How VCs Use Advice From Experts

Recent media articles have scrutinized the use of doctors, scientists and experts by pharmaceutical companies and hedge funds, often casting them in an unflattering light. Experts can play a valuable role, but it is a case of caveat emptor – and sometimes for the expert, as well as the organization hiring him. Biotech or medical device companies that are trying to promote new products, for example, could undermine a medical expert’s perceived objectivity if financial ties are not clearly disclosed upfront.  Experts providing information to hedge funds must be particularly careful not to disclose non-public information about publicly traded companies and run afoul of insider trading restrictions.

Venture capitalists also commonly rely on personal and business expert networks to help gather investment information to make smart investments in private companies.   Because early-stage venture firms do not invest in public stocks or promote independent projects, experts can work with VCs and VCs can work with experts without risk of reputation or objectivity.

Here is how I and other venture capitalists use outside experts:

Personal networks, by far, tend to be most valuable. For example, sometimes I contact a childhood friend who is now an orthopedic surgeon at the Cleveland Clinic. If CCV is thinking about investing in a product related to surgery, I ask his opinion. His input is good — and it’s free counsel from a valuable source.

Like other VCs, I also look for expert guidance inside existing portfolio companies. I’m currently working on a project related to a software system for gene sequencing, for example, and I have consulted a chief technical officer at a CCV portfolio company who is highly knowledgeable in this space.

Sometimes I do pay for advice, as do other VCs, and it is often worth the price. At one point, I was looking at a diabetics-related startup that focused on glucose intolerance and hired a diabetic’s expert from Abbott Laboratories who understood the market, the competition and what would be required to make this startup successful. Ultimately, CCV decided against making this investment, partly because of his input. Advice that helps dissuade a venture capitalist from making an investment is every bit as valuable as advice that prods him to make an investment because more startups ultimately fail than succeed.

When a VC does pay for advice, he has to be careful who he seeks it from. In particular, I avoid people who have skin in the game because they have published work in the area of interest or perhaps have even invented a product similar to what I am considering financing. Information from these people can be biased and hence hazardous to a portfolio company.

John Steuart is a Managing Director at Claremont Creek Ventures and has spent the last 20 years managing, building and investing in technology and life science companies. He focuses on the intersection of the information technology and life sciences markets, including bioinformatics, molecular diagnostics, genomics, proteomics, software and instrumentation for med-tech industries. He is an Industry Fellow at the Center for Entrepreneurship and Technology at the College of Engineering at UC Berkeley, as well as a member of the Advisory Council to the Lester Center’s Berkeley Entrepreneurs’ Forum at UC Berkeley.

4 replies »

  1. Thanks for the good writeup. It in fact was once a entertainment
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  2. Frank – What does your response remotely have anything to do with Barney Frank or what I posted?
    Insider-trading is notortiously vague and has been left that way largely due to the belief that as soon as the SEC set more specific rules/regulations for it that it would be gamed by the financial industry. Makes for a two-edged sword.

    ” .. Even though these firms including GLG have been investigated now numerous times by the SEC it is just very difficult to prove insider-trading ..”
    So .. OWEbama’s SEC is incompetent and you know everything? Have you told Al Sharpton this?
    Fatal flaw: there are criminal actions and civil actions. Latter can be quicker. Then again, you know everything, so everyone else is wrong.
    Hey — “Wall Street Journal” columnists criticized Bwarney Fwrank’s buddies at Fannie/Freddie for TEN (10) years. Nothing. Now — look at the mess. Even Bwarney had to admit, he screwed up.
    Plenty of incompetence inside the Beltway.

  4. There is a fine line here but it is often crossed especially when VCs/private equity/hedge funds pay ‘experts’ for knowledge regarding existing companies and offerings in a particular industry from firms such as Gerson Lehman Group (GLG), Primary Insight, and Vista Research to name a few. This has become big business quickly and GLG has revenues of well north of $1B last year.
    These experts often have proprietary knowledge that is divulged either willingly or unwittingly. Even though these firms including GLG have been investigated now numerous times by the SEC it is just very difficult to prove insider-trading because firms like GLG employ several methods (including ensuring that calls are hosted on their network and not recorded) to make it very difficult to get the evidence needed to make a case stick in federal court.