Possible reasons why you’re not getting the response you hoped for from VCs.
Even if only for a second, every entrepreneur has dreamed of their startup landing in Techcrunch headlines for raising a big A round. If only.
A lot of this will be covered in this Alternative Financing for Startups Info Sessions so just register for that if you don’t feel like reading!
The reality is only a fraction of a percent of small businesses seeking capital will raise from VCs. Over 7 million U.S. small businesses (~25%) report inadequate access to capital while the VC industry can support ~5,000 early-stages companies at one time. The pandemic has made the fundraising trail even harder with the tough economy and absence of in-person meetings has driven first-time financings to record lows. In Q3 2020, 5.5% of VC funding went into first-time financing across 23.7% of total deals according to Pitchbook and NVCA’s Q3 2020 Venture Monitor.
Entrepreneurs reading this probably don’t need a reminder of how hard it is to raise money. I think they do need help understanding why it’s hard in respect to their own venture.
Everyone who has raised money from VCs has heard “it’s a little early for us” which isn’t super helpful when you need to raise now. It can be hard to get more candid feedback from VCs for a few reasons. One of them being the investors don’t want to spoil the relationship with an entrepreneur by questioning the entrepreneur’s chances at success or telling them they have a different, maybe more competitive deal they want to invest in before your company.
Time is money. Whatever feedback you’re getting, it is critical to understand your odds of success raising venture capital as quickly as possible. Every week you spend fundraising without viable strategy you’re confident in is one you could’ve been selling product, building product or pursuing an alternative financing route like revenue-based financing or shared earnings agreements. To accelerate your discovery of a viable fundraising strategy, below are a few deeper reasons why companies usually don’t fit the VC model that I’ve come across while working with over 100 companies on their venture raises.
Before diving into self-examinations, it’s important to consider one first principle: Investors need a good investment not just a good business. I first heard this concept talked about to founders by Chris Traylor and John Dirvin who teach Fundraising Academy to the top portfolio companies at Capital Factory preparing to raise a Series A. The point is if an investor says they like your business it does not mean they are ready to write you a check. To get an investment, you need to go further by informing their understanding of how an investment in your business will contribute to the investors target return goals.
Traditional venture capital funds, for example, aim for a 3X return to investors in the fund within 10 years. History shows ~70% of venture investments won’t return all invested capital and the majority of returns are driven by one or two portfolio companies. Therefore, to raise from a VCs you must build conviction in your future investor that your startup can cover costs for lost investments and drive fund returns. This dynamic creates the fixation on “unicorn” companies within the startup ecosystem because a $1B venture fund will need ~$10B of exit value within their portfolio to achieve the target return (assuming ~30% VC ownership at exit).
With this in mind, here are some core reasons a company may not be a fit for VCs:
- The entrepreneur doesn’t have a unique vision for capturing a multi-billion dollar market. You can have the best business in the world but without room and talent to go big the fundraise is dead in the water.
- The entrepreneur hasn’t demonstrated potential to grow revenue at 3X annual for at least two years. Getting to unicorn status isn’t really even enough. To work as a VC investment, a company needs to achieve unicorn style returns before the end of the fund’s lifecycle which is usually within 7 to 10 years of initial investment. Check out this article by an investor at Battery, Helping Entrepreneurs Achieve the Triple, Triple, Double, Double, Double to a $1B company, to dig deeper into an example VC company trajectory.
- The entrepreneur hasn’t proven their team is the best in the world working on their problem. Realistically, the top 5 to 10 teams working on something will get funded since not every VC can get into the #1 company otherwise they would. VCs you pitch can snap a finger and connect with any teams from Stanford, Harvard and MIT working on your same problem so there is no room for B players in VC.
- The entrepreneur elects to pursue a business outcome incongruent with the dynamics of a venture fund. This could be that the entrepreneur wants to optimize for financial freedom with a $20M exit in a shorter time-frame than when a company is venture backed. It could also be that company’s vision doesn’t involve hyper-growth, rather it is built for a more strategic and sustainable impact.
The last consideration when analyzing why a company isn’t a fit for a VC is that every decision an investor makes is comparative. You’re not being evaluated in absolute terms rather in comparison to other companies raising capital at the same time as you. In order to get funded, you need to be better than all the other companies that investor has the opportunity to invest in the present moment.
I hope this help provide some color to entrepreneurs out on the fundraising trail. I hope this also started to help you understand that just because VCs aren’t investing in your company that it’s not investable at all. Startups have access to an array of alternative financing options that, while not as sexy as VC, can unlock new phases of growth for your business.
Here are some alternative financing routes for entrepreneurs to consider:
- Revenue-based Financing
- Shared Earnings Agreements
- Grant Funding
- Tax Credits & Incentives
- Joint Development Agreements