(That Are Rarely Shared)
Life as an investor is about saying “no” a lot of the time.
For founders looking for one “yes,” it can be maddeningly impossible to decipher why VCs are telling you “no.”
Around 1 percent of companies seeking venture money get funded. If your company stinks or you have a black hole for a personality, it’s easy to see why a VC would turn you down.
But what if you’re a rock star with a great team and a a stellar company?
There are a lot of subtle and hidden reasons why your company isn’t a fit for any particular VC firm. Running into them can feel like beating your head on the sidewalk, especially if the reasons are a mystery to you.
Over the years I’ve been blessed to interact with a handful of investors. Here are 12 common reasons that don’t often get shared.
#1. You aren’t swinging for the fences
This is probably the least mysterious of the 12. VC investing is a risky endeavor. Most startups don’t make it, therefore most VC investments turn out to be failures.
If that’s true, how does a VC make any money?
Well, the few winning companies have to make up for a lot of losers.
Y-Combinator founder Paul Graham blogged,
“In startups… the distribution of outcomes follows a power law…. The big successes are so big they dwarf the rest. And since there are only a handful each year (the conventional wisdom is 15), investors treat ‘big success’ as if it were binary. Most are interested in you if you seem like you have a chance, however small, of being one of the 15 big successes, and otherwise not.”
VCs are trying to figure out which companies in their portfolio are going to be those all-important winners.
As for founders, you must at least be trying to win big. You’ve got to have big vision and big energy behind it.
In other words, if you aren’t swinging for the fences—VCs literally can’t afford to consider investing in your company. In that case, it’s super easy to calculate your probability of hitting a home run (and of getting VC investment).
#2. It’s hard making a living at the horse track
Venture investing is a lot like betting on horses.
It’s not purely gambling. You can learn how to judge horseflesh and jockeys. And the right odds can set you up for a windfall.
But it’s hard to consistently pick winners and you lose more often than you win.
With startups, it isn’t just about telling a good one from a bad one. I love what Jerry Neumann spoke about recently on Patrick O’Shaughnessy’s podcast: Startup investing is not about risk, it’s about uncertainty. Risk can be adjusted for. But nobody knows what will happen in an uncertain situation. Great investors are those who have the stomach for uncertainty.
All startups are by nature riddled with flaws that could become fatal. There’s always a genuine reason NOT to invest.
(Check out Bessemer Venture Partners’s Anti-Portfolio, highlighting the great companies, which they passed on in the early stages.)
The moral of the story is that VCs are justifiably picky and there is always a legitimate reason to say, “No.”
You have to accept that the reason may not make sense to you. In this case, you’ve just got to move on.
#3 The cream didn’t rise fast enough
VCs are looking for big winners. A VC may say “No” because it wasn’t obvious enough, fast enough, that your company had the potential to be a big winner.
Or, the competition beat you out for the top spot on their roster.
VCs screen a lot of deals, but invest in relatively few. If your company is awesome, but the third best deal they’re reviewing, you may get a pass. If it takes too long or your company doesn’t rise to the top of the list, that can make the difference.
You will likely not know who you are competing against or what the factors were that ultimately tipped the scales against you. Since there isn’t a lot you can do about that, your best bet is to stay focused on relentlessly building the best company you can.
#4 You lost momentum
So much of raising money is about timing.
Momentum matters in the VC community. A sense of inevitability around your company builds FOMO and signals to investors that yours is a train they need to be on.
Momentum matters both in your company’s pace for hitting milestones and in the critical mass of your relationship with prospective investors. Don’t be annoying, but don’t allow the pace of your contact and interaction to stall.
That can be a difficult line to walk.
And means you have a lot of timing issues to navigate. What’s your timing in the market? What’s the timing of your company’s milestones? Where’s the urgency? Where should it be?
At one company I was at we were raising a Series A, and we started in an awkward phase where our ARR was on track to be 200% YOY plus we had just inked a key partnership deal that would double our new revenue for the year. We were set to have a 400% growth year!
The problem? These revenues were tied to industry seasonality and wouldn’t materialize until that fall, eight months later.
Key performance measures were in place. The work was done and nothing else was required on our part.
But the timing was off for us to show the momentum we saw inside the company.
Ultimately, we used the Spring and Summer to plant seeds with prospective investors and painfully waited until fall to kick our fundraising into high gear. This allowed us to paint an up-and-coming story with investors, which was borne out as the revenues we had secured materialized.
We easily could have made the mistake of going out to raise without momentum which would have been injurious to the business and our fundraising prospects.
Bottom line is that VCs are human beings. Human beings sometimes behave like magpies and are quickly distracted by shiny new things. If your deal slips into the old news category, you have the now much harder job of trying to breath life and excitement back into it in order to secure investment.
A VC Explains Why It Takes So Long for Startups to Raise Money, by Diane Fraiman of Voyager Capital. (An excellent article on why it can take longer to raise money than you think, and how to keep up the momentum.)
#5 No dry powder
It turns out VCs don’t have unlimited funds.
And the timing within the lifecycle of a VC fund affects how deals are evaluated.
A typical VC fund is created with a ten-year lifespan. Roughly speaking, the first half of the fund (both time and dollars) is for making new investments, while the latter half is for follow-on investing and pushing deals to exit in order to finalize returns to the fund’s investors as the fund draws to a close.
A new fund is raised each 2-4 years.
Depending on the deal flow, VCs often don’t have a constant availability of capital to invest.
VCs may be asking, would this deal fit better in the new fund? Is this deal appropriate as the final deal in a fund that is nearly all deployed? Am I distracted by issues related to raising the new fund?
