The Venture Quest

Posted in Venture Capital
By David Kaplan -
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Many start-ups literally spend years chasing venture capital funding. Now, sometimes that perseverance makes sense, but often it does not. Still, once an entrepreneur has decided that her enterprise is suited to VC investment it can be difficult if not impossible to change her mind. A big part of the problem is that the feedback that the VCs give to entrepreneurs may not be entirely frank. As a result, some start-ups go on a seemingly endless quest for venture capital at considerable cost in time, money and energy, to say nothing of lost opportunity. In many cases if the entrepreneur knew the truth, they might adjust their strategy and move forward. This article explores some reasons for the “quest” phenomenon and some specific ideas for avoiding it.

By the time entrepreneurs go looking for venture capital funding, they have already invested a great deal. They have spent years developing and refining the business concept, researching technologies, markets, customers, products, competitors and alternative business models. Inevitably, they have invested some of their own money and maybe asked family and friends to take some risks too. Moreover, they have spent months drafting, vetting and editing a business plan that proves – right there in black and write – that this business is a winner with enormous financial upside. When they finally gets an audience with a VC, they are in no mood to hear a “no thanks.”

On the other side of the table, the VC knows exactly how the entrepreneur feels; he has been here many times. Any investor with an ounce of empathy would find it had to say no thanks to someone who has worked so hard to hear a “yes.” As if empathy were not enough, there are plenty of other reasons for VCs to avoid saying “no;” some good, some bad, some true and some false.

Now most VCs are honest, fairminded business people who behave ethically.  Still, VCs often fail to voice their sound business reasons for saying “no thanks.” For example, if the entrepreneur has failed to make a convincing case that the target market size is attractive, that the product or service is compelling enough to sustain competitive differentiation, that the business model will work or that the management team has relevant experience, then a “no thanks” makes sense. Still, it feels bad to say “no” and VCs know that entrepreneurs don’t like it. Many presenters become defensive, some will think the VC is stupid and/or out of touch. The entrepreneur might even tell her friends and networking colleagues that this particular VC is a jerk.

If a VC does say “no thanks” and the entrepreneur reacts calmly and rationally, she is still rather unlikely to simply take one “no” as a final answer: The VC may well be in for a long discussion of the merits of the business plan, whether they want to listen or not. Yet VCs are professional investors disciplined to think ahead, to keep their options open and to avoid alienating rare resources such as smart entrepreneurs, so they often perceive that their interest lies in simply saying little or nothing; at least not saying “no” directly.

For VCs, there is always the nagging possibility that this idea might turn out to be the next Google, Genzyme or Facebook. If they say “no thanks” now, they may fear that the entrepreneur will shut them out of later investment rounds. Even if the VC is convinced that this venture is a loser, he may worry that the entrepreneur may not come back when she does have a great idea. It may be selfish to avoid saying “no” directly and not telling the candid truth about why not, but then entrepreneurs are unlikely to ever find out that the reason the VC gave them for not investing was only an excuse. 

VCs may avoid saying “no” in some quite ambiguous ways that are tough for an entrepreneur to see through. For example, they may tell the entrepreneur that the firm has too many portfolio companies that need attention just now; “Try me again in six months.” That could be true or it could be just the right “maybe” to get the entrepreneur out of the office without making them angry or inviting a debate. “I just could not sell the idea to my partners” is another hard answer to figure out. “This looks interesting, but it’s not in our space” might be true as well (but makes one wonder why the VC had you in for a presentation in the first place). A little advance homework should shed light on what kinds of deals a particular VC firm prefers and largely avoid this reason.

One egocentric, insensitive and potentially dangerous way that some VCs may avoid saying “no” is to send the entrepreneur on an impossible mission. “Get your sales up to $2 million before the next partners meeting and I’d say you have a shot” is one example. Another might be, “If you get Warren Buffet or Bill Gates to invest, we’ll come along” or “sign up a few high profile reference accounts like Boeing, Microsoft and Intel and we will reconsider.” These are extreme examples, of course, but you get the idea. By setting a high bar and/or a short timeframe, the VC can not only avoid saying “no” but also leave the entrepreneur believing that it was their own fault that they missed out on funding.  A thoughtless VC may may set a lower bar, or repeatedly send the entrepreneur off to put together just a little more information.  That behavior is sure to start a meaningless quest.

That is not to say that every suggestion that a VC might be more interested if the start-up achieved a certain milestone or had more information is either false or unreasonable. Yet sending start-ups on an endless quest leaves open the selfish possibility that if someone else funds them, the VC could still get in on the next round. Of course, if the entrepreneur does meet the challenge, the VC can always set up another impossible quest, or revert to “My partners are not crazy about it” or some other excuse. Again, most VCs strive to be fair and completely straightforward, but some do not.

So what’s the harm when VCs don’t say “no,” even when they mean “no?” Entrepreneurs are optimists by nature and they need to be. So the lack of a “no” sounds like “maybe” to them, or least an affirmation that there is nothing fundamentally wrong with their plan. Yet in fact, the mere lack of a “no” from a VC says nothing of the kind and it can create serious problems, especially for inexperienced entrepreneurs. Their idea may be a stinker, and plainly so to a professional investor: More commonly it may just be too risky to fund, or not have the potential for the $100 million to $500 million in fifth year revenues that attracts venture money. VCs reject many plans because the management team lacks relevant experience, but any one of a dozen other good reasons may apply.

So a discussion with a VC that ends in only a “not now” may actually teach an entrepreneur nothing of value, perhaps even mislead and encourage them to continue to seek funds and obfuscate that the management needs to make substantial changes in the business model, strategy and/or management. An entrepreneur may well leave the VC’s office, not only without a clue, but essentially lulled into believing that it was only his timing that was off or some other reason that seemed false but benign to the VC.

To avoid a long wasteful quest, entrepreneurs need to hold VCs to a higher standard. They must state clearly at the outset of their conversation that they welcome constructive criticism, that they want the whole truth, no matter how difficult, that they do not need coddling and won’t take a “no” personally and that they will not insist on a long debate. It may help to remind the VC that entrepreneurs hear “no” all the time. Point out that the VC’s experience and insights could really be helpful, but only if his assessment is frank and straightforward. No one wants to hear “no thanks” but the reasons underlying a decision not to invest are inherently valuable. Hearing only happy talk that avoids the actual issues can inadvertently fuel a fruitless quest that wastes the resources of entrepreneurs and investors alike.

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