To many outsiders, venture capital is a somewhat mysterious industry. People who are called VCs are managing multi-million or even billion-dollar institutional money, saying much more “No”s than “Yes”s to founders, and trying to bet on the next Google.
Getting VC money is hard. A VC usually screens over 100 companies before (s)he makes one investment decision — By math, the selection rate is less than 1%. As someone who has worked with several startups/companies in Kenya, Nigeria and Uganda, and also as an early-stage investor who has vetted global investments in Europe, SE Asia and the US, I usually get questions like “what is the decision-making process of a VC?” “What is going on in a VC’s mind?”
Today I’d like to share some thoughts and common pitfalls I’ve seen when founders approach VCs.
Forget about the “Eureka” moment
Like many people, I used to think entrepreneurship is all about passion and ideas; I’ve also read many books/business cases that acclaim the protagonists’ ‘aha’ moments following which a global business empire was born (e.g. the story of Howard Schultz’s visit to Italy and Starbucks). After screening hundreds of prospective companies and witnessing the saddening failures, I started to learn that passion is usually overstated in the success stories with hindsight bias. A lot of startups fail not because they lacked any passion.
It is a long journey from the initial ideation, form a solid team, develop the MVP, customer acquisition, to demonstrate a clear market fit and eventually scale up and grow… Even if a founder has come up with an idea that no one has had before, (s)he is still against all the odds to successfully get through each phase, and any mistakes made in even one step can kill the greatest ambition to change the world. On the contrary, even for an existing product, if the team can solve the true pain points, provide a 10x superior customer experience or product (like Zoom), and have excellent execution capability, a latecomer can still take over market share and become profitable. From my VC experiences, it is not unusual for me to hear a similar business idea or problem. More often, when an entrepreneur pitches to a potential investor, it is likely that this VC has heard a similar pitch from another startup several days ago.
Because VCs are usually approached by many entrepreneurs and thus have a better edge to compare across companies, VCs tend to enjoy information asymmetry and have a more holistic view of the competitive market environment. Many times, we decided to turn down a deal not because the idea doesn’t make sense, or that the founders are not passionate enough. It is because we can’t find real differentiation or conviction that they have a sustainable competitive advantage. Yes, we’ve seen startups talking about its value proposition in the pitch deck with a typical four-quadrant graph (shown below), but sometimes it feels like the presentation didn’t really grasp the complete market landscape or the potential threat: not only the existing competitors, it could also be a supplemental product or an incumbent who could develop a similar product at a much lower cost. This is understandable from a founder’s perspective: the venture is your baby and naturally you are biased; it is also difficult to get that much rich information about your competitors as VCs do.
One of the most common value-proposition quadrant graphs
So what is the bottom line? Beyond the “flash-of-insight” moment and passion, it is more important (and also more difficult) to be self-critical and objective. Try to take a step back, make a conscious effort to know your competitors really well, develop a deep understanding of the strengths and weaknesses of both yourself and the competitors, and choose the combat that you can quickly win (or better, where there’s no combat yet). In this way, you can prove to the investors that you are not only passionate and hardworking but also have the maturity, self-awareness, and deep expertise in the market. This will certainly help you improve your chance during the fundraising process.
Think two (and more) steps ahead
As early-stage VC investors, one of the common concerns we have when faced with investment decision is: can this startup continue to raise money in the next rounds? There is a significant drop rate in successful fundraising from seed/pre-seed to series A as shown in the chart below. Because the odds are so low for early-stage startups, VCs would usually cross-check with later-stage investors to gauge their interests in the startup in question. For example, if a startup is raising the seed round, an interested VC might ask the series-A investors about their views; if most series-A investors have doubts about the company’s growth or “fundability”, it will adversely affect the decision of the potential seed-stage investor too.
In my portfolios, many companies who are successful at fundraising usually have done an excellent job of building relationships with multi-stage investors way before the official fundraising process kick-off, and of continuously cultivating the relationships along with the progress. For example, they would actively meet future investors, vet for the best fits, and regularly email them about updates and milestones to keep the relationships warm.
Bottom line: Never wait until your startup actually needs money to approach the investors. Also, take a long-term view beyond the current steps and pave the way for future partnerships.
Don’t underestimate the role of junior investors
I get it. Many blogs and fundraising gurus have told you not to waste your time talking to associates in a VC firm. But what if you do not have a direct relationship with the partner in a potential investor? A VC team is usually small-sized, and the partners are understandably extremely busy. In many cases, analysts/associates are the first people who talk to entrepreneurs and decide whether to bring this company to the team. As a result, his/her opinions and even tones when talking about the prospective startups would influence the team’s impression. If an analyst/associate is insistently against proceeding an investment and has a good reason for that, the partner would not want to push it forward either. The decision-making process of each VC is different. Taking one of the firms I worked with as an example:
- The team receives an introduction/cold email/call from the entrepreneur
- The junior investor conducts a first meeting with the founder.
- If the junior investor feels excited about this startup, (s)he will present this company in a team meeting
- In the team meeting, this junior investor answers various tough questions raised by other members
- Then the team would vote. If most voters agree to move forward, then (s)he can continue to spend time on the company; if not, then this person should immediately pass this company and focus his/her energy on other pipelines.
