June 17, 2020
Before becoming a VC, I often questioned why so many investors say “no” to a seemingly good idea. It was only after becoming a VC that I got clarity on this simple question.
It’s important for founders to know that statistically speaking, VCs invest in less than 1% of companies they look at. Given the sheer number of times VCs say “no,” you would think they’d be better at explaining why they pass. Many VCs are notorious for not saying “no” at all and just fading away into silence. That’s because most of the time, it’s in their best interest to have you stick around in case one day they get excited about the progress. In this article, I share some explanations of a VC’s decision-making process and some tips to increase your probability of getting funded.
“We like you and the business, but you’re just not a fit for our firm (or investment thesis).” The earlier you know this, the better. By looking at their portfolio companies, stages of investment, geographic limitations, sectors of interest, and team backgrounds, you can get a good sense of fit. In the first meeting, ask about what kind of companies excite them, the stage they typically invest at (e.g., seed, series A), if they lead investments, and, generally speaking, what their investment process is. Those are not intrusive questions but rather demonstrate that a founder is mindful of everyone’s time.
“You’d be a better fit for our next fund.” The timing of a fund’s lifecycle can affect your deal’s attractiveness. A typical VC fund is created with a 10-year lifespan. Roughly speaking, the first half of the fund (both time and dollars) is for making new investments, while the second half is for follow-on investing and pushing deals to exit to finalize returns to the fund’s investors. Their timeline may not align with yours. There’s only one way to know about a particular VC’s fund lifecycle dynamics: ask questions.
Whether investors say it outright or not, a lack of fit can result in a pass that may have nothing to do with your business's potential.
Tip: Conduct your own due diligence and ask questions about the fund. It demonstrates that you are trying to align with their fund and help ensure a mutual fit.
While it may not always be apparent to an outsider, investors build beneficial synergies between portfolio companies and almost never invest in overlapping (competitive) businesses. This helps them leverage knowledge, talent, network, and support companies better. Lack of portfolio construction fit is a common reason for a “no.”
To build a successful startup, it takes passion, agility, and strong will. Successful VCs invest in top-tier teams they believe in and trust. Founders must demonstrate that they know their market, can make the right strategic decisions, and attract other qualified team members and advisors. I admire a founder who has a good mix of sales and technical skills. If your team is weak, good VCs will pick up on that and go no further without necessarily pointing to this particular reality. That’s not to say it will be impossible to raise seed funding when you are unproven or early in your career as an entrepreneur, but the pool of investors that may be interested is limited.
Tip: Early in the process, offer to introduce investors to credible connections in your network that will speak highly of your team.
You might have a great team, but if there is a lack of fit with the investor, it just won’t work in the long term. One test of this dynamic occurs during the due diligence process or term sheet negotiations when things can sometimes be stressful. If those discussions feel one-sided or contain unresolved tension, it can be a red flag for either party. Remember, this is a long-term mutual relationship that needs to build and last for years. In the book Trillion Dollar Coach, Bill Campbell explains that a relationship in the boardroom needs to evolve from handshakes to hugs.
“We’ve decided not to invest because we just don’t know your market well enough.” Investors often say “no” when they don’t understand enough about your market and can’t help. Knowledge of the market significantly increases an investor’s likelihood of making the right bet. It also allows them to leverage their industry insights, network, and, most importantly, support founders in strategic decision-making.
Tip: Speak to other portfolio founders and get a feel for how they work with investors. Investors respect a founder that does their homework on them as much as they do on you. Share your market expertise to help them make an informed decision.
“The business is a little too early (or too late) for our fund.” Founders might hear this response a lot from investors. It’s either because they don’t make investments at your stage, don’t believe enough in the business, or don’t have the stomach for the risk at that time. Founders may also get this response if the investor feels the valuation is too high. Demonstrating some level of traction in terms of sales or positive user metrics can remove doubt or address concerns. That’s not to say startups without sales do not get funded. However, raising money from top investors is a highly competitive process, and demonstrating early indication of product-market fit speaks loudly.
Investors do not have a crystal ball and make mistakes. Here are some examples of a few examples of anti-portfolio mistakes.
Tip: Make sure your forecast is realistic. In your data room, detail your pipeline or list of target customers, interest level, and market data that supports your financial model. If your forecast is unrealistic, it will hurt your credibility.
Generally speaking, one-third of companies in a VC portfolio return no capital, one-third return less than the capital invested, and one-third contribute to returning the fund. To make money, a venture fund needs to return big on a few companies to make up for losses. About 80% of returns come from less than 20% of investments. To understand, read this simple blog post: “Venture Math 101.”
Founders need to demonstrate they are going after a large and growing worldwide market, can capture their share of that market, and that there are buyers with deep pockets for the company down the road. If the market appears too small, it will be hard for them to justify that the investment can provide a meaningful return to their fund.
Timing is also crucial. A business that is too early can burn a lot of money before the market growth helps the business take off with it. If a company is a late entrant, it is likely too late, and the market is already crowded with competitors. Takeout Taxi was a great idea for food delivery, but that market only took off years later after Uber was everywhere, which paved the way for Uber Eats and others. “Why now and will the market hit an inflection point in the not so distant future?” is a question good VCs ask and founders should be prepared to answer.
Tip: In your data room, keep market size numbers, exit comparables, and any industry reports that support market timing and growth.
Investors can get sidetracked by other priorities such as managing current investments in closing, portfolio exits, new fundraising efforts, or reporting requirements to their investors—all of which can take precedent over early discussions on a new investment. That said, the fear of missing out (FOMO) is a real thing for investors, and your job is to convince them that your train is leaving with or without them, and they need to get on it. You can’t be pushy, but you can’t let their pace decide yours either.
A referral by someone the investor trusts and respects like another VC (e.g., a later-stage VC interested in your next funding round), or one of their portfolio company CEOs will increase your chances of a meeting. This introduction can help you move up on their priority list. Your objective should be to get a short first meeting to get them interested in a deeper dive into the business. If there is a fit, follow-up quick with answers to their questions or concerns. I’d suggest a maximum of two days to follow-up on post-meeting questions while the meeting is fresh in their minds. Regardless of their speed, keep them up to date on product or customer traction. Feed them with information step-by-step but do not overwhelm them. Offer to share your data room only if they are interested—show them you are also selective with whom you share it with. Finally, if you receive a term sheet, let them know before signing it but do not share the details. Having investor optionality is always a good thing until the check is in the bank!
Tip: Get a warm introduction, and do your research on the VC, their team, and portfolio. Never wait too long before following up. If a VC says “no,” ask for honest feedback and keep them posted on your progress. You may want to re-engage with them at the next funding round.
Just because VCs say “no” does not mean they won’t be open to investing in the future, so ensure the relationship remains positive. VCs are justifiably picky, and there is always a legitimate reason to say “no.” Founders have to accept that the reasons may not make sense to them at that time, but down the road, if you prove them wrong, they will be pitching to you to take their money.
Bonus tip: You can also say “no” — it’s hard for a founder to turn down money, but sometimes that’s the right choice. The right VC may not guarantee your success, but the wrong one can hurt your chances. When things don’t feel right, or the term sheet comes in and goes against everything in you, it’s okay to say “no.”