Why Won’t Anyone Give Me Money? (Part 1: The Reasons)
Note: This blog post is an extended version of a post published in Recode, expanding on a number of points raised by readers.
As a former entrepreneur and current investor, I’m often approached by friends or friends of friends for advice regarding their startup companies. One of the most frequent questions I get is, “Why am I having so much trouble raising money for my startup?” Well, aside from a flip, “They just aren’t that into you”, what are the real reasons investors hesitate to invest, and what is the “investor speak” they use to communicate their reluctance? I’ll cover “VC Speak” in Part 2.
Usually, VCs don’t invest for one of the following reasons:
· Market size appears too limited. Early-stage venture investors are seeking a 10x return on their investment. Just as importantly, if the company is successful, it will hopefully return a sizable portion of the VC’s fund (bear in mind this is baseball – more VC investments fail than succeed -- a couple homeruns in every 20-30 at-bats, even with lots of strike outs, is major league.) That means for a $200M fund, which on average will likely own around 15-20% at an IPO, the company must be worth $500M to a $1B or more. That in turn means the market the company serves must be substantial – well into the billions of $s.
· The business idea fails to meet the investor’s “is it a feature, a product, or a company” test. A feature will almost never get funded and a product might, while a company often finds backing.
· Poor product/market fit, at least in the investor’s eye. Poor product/market fit means excessive sales costs and lots of additional development expenses – both fatal to capital efficiency, a major consideration for venture investing and returns.
· Poor articulation of the opportunity/need and the offering. The entrepreneur just isn’t a very good promoter. And yes this matters – you have to get customers to buy, partners to engage, and next year’s investors to commit. Investors want and need you to be a good pitchperson. It doesn’t mean you have to be a used car salesman, but it does mean you need to be a good evangelist – articulate, clear, passionate and authentic.
· The opportunity/need isn’t compelling enough, or the offering isn’t differentiated. Most markets have competitors and are noisy, and buyers are often reluctant to try something new, unless the benefit is compelling and well outweighs the perceived costs and pain of change. A long-time rule-of-thumb is that a new market entrant needs to be 10x better, faster, or cheaper to break through the noise and market inertia.
· Serious doubts about hitting meaningful milestones that will allow the company to raise the next round of capital at a higher valuation (or at all) after this one. This may be related to the sufficiency of the requested investment $s, or to other questions about realistic timelines, etc. Regardless, investors want as much confidence as possible that the company will be able to raise additional new capital in the future, or the dollars the investors put in now will be lost.
· Lack of relevant experience on the team, or questions about the competency, savviness, or commitment of the team. At the end of the day, people make companies successful. If there is any doubt about the team, investors will be very reluctant to pull the trigger, regardless of how compelling the market opportunity is.
· The valuation is too expensive. Don’t let this week’s eye-popping funding announcement in your favorite tech rag fool you – for every one of those, there are a hundred companies that can’t raise money at any price. Some VC investors can get caught up in the frenzy, like anyone else. Most, however, are usually sensitive to price, which is a function of the amount of capital required to buy a minimum percentage ownership in the startup company. Most VCs need a minimum amount of ownership to make the numbers work for their portfolio. How much they are willing or able to pay for that ownership is dependent on a number of factors that, for the most part, have to do with various aspects of the risk being taken. Those factors include team quality or track record, opportunity size, maturity stage of the company, usually a function of market traction, etc.
Bear in mind that venture investing is a very individualized and case-by-case process for each firm. There is no set formula or algorithm (aside from perhaps Correlation Ventures). Just because a VC firm did a similar investment last quarter doesn’t mean they are still looking for more of the same. A “no” or “slow roll” doesn’t mean your idea or company is unfundable – it just really may be bad timing or not a good fit for one or two firms. If you have several firms all doing the same thing, you likely have one or more issues you need to address.
In Part 2, I’ll delve into “VC Speak” and how to interpret the objections you may be hearing.