I hate this part

8.12.11 by Dov

OnStartups has a guest post with 5 reasons an angel investor will walk from your deal.  All true, all also applicable to VCs, and all basically common sense (do what you say, don’t lie, don’t assume you know everything).

I thought it might be useful to list some of the reasons that VCs (and angels) will pass but no one likes to talk about (at least to entrepreneurs).  The hardest part of my job is how often I have to say “no”.  While I got a lot of practice when I started my venture career as an associate doing entry triage (I averaged two turndowns a day), it doesn’t really get easier.  And for me, it’s the whole “crushing someone’s dream” thing.

We make hardly any investments relative to the number of companies we meet, so simple math says that lots of good companies are going to hear “no” from me.  Even ones who aren’t run by lying, know-it-alls who can’t deliver on their plans.  I try to be as upfront as possible about the reasons for our turndowns, though sometimes that’s more difficult than others – for example, if I think you’re a lying know-it-all who can’t deliver on your plans, I’m not likely to actually tell you that.

In any case, without further ado, here are the other primary reasons a VC or angel will pass on your company:

1. Your business doesn’t match our strategy – come on, you did read the website, didn’t you?  We announce our strategy to the world for a reason.  There’s even a checkbox on our “submit a business plan” page to verify that you’re a “fit with our investment criteria”.  And yet, more than half of the plans submitted through our website aren’t.  And I’m not talking close.  I’m talking a chain of retail stores in Brazil selling yogurt to dogs.
2. I don’t have faith that you can run the business.  This comes back basically to the points made in the OnStartups article.  And I’ll add that, with very few exceptions, if I know more about your industry than you do, that’s a bad sign.  Not that you have to be the world’s expert in whatever (Brazilian dog yogurt, for example), but by the time you’re raising several million dollars, you should have a pretty good handle on the dynamics of your industry and the levers you have to play with in your company.
3. Your market’s too small.  Some businesses just aren’t suitable for venture capital (or at least not for our version of it).  Not your fault, not our fault.  Just not a match.  We can still be friends, right?
4. There’s no competitive advantage.  I admit this is a hard one for a young company.  Sort of by definition, if you just started this company, so could lots of other people.  Two answers:  First – IP.  Whether it’s patents or trade secrets, some businesses really can benefit from intellectual property.  Second – business model.  Particularly in the software world, we want to see companies where there is a dynamic in the market that will make it difficult for competitors to follow you.  Being the first mover is irrelevant.  Being the first mover selling a software solution with an iron-clad, 50-year contract is a competitive advantage.  More typically, the competitive advantage will take the form of some sort of network effect. That is, once you have a large base of users, there’s something about the product itself that makes it more valuable for the next user to sign up with you rather than your smaller-customer-base, but otherwise identical, competitor.
5. We’re too busy right now with other things (usually other prospects).  This one sucks.  We could be soul mates, but I’m standing outside your subway door as you ride away, never to be seen again.  Unless you’re willing and able to wait a bit or we unexpectedly free up, there’s not much anyone can do.  I guess it wasn’t meant to be.
6. Your business isn’t interesting (to me). I’ll admit – this is one that you’ll rarely hear me tell an entrepreneur out loud. I hate telling people their babies are ugly – especially since in this case, beauty really is in the eye of the beholder. Many of the companies that I turn down for this reason probably get funded elsewhere, and many of those probably go on to success. But when it’s time to write the check, someone in our firm has to be absolutely passionate about your company. And if I’m 99% sure that’s not going to happen (and the partners all know each other pretty well), there’s no point wasting your time (or ours) trying to get there.
   
   This is a bit of a dangerous line to walk – between not wasting our collective time and making sure I have enough information to make an informed judgement. There have been multiples times when it’s just taken me a while to understand why something is interesting, but I really hate feeling like I’ve led an entrepreneur on. So, take this as a confession. This is a black box. It’s gut feel. I make mistakes periodically. Sorry.
7. A final variant of this is that your business just doesn’t hit the “high bar”.  This is the absolute worst.  For us, only making 2 or 3 investments a year, this happens a fair amount.  There are lots of entrepreneurs who we like, with really interesting businesses, in big markets, but who we’re still going to pass on.  Many will go on to great success.  (Hopefully not too great, though – no offense, but that would make me a little sad.)  We have to prioritize, though, and that means passing on some really good opportunities each year.  In these cases (even more than the others), we’re happy to make referrals to others and be as helpful as we can, because we really do want to see you succeed.  And much like #6, every investor is going to have a slightly different take on what gets over the high bar, so in these cases, it really isn’t you – it’s us.

One final point – a response of “it doesn’t fit our strategy” is pretty ambiguous.  For example, a VC might be thinking in the back of their head when they tell you this that “we have a strategy of not investing in stupid ideas.”  So, if you hear that out on the fundraising trail and it doesn’t ring true (because you’ve read their website, so you know better), push back.  It doesn’t do you any good for VCs to not be honest about why they’re passing, so if you’re not satisfied with the initial answer, try to get a better one.  And if you still can’t get a good answer out of them, just make sure none of these apply and then cross that investor off your list.

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Posted in Entrepreneurs, Fundraising, Venture Capital Industry | 1 Comment