Why VCs say “NO”

Before becoming a VC, I often questioned why so many investors say “NO” to a seemingly good idea. It was only after becoming a VC that I got clarity on that simple question.

It’s important for founders to know that statistically speaking, VCs invest in less than 1% of companies they look at. Given the sheer number of times VCs say no, you would think they’d be better at explaining why they pass. In fact, many VCs are notorious for not saying “no” at all, and just fade away into silence. That’s because most of the time it’s in their best interest to have you stick around in case one day they get excited about the progress. Below, I’ve shared some explanations of a VCs decision making process and some tips to increase your probability of getting funded.

1- FIT WITH THE FIRM

“We like you and the business but you’re just not a fit for our firm (or investment thesis)”. The earlier you know this the better. By looking at their portfolio companies, stages of investment, geographic limitations, sectors of interest and team backgrounds, you can get a good sense of fit. In the first meeting, ask about what kind of companies excite them, stage they typically invest at (ex: seed, series-A), if they lead investments and generally speaking what their investment process is. Those are not intrusive questions but rather demonstrate a founder is thoughtful about everyone’s time.

“You’d be a better fit for our next fund”. Timing of a fund’s lifecycle can affect the attractiveness of your deal. A typical VC fund is created with a ten-year lifespan. Roughly speaking, the first half of the fund (both time and dollars) is for making new investments, while the second half is for follow-on investing and pushing deals to exit in order to finalize returns to the fund’s investors. Their timeline may not align with yours. There’s only one way to know about a particular VCs fund lifecycle dynamics: ask the question.

Whether investors say it outright or not, lack of fit can result in a pass and that may have nothing to do with the potential of your business.

Tips for founders: Do your own due diligence and ask questions about the fund, it demonstrates you are trying to align with their fund and help ensure a mutual fit.

2- FIT WITH PORTFOLIO CONSTRUCTION

While it may not always be apparent to an outsider, investors build beneficial synergies between portfolio companies and almost never invest in overlapping (competitive) businesses. This helps them leverage knowledge, talent, network and better support companies. Lack of portfolio construction fit is a common reason for a “No.”

3- TEAM

To build a successful startup it takes passion, agility and strong will. Successful VCs invest in top tier teams they believe in and trust. Founders must demonstrate they know their market, can make the right strategic decisions and attract other rockstar team members and advisors. Personally, I admire a founder who has a good mix of sales and technical skills. If your team is weak, good VCs will pick up on that and go no further without necessarily pointing to this particular reality. That’s not to say it will be impossible to raise seed funding when you are unproven or early in your career as an entrepreneur, but the pool of investors that may be interested is limited.

Tips for founders: Early in the process, offer to introduce investors to credible connections in your network that will speak highly of your team.

4- LACK OF FOUNDER/ BUSINESS FIT

You might have a great team but if there is a lack of fit with the investor it just won’t work long term. One test of this dynamic occurs during the due diligence process or term sheet negotiations when things can sometimes be stressful. If those discussions feel one-sided or contain unresolved tension, it can be a red flag for either party. Remember, this is a long-term mutual relationship that needs to build and last for years. In the book Trillion Dollar Coach, Bill Campbell explains that a relationship in the boardroom needs to evolve from handshakes to hugs.

“We’ve decided not to invest because we just don’t know your market well enough”. Investors often say no when they don’t understand enough about your market and can’t help. Knowledge of the market significantly increases an investors likelihood of making the right bet. It also allows them to leverage their industry insights, network and most importantly support founders in strategic decision making.

Tips for founders: Speak to other portfolio founders and get a feel for how they work with the investors. Investors respect a founder that does their homework on them as much as they do on you. Share your market expertise to help them make an informed decision.

