Don't Talk to Your Competitors' Investors
(or On Ethics, Morals and Fiduciary Duty)
One question many startup founders have is whether or not they should pitch VCs who have invested in their competitors. While the answer might seem obvious, there are legitimate reasons why a conversation could be worthwhile:
VCs who have invested in a competitor are likely to be more knowledgable about the space, leading to conversations with more substance
VCs who have invested in a competitor have already demonstrated interest in the space, so a fundraising conversation could have a higher likelihood of success
Many founders believe that if they are not “exactly the same” as a given competitor, all they need to do is convince that company’s investors of the difference and an investment will make all the sense in the world.
Let me take a few minutes to explain why (1) this line of reasoning is flawed and (2) why it is not just a waste of time to talk to a competitor’s investors but why it can be extremely dangerous to do so.
Some founders like to fly too close to the sun…
When it comes to how investors should behave around competitive startups, there are plenty of strong opinions and lots of areas of grey.
So let’s start with two situations that are (or should be) relatively clearcut:
If a VC has divested (sold) all of their shares in a competitor and no longer has any formal relationship with that company, then you should absolutely talk to them
If a VC has a seat on a competitor’s board of directors, then you should absolutely not talk to them
Past Investments
If an investor has divested (sold) all of their shares in a company and no longer has any formal relationship with that company, then they can make an ideal target for a “next generation” startup.
Regardless of the outcome of their prior investment, the VC is likely very well-educated about the space after that experience (whether they feel positive or negative about the space is a different question altogether). So long as the investment is firmly “in the past”, you should absolutely include them in your fully-researched investor pipeline.
Please sir, may I have another?
Board Investments
If a VC holds a seat on a competitor’s board of directors, then you should never approach them during fundraising. This is because the VC has a “fiduciary duty of loyalty” to the company.
fi·du·ci·ar·y du·ty
noun
the legal duty of a fiduciary to act in the best interests of the beneficiary
Historically, the duty of loyalty was intended to prevent self-dealing amongst directors (that is, to ensure that directors put the best interests of the company and its shareholders ahead of their own) and to ensure confidentiality of company information (preventing directors from using privileged information to enrich themselves).
Over time, the definition of the duty of loyalty has evolved and diverged from country to country. In Canada, the fiduciary duty of loyalty requires that directors and officers of a company must “act honestly and in good faith with a view to the best interests of the corporation.”
But what exactly does that mean? The Supreme Court of Canada has ruled that the fiduciary duty of loyalty is owed at all times to the corporation while steadfastly avoiding narrowing the definition (other than to note that directors must act in the long-term interests of the company):
“The fiduciary duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation.
What Does This Have to do With Fundraising?
The fiduciary relationship between VCs and the companies they sit on the board of impacts fundraising in two key ways:
A VC with a board seat in your competitor will (almost) never be able to invest in your startup
Practically speaking, it’s impossible for a VC to make a new investment into a competitor while completely ignoring all of the confidential information they have learned (and will learn) through their position on the board. As a result, investing in a competitor places them at a high risk of legal liability from the company they sit on the board of.
In other words, if they invest in your company and you become successful in the future, they are at a high risk of being sued for breaching their duty of loyalty.
A VC with a board seat in your competitor will (almost certainly) share any information you give them with your competitor
While the duty of loyalty may not legally force a board member to provide information you share with them to the company they sit on the board of, in all likelihood, they’re going to do so. At the end of the day, their loyalty is unequivocally to your competitor, so you should not have any false illusions that they will keep your conversation private (even if that might seem like the “good” thing to do).
Non-Board Investments
What about VCs who have an investment in your competitor but don’t have a seat on their board?
Legally speaking, they don’t have the same fiduciary duty of loyalty to the company that they would if they had a board seat. Pragmatically speaking, they’re very likely to behave the same way.
A VC with an investment in your competitor will (almost) never be able to invest in your startup
Regardless of board seats, the vast majority of VCs avoid investing in both direct competitors and companies that are immediately adjacent to existing portfolio companies. Pivots are a fact of startup life and investors generally want to make sure that there’s enough “room” between portfolio companies to avoid having two investments in conflict.
Why? Because regardless of whether or not there’s a fiduciary duty at play, competition amongst portfolio companies just isn’t good business. The founders of companies in conflict are less likely to trust the investor in the short term (which prevents the VC from being able to help them). In the long term, one or more founders might feel upset to the point that they actively tell other founders to avoid the VC, affecting long-term deal flow (“don’t take money from them…they’ll just invest in your competitor!”).
Over the years, more than a few VCs have tried to make competitive investments work, only to discover how loud a founder scorned can truly be.
A VC with an investment in your competitor will (almost certainly) share any information you give them with your competitor
Regardless of board seats, investors have a very clear interest in helping their portfolio companies succeed. If they come into possession of competitive information that can potentially increase the likelihood of success, you’d better believe they’re going to share it with them.
The Exception
There is one important exception to the above rules-of-thumb: investors with large portfolios and no information rights.
Certain investors, such as most accelerators, make a large number of small investments into companies and don’t receive access to confidential information (referred to as “information rights”). These investors are generally comfortable investing into competitors and are seen by the market as “safe” with it comes to pitching, simply because they don’t really interact with the companies they invest in after the investment is made.
The Grey Area
At this point, you’re probably thinking that all VCs are greedy assholes and that all they want to do is steal your ideas and share them with your competitors.
Here’s the thing: most investors don’t want to be in a conflict of interest. The vast majority of VCs genuinely want to see founders win, regardless of whether or not they’ve invested in them.
The Onus is On You
It’s important to keep in mind that, prior to meeting with you, the average VC has no clue who you are or what your company does. That means they have no idea whether or not you’re competitive with one of their portfolio companies.
This is where morals come into play (and where you can rightfully judge investors on their behavior). What does an investor do when they realize that you are potentially competitive with one of their portfolio companies?
The best investors will immediately stop you and tell you that they can’t proceed any further.
They best investors don’t want to be in a position of conflict. They don’t want to have to choose between your company and their portfolio company, so the moment they sniff an overlap, they’ll pump the brakes.
This might seem harsh (and many founders immediately react with a feeling of unfairness), but the reality is these investors are airing on the side of caution. They would rather be overly cautious when it comes to avoiding conflict and immediately end a conversation than find themselves in a position where they have to choose.
In my experience, this is how the vast majority of VCs behave.
There are, of course, other investors who will ask pointed, incredibly well-informed questions, only to admit at the end of the meeting that they have already made an unannounced investment into a competitor, but thankfully they are few and far between.
So What Should You Do?
First off, avoid all VCs who have invested in your direct competitors. Don’t reach out. Don’t tempt fate. Just move on.
Second, at the beginning of every meeting, ask investors a simple question:
“Before we get started, I want to check one thing: have you made any unannounced investments into a company that you would consider a competitor to us, based on what you know so far?”
At best, I would guess that 1 out of every 100 founders I speak with asks this. Not only does it make me pause and think, but it immediately adds a couple of points to my impression of the founder. It comes across as experienced and self-aware, without being cocky or aggressive.
Finally, if an investor ever makes a comment or gives you a look that makes you feel as though something is off, trust your gut. Don’t be afraid to call them on it or ask if something is amiss. Most investors will be direct with you. If something still feels wrong, then politely end the meeting.