As we can see from the process, this junior investor is like the startup’s representative in the VC team. For entrepreneurs who want to strategically build a relationship with the VC firm, my suggestion is, do not overlook the importance of junior investors in the process. Instead, learn to manage and influence these contacts, and make them excited for what you’re building so that they are willing to introduce you to the key decision-makers and be your advocate.
Be willing to accept Feedback
Especially for very hands-on investors (e.g. those who usually seek a board seat), one of the questions lingering in their mind is, how is it like to work with the startup’s management? Can I have a say in important decision makings? Therefore, during due diligence phases, investors tend to find signals to assess the entrepreneur’s receptiveness to different opinions. Maybe out of strong confidence or passion for his/her own venture, I’ve seen entrepreneurs who tend to turn into a self-defense mode in the face of disagreements. This type of founders usually reacts to challenging questions by insisting on their own ideas and refusing to take a step back to check if any blind spots that they might have not noticed.
As a reminder to the aspiring entrepreneurs: during the contact with potential investors, not only the stories on the pitch slides that matter to your investors, your responses, behaviors and interaction with the team are also being closely checked on.
Know the investment thesis
Another reason for VCs turning down a startup’s fundraising is that it is not a good fit for the VC’s investment mandate. Generally, either it is VC, PE, or public securities managers, each fund must strictly follow its own investment guidelines agreed by the LPs (limited partners). It includes the investment stage, the ticket size of initial and follow-up investment, the markets/sectors/business models that can be invested, and other specific criteria. As institutional money managers, VCs have the fiduciary duty to act within the pre-set mandate and cannot invest in any company that they think is interesting.
When an entrepreneur feels disappointed by a ding from the VCs, (s)he might feel better by putting him(her)self in a VC’s shoes: same with the startups, most VCs also have their own investors that they regularly report to, get rejections for fundraising, and worry if they can raise for the next fund or not (In fact, most VCs in the market fail to raise the 2nd fund). Therefore, before reaching out to every single investor on the street, I suggest entrepreneurs do more homework to understand the VC’s investment mandate to improve the chance of getting responses.
African Entrepreneurs during the Pandemic
From my experiences of working with startups in Africa, most of the advice or common mistakes mentioned above are applicable to all entrepreneurs regardless of geography. However, the limited number of local funding resources and institutional investors have added another layer of difficulty for African entrepreneurs. On one hand, the chance of success for startups will only rise in parallel with the development of the local ecosystem that provides various kinds of support for the local startup community, including policy incentives, talent pool, investor/founder networks, and mentorship. On the other hand, African founders should also consciously build a diverse international network in order to tap into the funding opportunities global wise, which includes government programs, NGOs, international organizations, angel investors, and overseas family offices or emerging managers that have exposure to African investments. For example, Blue Haven Initiative, a family office based out of Boston, has an Africa-focused fund strategy. Accion Venture Lab is also an active venture investor in Africa with an office in Nigeria. NGOs such as The Baobab Network leverages its relationships with investors in Europe and the U.S. to help startups across the African continent build connections. To ease the process for fundraising from international investors, I’ve also seen founders incorporating their companies in the U.S. or Europe while operating in Africa.
Fundraising during the COVID-19 environment makes the daunting task even more exhausting. Data has shown that generally, investors increased the funding in terms of dollar amount in later-stage companies while squeezed the funding volume in early-stage startups, to reduce their risk exposure. Valuation has been hit as well, although certain verticals have benefited from the soaring digital footprints such as e-commerce, gaming and fintech. As such, venture investors’ focus has also shifted from growth potential to a more careful and closer examination of the business model profitability and the founding team’s financial savviness. In order to secure funding in this unusual time, I advise a startup founder to pay much more attention to the commercial line items (e.g. CAC, burn rate, retention rate) and show to the VCs that the team has thought through the worst scenario and has a plan. This way helps funders to become more confident in the team’s maturity and that the venture can survive the winter.
Final words: Entrepreneurship is like navigating an untraveled road without any existing maps to follow. The current environment has made the journey even more trying and challenging. However, as Dalai Lama says, “whenever there is a challenge, there is also an opportunity to face it, to demonstrate and develop our will and determination”. I hope the thoughts shared above can be helpful for founders to get through the current situation and succeed in the long run. Comments and/or questions regarding fundraising are always welcomed. Please feel free to reach out on my LinkedIn.
May is a US-based venture capital investor with a focus on fintech. Prior to her current role, May was most recently an MBA associate at multiple VCs including Accion Venture Lab, one of the most well-known impact investors focused on financial inclusion, and Bowery Capital, a B2B SaaS early-stage fund. May also worked with startup co-founders for various operational initiatives including international expansion, fundraising and growth strategy. She went to Poland to help Lidya, a Nigeria-based fintech startup, expand to Europe and launch the new office; she was also an advisor for UjuziKilimo, a Kenya-based ag-tech startup, that supported the firm’s corporate development and fundraising. May has worked at a top-tier investment bank where she managed multi-billion-dollar liquidity assets on the firm’s balance sheet. May holds an MBA from Columbia Business School and an MA from the University of Pennsylvania and speaks fluent Mandarin, Japanese and basic Spanish.
The content of this article is based on individual opinion, not a representative of any organization’s official statement or advice.