When Are Venture Scouts Dangerous to Work With?

Most founders aren't aware of the nuances of accepting a check from a venture scout.

Especially if you’re a founder who’s excited about the big-name brand they say backs them (be honest if you are) then you likely are confused and should read this carefully.

It's crucial to understand the subtleties of venture scouts before deciding to engage with one for your early-stage startup.

Understanding Venture Scouts

First the dry definitions... A venture scout is an individual investor who gets their investment money from a larger venture capital firm. Venture capital firms set up venture scout programs for various reasons:

1. To simply get money into good deals
2. To be able to access deals earlier than their core strategy dictates and monitor them as they progress towards being a fit for their core fund.
3. To strengthen a relationship with the scout whose network and loyalty benefit the venture capital firm.

First-time founders can often get excited by any investor interest, especially if it is affiliated with larger firms. It's common to see these founders promoting that a venture scout has invested in their startup.

Impact and Implications

This publicity can have positive impacts on smaller investors, other angels, and less experienced venture capitalists.

There is indeed some positive signaling that comes with a scout from a larger firm investing in a startup. However, that certainly doesn’t mean the firm itself did its diligence and deemed your company quality enough to invest in. 

The Risks: Negative Signaling

Negative signaling can come into play when scouts invest, especially in early rounds. The fact that a big VC invests a small check implies they’re setting themselves up to make a bigger bet once you grow to their sweet spot. If they don’t invest at the bigger round, there will be huge question marks. Other investors will think, “That firm had a front row seat and knows this company better than anyone else, but they’re not investing. Why?”

To bypass these potentially damaging effects, many venture scout programs mask the relationship between the scout and the parent venture firm. They either don’t have their scouts explicitly brand themselves as a scout of the parent fund instead allowing the scout to casually manage the affiliation on the side. 

Many savvy founders will avoid negative signaling by accepting venture scout investments but do so discreetly. By doing so, those scout checks sit on your cap table, with less likelihood of drawing a direct line to a larger venture capital firm (unless you want it to).

It can be helpful but be careful

While Venture scout money can seem appealing, especially when urgently needed, it’s essential for founders to fully comprehend the dynamics at play. By being aware of the potential risks and challenges, founders can be more discerning when accepting investments or sharing what investments you take on. Good luck!

Key Takeaways:

1. Understand the role and implications of venture scouts: Venture scouts are funded by bigger venture capital firms and can invest in early-stage startups. These investments can have both positive and negative impacts.
2. Recognize the potential risk of negative signaling: Negative signaling might occur if a venture scout invests in your early-stage startup and the parent firm chooses not to invest at a later stage.
3. Consider being discreet about any scout checks you do take on.
4. Be cautious about the investment you accept: It's crucial to understand the dynamics of venture scout investments to make informed decisions regarding accepting and disclosing the funds you take on.

Be chased,
Jason