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Why pitching to VCs is the numbers game

23rd January 2022

A founder's 'insight' is the core ingredient for startup creation. It's the thing that they know but others don’t yet know. The insight reveals a unique market opportunity that the founder believes they can exploit before others jump in.

The startup's first product embodies this insight.

To fund the startup, founders must find investors that will embrace the insight and buy into the vision. This can take a lot of approaches. What experienced founders know but can seem counterintuitive to first-time founders is that many of these pitches will go absolutely nowhere - but this is not necessarily a bad sign. If investors think the idea is too offbeat or they just don't get it and pass, this can actually be a good sign.

But surely, if investors don't immediately fall over themselves to invest, the idea must be a flop?

A great parallel throws light on this. We know from lean startup theory that the first market to attack is the 'early adopter' market. The early adopters eagerly grab the initial product 'as is' and use it to solve an immediate problem. The first job is to conquer this initial, if small, market. This validates the fundamental business hypothesis and provides credibility to expand.

Importantly, in seeking the early adopters, a founder does not iterate on the product. They iterate on the customers. They search for the customers that immediately resonate with the insight and the product that embodies it. These customers will jump on board with enthusiasm and the sales cycle will be minimal. Price will hardly matter.

In the case of early investors, a pattern-matching mindset can often filter out the unconventional. An offbeat proposition can easily get passed over. This is only human nature at work - safety lies in consensus. But somewhere in the crowd a contrarian is waiting. So don't iterate on the story, iterate on the investors.

The world's most successful VC's say that the biggest returns are often associated with insights or ideas that seem to defy conventional wisdom - what PayPal founder turned investor Peter Thiel calls a “secret” in his book, Zero to One. These are the breakthrough ideas that have the potential to create a "category winner". For a VC, these are the ideas that will ultimately "return the fund", perhaps several times over.

Such secrets clearly must possess some special attributes, but what are they? Benchmark Capital co-founder Andy Rachleff has described perhaps the best known model, often credited to legendary investor Howard Marks of Oak Tree Capital.

“Investment can be explained with a 2×2 matrix. On one axis you can be 'right' or 'wrong'. And on the other axis you can be 'consensus' or 'non-consensus'. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.”

In other words being right and consensus is not enough.

By 'consensus' we mean that the business opportunity is already known in the market - the competitive landscape is warming up and investors have started making their moves. Some of the most successful VC's will say you simply can't make any kind of return in this 'follow the crowd' scenario as the company will never make a big enough impact. The danger is that this just becomes a race to the bottom on price.

VC Mike Maples of Floodgate Ventures has explained the critical importance of non-consensus: "It is extraordinarily difficult for a tiny, undercapitalised, understaffed company with zero customers and no market awareness to identify and exploit a new opportunity fast enough to leave all competitors behind. As soon as a business opportunity becomes apparent to even a small number of people, the odds begin to work against the startup...[but] being non-consensus and right affords the startup the time and runway to survive, adapt, and succeed after trial and error without fatal consequences." 

Of course, there are cases where some highly successful startup has not held a non-consensus view, but it's rarer than people think.

Marc Andreessen, whose VC firm a16z has invested in some of the biggest startup success stories, has put it even more dramatically: “If something is already consensus then money will have already flooded in and the profit opportunity is gone. And so by definition in venture capital, if you are doing it right, you are continuously investing in things that are non-consensus at the time of investment. And let me translate ‘non-consensus’: in sort of practical terms, it translates to crazy. You are investing in things that look like they are just nuts...It has to be something where, when people look at it, at first they say, ‘I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual."

Many of the most successful tech companies seemed crazy at first. Investors just didn't pile in straight away, as the ideas either bucked conventional wisdom or were just too outlandish to comprehend: Classic examples include PCs, the internet, Bitcoin, Airbnb, Uber, and Twitter.

This is why pitching to VCs is often the numbers game. With a non-consensus (and right) proposition, many may not get it, or they'll think it's too contrarian. Then, sometimes after dozens of approaches - perhaps when you think all is lost - the next VC on the list will lean right into your story.

Your secret will have suddenly found a believer.

John Hall is CEO and Co-Founder of Duet Partners Ltd. Duet is a startup to scaleup advisor that supports ambitious founders in the development and execution of funding campaigns at Seed and Series A. We've worked with some of the UK's most exciting startups over the past 12 years, helping raise £100M's. Our client list is here.

We publish a newsletter, 'Weekly Briefing Note for Founders', as well as the occasional essays and articles in our blog. You can subscribe (free) here.

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