5 mildly uncomfortable truths about venture capitalists
In January 2019 I joined Inovo Venture Partners. After being always on the startup side of the table, the experience has been eye opening. Here are a few things that surprised me.
They really, really want to invest
Many startup founders trying to raise money tend to see venture capitalists as gatekeepers. They stand between them and the sweet, sweet capital they need to buy fuel for their rocket. Yet, this couldn’t be further from the truth. No one got rich in the VC business by being amazing at not investing in shitty companies. The only way to make money is to invest in the good ones. And if you manage to do one amazing investment, it usually means any bad ones hardly matter.
Meeting a ton of startups is a lot of work. You know what motivates people to keep at it? The belief that this next startup could be THE ONE — the next Google, Facebook, or Uber. The company that will make them stop worrying about money for the rest of their lives. Often what they know about the company they are meeting does not warrant a lot of optimism (“It’s like Uber, but for dogs… No, we don’t rent dogs, they drive the cars.”). They will still rationalise it that this will be the black swan — the unicorn everyone else overlooked.
This is true regardless of where on the totem pole is the person you are meeting with. If an analyst is working on a deal, they will be immune to the shitty jobs that usually get thrown their way. For the associate spotting the new cool thing is the surest way to make a name for themselves and give their career an upwards trajectory. The partner is probably worrying that the other partners have already found a deal this year, but he or she is still moping around.
Putting lipstick on the pig is a bad idea
Most companies have at least a few skeletons in their closets. There will be cap table issues, annoying angel investors, paperwork that wasn’t handled entirely by the book, companies incorporated in the wrong country, founders who are still working at their other job. Many founders feel the temptation to try to paper over those issues when pitching to investors. The thinking is that once the investors fall in love with the project, they will be much more likely to overlook them. This is a terrible strategy.
The big things will surface, eventually. The later they do, the more pissed off everyone will be. The VC will have spent thousands of dollars on the due diligence process, and will feel cheated. Which is not the right state of mind to sign someone a big check.
For any given firm, some issues will be true deal breakers, others will be mere annoyances someone needs to deal with. If your issue belongs to the former, no matter how much the VC firm loves the project, the deal won’t happen, full stop. For the latter, solutions will be found and implemented (unless their cost exceeds the firm’s appetite for the deal). The sooner the issues are in the open, the easier it will be to plan overcome them.
It is important that the understanding of what is a deal breaker will vary from fund to fund. What’s a no-no for one firm may be fine for another. For example, some funds invest in companies from some geography. Or at a given growth stage. If the VC likes you as a person and they don’t think you are a crook, they will be happy to refer them to their colleagues in other firms.
Finally, your worst case scenario is being successful at your lipstick application. If you suckered a fund into a deal, then you have two issues. You’ll have to deal with them in the foreseeable future, as they are the co-owner of your startup. When you are raising the next round of financing, you will be stuck a sucker on your team.
Growth trumps everything
As mentioned, no company is perfect. Fortunately for startup founders, there’s a magic cure that gives you immunity from all except the most serious objections: growth. If you can demonstrate a sustained month over month growth of 15% or more, you would need to have an epically broken cap table to make a fund go away. Similarly if you suffer from questionable technical leadership, unstable product, or being incorporated in the wrong continent.
The reason for that, at its most basic level, the VC business is about buying companies whose value will quickly increase (and then sell them). The only way to get there is through growth: be it revenues, unique users, or whatever metric makes most sense for your business.
Of course, I am aware that “just grow more quickly” is not very useful advice. It’s a bit like answering “just be more handsome, funny, and a more decent human being” when asked about tips for picking up girls. Growth is one of those few things that you cannot make happen through sheer willpower, working harder, or being smarter. However, you could also interpret lack of growth as the Universe giving you a hint: you are doing something wrong (at least if you want to have a venture backed business). It may be a good idea to listen to the Universe.
YES! means yes
Or actually, the corollary: everything that’s not a very enthusiastic “yes” (note the all caps and exclamation mark in the section title) means a plain old no when it comes to an investment. “We will follow if someone else leads” — that’s a no. “Come back to us when you get $ XXX in MRR” — nope. “I like your idea, keep me posted” — ha ha no. “Yeah, we are sort of busy this quarter, ping me in June” — nay. That email that you didn’t get an answer to for 10 days — you guessed it, it means no. No, no, no, no.
You could argue that honest feedback would be good for everyone, especially for the startup founders. However, being rejected is unpleasant. But that email to which you didn’t get a reply is in a way comforting. They might say yes! As humans, we tend to cling to any sliver of hope available. VCs feed this self-deluding aspect of our nature, as they have very little incentive to ever close any doors. The company that is uninvestable today could get their act together and become a rocket in 6 months. It would be awkward if someone had told them to get lost for good, wouldn’t it?
Same goes with any feedback you get about the reasons you were rejected — I just wouldn’t trust it. It can be true (especially if it is “you are not growing quickly enough”), but in most cases it will be something generic and harmless. The reason is that people tend to forget what was the essence of negative feedback, but remember the emotions negative feedback elicits. In a business like VC, this not a risk worth taking.
Now, how can you tell if a VC is honest when they say that you are doing a good job, but your company is not a great match for their fund? By observing their actions. They will make intros, send you commercial leads, reach out to you to ask how you are doing.
Everything takes longer than expected
Every investor says that they are very efficient in wrapping up their deals. They understand that for a startup time is of the essence. The founder needs to get back to running their company (as opposed to raising money). The deal may fall through (especially if it’s a hot startup with a lot of other people interested in it). If the process takes too long, a promising company may run out of money.
Unfortunately, even when everyone on board is competent and has the best of intentions, signing investment agreements tends to drag out horribly. The rare exceptions are angels investing their own money through standard instruments, like convertible notes or SAFEs. Why?
First, the stakes are high. The investor is giving the founders a significant chunk of money. The founders are giving investors partial control over their company. It’s only natural that this sort of decisions are not taken lightly.
Second, an investment deal is a complex process with a lot of stakeholders. There’s the VC fund, any other investors in this round, the founders, and investors from previous rounds. Each party has their own lawyers, and there’s the teams working on various parts of the due diligence (technical, legal, financial, etc.). With so many people involved it’s almost impossible that nothing goes wrong. One of the lawyers gets stuck in the elevator, so he misses a meeting. That was the free slot in one of the previous investors calendar. The meeting gets rescheduled for a week later. Now the technical due diligence guy doesn’t get a go signal, and in the meantime he starts working on a different project. When finally he is done, it turns out that the senior partner has a vacation planned. His wife booked it two years ago, and she threatens divorce if he flakes out. Now the process is late by 5 weeks — and all this assuming the term sheet negotiation was super smooth (which is not always the case).
Finally, there’s a ton of legal details that need to be handled correctly, and this takes time. Everyone loves complaining about the lawyers, how they create work for themselves. But it’s this creativity in predicting threats that saves your ass from a rogue party hijacking your startup.
So, assume getting from a handshake to money in the bank account is going to take longer than anyone is telling you. If they say two weeks, brace yourself for two months. If your company may run into cashflow issues, plan accordingly. Talk about getting a bridge loan — if a fund has already signed a term sheet, they should be ok with that. By all means, plan to go on a vacation after signing, but go somewhere where you don’t need to book too much in advance. And so on, and so on.
