Duet Partners
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Why VCs will ‘pass’ on your startup

19th July 2019

The first thing investors will evaluate is YOU

With capital flows into private companies reaching record highs in the first half of 2019, founders would be forgiven for thinking that there’s never been such a good time to be out pitching for investment. But as we reported recently, whilst the amount of money being raised at early stage is rocketing, the number of funding transactions is falling just as abruptly. VCs are becoming much more selective.

They say that the everyday reality of being a VC is that they spend ~99% of their time saying “no.” It’s a core competency of any VC. With the backdrop of deal numbers collapsing across Europe by 35% since 2015 as we highlighted in an earlier article, savvy founders currently gearing up for investment are working more diligently to develop funding strategies that will beat these challenging odds.

Our own insights from dealing with dozens of early stage businesses over recent years is that the “No” will be either due to a weakness in the investment proposition or pitching your story to the wrong investors. Either one will severely impact your plans, both will likely put you on the ropes.

The objective is to develop the strongest proposition AND target the right investors. Even then, as the graphic above shows, you will still need something extra to get the “Yes”. We will come to this.

The Investors

Let’s start with the easiest one, the right investors.

The first client we ever had came to us because they were at their wits end. Having been turned down by almost 30 investors, mostly VCs, they were deflated and deeply anxious. Their cash runway was declining rapidly and they urgently wanted to know what they were doing wrong.

It quickly became obvious that most of the investors they had been approaching were simply not a match for their type of business. They were developing a deeply embedded technology component and the road ahead to commercial viability was likely to be long, capital intensive, and full of supply chain uncertainties.

This required a patient investor with deep pockets, a solid understanding of their target market, and a belief that their proposed business model would deliver the growth promised. Many of the funds they had spoken to were simply too small, too generalist, couldn't really grasp the tech, or expected more evidence of commercial traction before committing.

After some reworking of the proposition and the associated investor pitch, a more targeted list of investors was developed. The team, feeling more confident with their new plan, embarked on a second phase of investor meetings, which finally resulted in an investment by a tier 1 UK tech VC who had history in the sector. Since then the Company has raised almost £20M in further capital and is now firmly in growth mode.

Any decent adviser with good research is going to ensure you don't waste precious time talking to the wrong investors. Qualifying suitable targets based on their sector preferences, stage focus, and track record is part of the brief. Other preferences to be checked will include geographic focus, capital intensity, size of the ‘ask’, scar tissue from similar failed businesses, and competitive risk versus other companies in the portfolio. Approaching the right partner in the VC firm may also be an important factor. If you aren't using an adviser, do your homework. Many VCs now publish their investment criteria on their websites.

The Proposition

The far trickier part, however, is the investment proposition. This is where preparation has become more vital than ever.

As an adviser we’re regularly approached by entrepreneurs who will say, “We’re all set to start our next capital raise, here’s our pitch deck, can you help us meet the right people?” Unfortunately, this is usually a big red flag. Unless we’re dealing with an experienced entrepreneur who has successfully raised capital fairly recently, it's highly likely that there will be fault lines in the story – at least from an investor perspective. These may take time to iron out and if the cash is already running low, it may simply be too late to help.

From our experience the most successful companies allow time to stress test the investment proposition well before its time to sit down and develop the investor pitch. Their CEOs will have been developing the funding strategy alongside the business strategy. They will have been taking regular soundings from peers they trust in the market and, importantly, will appreciate how the different stages of company development link to the main funding milestones from Seed through Venture to Growth. They will have developed a good understanding of what investors are looking for.

A wonderful fly on the wall insight into how investors will examine the proposition is provided by US VC Sarah Downey in her article “The real reasons why a VC passed on your startup”. This covers many aspects of what will turn VCs off, from market related, founder/team related, product/tech related, and business model related issues.

The priority that investors give to these factors will change depending on the stage of the business:

For a startup at Seed stage the most significant factor is likely to be people related - the founder, their vision and their sense of mission.

At Growth stage (typically Series B onwards) it's more about commercial momentum, based on the financial track record being established.

But between these two, from late Seed to early Venture stage (typically pre-Series A, Series A), investors will be even more diligent in evaluating the risk/opportunity balance, given the inevitable lack of commercial track record. This is 'the chasm', probably the most challenging point on the entire funding journey from Startup to Scaleup. Here the focus will very much be on the validation of product/market fit, the go to market strategy, and the business model.

The X factor

Finally, when you’re sure you have identified the right investors and have optimised your investment proposition to the max, you’ll have given yourself the right to be heard. But remember, there will be many others competing for the same capital you are bidding for.

Mark Suster, entrepreneur turned VC at Upfront Ventures, one of the most prolific early-stage VCs on the West Coast has written extensively about the fund-raising process. He says: “Remember that fund raising is a sales process. The investor is a customer and they have money to spend but only for a limited number of companies. They are buying trust in you that you will build a large business that will be valuable. The first “Blink” evaluation they’ll make is about YOU and only when they’ve subconsciously decided whether they find you smart, likeable, credible, a good leader, inspirational, competitive and all of the other subconscious attributes they’ll look for, do they begin to truly think about whether your business idea has legs.”

So, you will need to really stand out sharply from the crowd and convey a compelling sense of mission to progress to the “Yes”.

As Downey reveals: “In the spirit of transparency, the two most common reasons why I pass are first, not feeling strongly about the founders, and second, a lack of personal interest in or conviction about the space. I’ve seen how hard it is to build a successful venture-scale company. It’s riddled with adversity. Pivots and crises are the norm. If I don’t have a real connection with the founders in a space that they are mission-driven to care about immensely, it’s a pass.”

Being aware of why investors can say “No” and ensuring you are fully prepared is crucial. It will take longer than you think to set your plan, but it will be worth it in the end. In Downey’s words: “Success takes a rare combination of exceptional people, timing, and technology. It’s a long, drawn-out battle, and VCs will crawl over broken glass for the founders we’ve chosen to back.”

About the author: John Hall is CEO and co-founder of Duet Partners, a corporate finance firm that provides specialist funding support to high growth technology companies. His 30 year tech career began with major US semiconductor and software companies, and was based in the Valley during the late '90's. Before Duet he was CEO of a VC-backed consumer electronics company, sold in 2009 following several rounds of capital raising. In the past 10 years he has advised dozens of founders on the startup to scaleup journey and is a retained Board advisor to a number of UK technology companies.

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