How VCs Use Advice from Experts

12/23/10

In recent years, doctors, scientists, and experts who consult with pharmaceutical companies and hedge funds have come under increasing scrutiny from the media and their fellow professionals. The truth is, it’s a case of caveat emptor—both for the experts and for the organizations hiring them.

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 up front. 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 normally work with experts without risk to their 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 my firm, Clarement Creek Ventures, 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 diabetes-related startup that focused on glucose intolerance and hired a diabetes 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 by virtue of having published work in the area of interest, or by having invented a product similar to what I am considering financing. Information from these people can be biased and hence hazardous to a portfolio company. The upshot is that outside experts, including those who are paid, are often valuable as long as a VC makes sure they are objective, as well as well-informed.

John Steuart is Managing Director at Claremont Creek Ventures in Oakland, CA. Follow @

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