This means two things to founders. First, the lifecycle timing of a fund can affect the attractiveness of your deal to the fund. It’s important. Second, there’s only one way to discover anything about a particular VCs fund lifecycle dynamics. And that is to ask them.
In my experience it is uncommon for this information to be volunteered, but is generously offered when asked for.
VCs are constantly on the lookout for great deals, so they will not necessarily balk at taking a call or appointment with you even if they have no dry powder to make an investment.
Find out if the VC has dry powder.
#6 The Goldilocks principle
When a VC fund is created, it typically has a set of governing documents—a charter, an operating or partnership agreement—which spell out how the fund will operate. VCs typically focus on a fairly narrow band in terms of investment amount. A minimum or maximum investment size may be spelled out in the documents, such as no single investment will be over $5 million or 15% of the size of the fund.
As a result, VCs can’t have their deals too big or too small. Just like Goldilocks, the deal size needs to be just right.
Find out whether the amount you are looking to raise is within the allowable and typical deal size for the VC.
If you’re outside the sweet spot, they may have no choice but to say “No.”
#7 Industry alignment
Venture fund organizing documents or management philosophy may limit investment activity to certain industries. VC firms may choose to invest only in technology companies such as Graylock Partners famously does. Or it might be biotech, SaaS, medical device, real estate, manufacturing, etc.
The key is to know what sectors your VC is active in, so they don’t have to tell you “No.”
That way you can focus your energy on investors where you have industry alignment.
#8 You’re in the wrong place
VCs may limit their investing to certain geographies. You need to approach those who ARE investing in your area or move your company to a place where investors are active.
The highest concentration of VCs is on the coasts. Silicon Valley in Northern California has more VC activity than anyplace else in the world bar none.
In the East, New York and Boston are the hubs. Some VCs in these areas will invest anywhere, while others like to stay close to home. If they have deal flow locally, why fly across the country for board meetings?
Less prominent communities still may have a strong startup ecosystem, such as Austin, TX or Salt Lake City, UT. It’s typical for those communities to have more local funding for early investments like Series Seed and Series A, while often companies must still turn toward the coasts when it’s time for a larger round.
Being in the wrong place is a reason VCs say, “No.”
#9 Portfolio construction
As a founder, a round of investment is a singular thing. You aren’t often raising multiple rounds at once.
This is not true for your investor. VCs invest capital in a portfolio of companies.
While invisible to you, the relationship between companies in the portfolio can be very important to the VC. They may already have invested in a competitor, in which case they are unlikely to fund you. They may be looking for synergies between portfolio companies where there is a mutual benefit. They may be looking for companies to shore up other dynamics between portfolio companies, such as exit horizon, access to talent or technology.
Portfolio construction is a common reason for a “No.”
#10 An ugly capital stack
Most companies don’t raise money the moment they are born.
That means they bring history to the table, which might include an ugly cap stack.
If you need to clean up your capital structure, that can add time, legal expense, and the potential for fights with existing shareholders (who may be unsupportive of corrective measures). Messiness, prospective hassle, and expense are turn-offs to investors.
Capital structure corrections are common, but given the choice between otherwise equal companies, one that requires extensive correction and one that doesn’t, VCs are likely to avoid the hassle.
Cleaning a messy capital structure is something you may want to tackle before you approach investors.
If an IPO is a potential exit, your capital stack may contain problems that need to be fixed before the price of your shares and the number of shares required for the public float are appropriate for a successful entry into the public markets.
The cleaner your cap stack, the more attractive you will be.
#11 Lack of social proof
VCs, like the rest of us, are influenced by social proof.
Whether its recommendations on Amazon or Yelp reviews, we feel more confident in making decisions when we see others making the same decision. Psychologist tell us that we’re wired to look to others for signals as to what the correct behavior is in any situation.
Social proof is also why warm introductions are better than cold ones.
It’s way more effective to be introduced to a new investor by one who has already committed to your deal, or via the CEO of one of the investor’s portfolio companies.
The intro comes with a tacit recommendation, which is disarming and safe.
When it comes to landing that first investment, no investor wants to be the first kid in the pool. It’s much easier to invest when another investor is already in the deal or when you know others are seriously looking.
Ideally, you want multiple investors chasing you right through your first investment, providing the confidence to each other that your company is a hot item.
Conversely, lack of social proof makes VCs afraid everyone else knows something they don’t and wonder why nobody else is interested.
Absent social proof, you’re chances of a ‘No’ go way up.
#12 You’re missing a champion within
As you build a relationship with a VC firm, you are likely to meet multiple people serving various roles. It’s common for VCs to have an investment committee where partners sponsor prospective deals.
Throughout the process, you need to establish a champion inside the firm. That’s the person who is likely to go to bat for your company. It rests on them to win internal support for issuing a term sheet and shepherding your deal through the due diligence process to funding.
Find a champion and make sure that she never regrets sticking her neck out for you.
#13 Know when to say “No” yourself
This is a bonus tip.
It is tough for a founder to turn down bad money. When you’ve pursued a long sometimes arduous process with a VC, saying “No” when the term sheet comes in can go against everything in you.
You owe it to yourself to understand your ultimate goals and know when terms represent workable compromises versus unreasonable requests.
There’s No Shame In a $100M Startup, by Eric Paley and Joseph Flaherty of TechCrunch
You should know when something is a deal breaker for you—it can be terrible to be tied to bad money.
Good luck out there.
The content of this article originally appeared as part of 101 Venture Capital Pro Tips. You can read the original as well as 84 additional tips for founders looking to understand the world of new venture financing there.