speak about.
I have thought there is room in our developing VC industry for outsourced skills – such as outsourced company screening, outsourced due diligence, even outsourced board governance. Different VCs have different skill sets – some are great at raising money, some are great at picking companies, some are great at company development/growth – not many can do it all.
An admittedly late comment but…I’ve been on both sides of this equation. I have been a VC / private equity guy doing buyouts and earlier stage investing over my career. And I spent a couple years as a consultant and “boutique” investment banker raising capital for real early stage companies (no fun).
My observation is that the private equity industry has a sourcing model that includes a heavy dose of intermediaries. The bigger the deal, the more likely there is to find one (or two) investment banks involved. This market has developed into an efficient market. Small buyout shops try to mostly buy companies that are not represented by IBs because they don’t want to participate in an auction process that will result in a higher price paid and less chance that they are the winning bidder. But the more sophisticated the seller, the more likely it is that they hire a banker so they can maximize the sales price.
The venture market is far less efficient. Big, later stage venture rounds do often have bankers involved but earlier stage financings generally don’t. My premise is that VCs don’t like deals where intermediaries are involved as this generally means that the efficient banker process may drive a higher valuation and drive more competition reducing the chance that they will get to invest. Saying that hiring a banker/intermediary cast doubts on the quality of the management team is a smokescreen because you are not looking for a management team that has a good fund raising rolodex (most VCs sell that they can bring this to the table), you are looking for a team that are good operators and can articulate their value proposition to customers, VCs, strategics… The intermediary should help the entrepreneur articulate and package the story and bring multiple parties to the table to make sure the fund raising process is efficient but ultimately the VCs should be talking to the entrepreneur for the real diligence and asses his/her skill set to get across the finish line. Far too often, early stage entrepreneurs are so busy trying to run their company / develop their technology that they sub-optimize the fund raising process and only go to a few local VCs or network into the few VCs their lawyer or accountant knows – particularly in fly-over country outside the Valley/Boston/Austin. This is good for the VCs as they don’t have much competition which is why, in my opinion, the VCs prefer that an intermediary is not involved.
Thanks for jumping in, Paul!
I don’t necessarily disagree with anything you say…
BUT – I think it is important to articulate what we are seeing with our early stage VC firm, and I believe this is the reality for most of our colleagues as well. Perhaps brokers make more sense downstream; they don’t make too much sense here. Currently, 95% of the deals that come with brokers attached are very clearly lower-quality deals, typically with alot of “hair” on them (i.e., broken team, rotten capitalization, etc).
I would highly recommend that if an early stage startup needs to use a broker to help them refine their pitch and figure out which investors to target, it should be much more in an advisory/consulting capacity, much more behind the scenes.
Thanks for your thoughts!