5- TOO EARLY OR TOO LATE

“The business is a little too early (or too late) for our fund”. Founders might hear this response a lot from investors. It’s either because they don’t make investments at your stage, don’t believe enough in the business, or don’t have the stomach for the risk at that time. Founders may also get this response if the investor feels the valuation is too high. Demonstrating some level of traction in terms of sales or positive user metrics can remove doubt or address concerns. That’s not to say startups without sales do not get funded. However, raising money from top investors is a highly competitive process and demonstrating early indication of product market fit speaks loudly.

Investors do not have a crystal ball and make mistakes. Here are some examples of a few examples of anti-portfolio mistakes.

Tips for founders: Make sure your forecast is realistic. In your data room, detail your pipeline or list of target customers, interest level and market data that supports your financial model. If your forecast is unrealistic, it will hurt your credibility.

7- THE MARKET IS TOO SMALL

Generally speaking, 1/3rd of companies in a VC portfolio return no capital, 1/3 return less than the capital invested and 1/3rd contribute to returning the fund. To make money, a venture fund needs to return big on a few companies to make up for losses. 80% of returns come from less than 20% of investments. To understand, read this simple post on venture math 101 of a VC fund.

Founders need to demonstrate they are going after a very large and growing worldwide market, can capture their share of that market, and that there are deep pocket buyers for the company down the road. If the market appears too small, it will be hard for them to justify that the investment can provide a meaningful return to their fund.

Timing is also key. A business that is too early can burn a lot of money before the market growth helps the business take off with it. If a business is a late entrant, it is likely too late and the market is already crowded with competitors. Takeout Taxi was a great idea for food delivery but that market only took off years later after Uber was everywhere which paved the way for UberEats and others. “Why now and will the market hit an inflection point in the not so distant future?” is a question good VCs ask and founders should be prepared to answer.

Tips for founders: In your data room, have market size numbers, exit comparables, and any industry reports that support market timing and growth.

8- MOMENTUM MATTERS

Investors can get sidetracked by other priorities such as managing current investments in closing, portfolio exits, new fundraising efforts, or their reporting requirements to their own investors. All of which can take precedent over early discussions on a new investment. That said, fear of missing out (FOMO) is a real thing for investors and your job is to convince them that your train is leaving with or without them and they need to get on it. You can’t be pushy but you can’t let their pace decide yours either.

A referral by someone the investor trusts and respects like another VC (ex: a later stage VC interested in your next funding round), or one of their portfolio company CEOs will increase your chances of a meeting. This introduction can help you rise up on their priority list. Your objective should be to get a short first meeting to get them interested in a deeper dive into the business. If there is a fit, follow-up quick with answers to their questions or concerns. I’d suggest two days maximum to follow-up on post-meeting questions while the meeting is fresh in their minds. Regardless of their speed, keep them up to date on product or customer traction. Feed them with information step-by-step but do not overwhelm them. Offer to share your data room only if they are interested to show you are also selective on who you share it with. Finally, if you receive a term sheet let them know before signing it but do not share the details. Having investor optionality is always a good thing until the check is in the bank!

Tips for founders: Get a warm introduction, do your research on the VC, their team and portfolio. Never leave long periods before following up. If a VC says “no”, ask for honest feedback and keep them posted on progress. You may want to re-engage with them at the next funding round.

FINAL THOUGHTS

Just because VCs say “No” does not mean they will not be open to invest in the future, so ensure the relationship remains positive. VCs are justifiably picky and there is always a legitimate reason to say “No”. Founders have to accept that the reasons may not make sense to them at that time, but down the road if you prove them wrong, they will be pitching to you to take their money.

Bonus Tip for Founders:

You can also say “NO” — It’s hard for a founder to turn down money but sometimes that’s the right choice. The right VC may not guarantee your success but the wrong one can hurt your chances. When things don’t feel right or the term sheet comes in and goes against everything in you, it’s OK to say “NO”.

About Luge capital

Luge Capital is a fintech focused venture capital fund, investing in early-stage teams shaping the way the world experiences financial services. Please follow our journey on Twitter, LinkedIn or by visiting Luge Capital.