A VC’s “No”, What is it good for?

Last year, Claremont Creek Ventures was exposed to over 500 startup ideas and entrepreneurs. As is probably typical in most early stage technology Venture Capitalists, we ultimately invest in less than 1% of the deals we see. That means we are saying “no” at least 99 times for every time we ultimately say “yes”. It is therefore understandable that VCs can seem negative, arbitrary and arrogant to the entrepreneurial community.

Why would we say “No”?

In this posting I'm going to try to explain what a VC's “no” means and perhaps more importantly, what it doesn't mean. One can generally lump together the explicit “no” answer with the no response outcome, but they sometimes mean slightly different things so I will distinguish them. I hope this doesn't come off as a load of lame excuses. I think most VC behavior can be seen as entirely rational. Hopefully this posting can also help entrepreneurs cope and adapt as they seek funding.

What “No” Does NOT Mean.

1. It does not mean YOUR IDEA is stupid.  VCs turn down very smart ideas from very smart entrepreneurs all the time.  Usually it is because the deal doesn't meet some criteria the VC needs to construct their desired portfolio of investments.  Many entrepreneurs don't realize that VCs have made promises to THEIR investors, their Limited Partners, about what kind of deals they will invest in. They have to stick to those promises or they risk not being able to raise their next fund.

   Now that is not to say your idea might not be improved, or we might have seen another deal which is built around an even better idea.  But a turndown is almost never about a stupid idea.  It's frequently about an idea that doesn't fit the venture fund's focus.  And when I hear a startup idea and during their pitch I think of a way to improve it, I openly suggest it to the entrepreneur, “free of charge”.  Most VCs love the entrepreneurial mindset or we wouldn't be in this business in the first place.

2. It doesn't mean YOU are stupid. Virtually all of the entrepreneurs we hear pitches from are smart, dedicated and courageous individuals.  You have to be courageous to even contemplate starting a company. In my fund, we've all started companies and we know the risks you are taking.  And a turndown is certainly not meant to denigrate the entrepreneur. Our business survives on the efforts of entrepreneurs. In my fund, all the investment professionals were previously entrepreneurs themselves. It is not in our best interest to even suggest they are stupid.  Many a successful startup has been founded by an entrepreneur who struck out on an earlier startup idea.

   Again that is not to say your team might not benefit from some improvement. First, your team might be insufficiently experienced in the target market area, in our judgment. Or, to put it bluntly, I've never seen a one-man startup get funded.  Team up with 1-3 other complementary individuals. Normally if we are saying no for team breadth or depth reasons, we will be upfront about it and tell you so.

3. It doesn't mean you will fail, either. Every seasoned VC has examples where they passed on a deal that later was very successful.  The VC business is not exclusively about picking winners. It's also about picking winners that meet our selection criteria, for capital required to win or market area addressed or time to success. Our fund would have been ill-advised to invest in SunPower, for example, even though it has been successful. It's required a lot of money to get to its current state, more than CCV has under management. Our fund needs to focus on deals where the all-in capital requirements are less than $30-40M. Fortunately in today's technology world, that includes a lot of interesting opportunities.

   
   

What “No” Might Mean.

1. Your market or technology focus doesn't fit our investment objectives or promises made to our Limited Partners. The Limited Partner community, typically large endowments, or pools of money from individuals or organizations, is trying to maintain diversity in their investments.

   

   For example, an LP may already have substantial funds invested in a number of high profile, later stage venture funds.  They may therefore invest in our fund as an offset to that strategy.  At Claremont Creek Ventures, our LPs invested in us because we were explicitly focusing on early stage startups. Our investment philosophy complemented their own portfolio and gave them desired diversity.  But that means CCV may turn down an otherwise good-looking deal if its stage doesn't meet our promised criteria.

2. Your capital needs exceed our investment criteria. Some businesses require more investment than others to become successful.  Today's web businesses require much less capital than in earlier times, but other businesses still require upwards of $50M to reach profitability.  Notable examples include pharmaceutical and semiconductor companies.  It doesn't make sense for a small early stage VC fund to invest in a deal that will ultimately require substantially more follow-on funding than that fund could ever muster.  At CCV, we focus on startups that need less than $10-12M all-in from us to reach breakeven, and therefore typically need $2-3M in a first round investment. Perhaps the most painful outcome for a venture capitalist is to have invested millions of dollars in an idea that is finally reaching fruition, but their fund is now running out of money to cover its position in a later round, and ultimately they get washed out.

3. You have insufficient protection for your ideas, and we fear you will be easily copied if you get traction.  I sometimes call this a “Success Tax”.  If your business is a success then other better-funded companies will copy it and compete with you.  On the other hand, if your business fails, nobody cares.  The “Tax” is only levied if you are successful.

4. We can't see how your idea will develop into a sufficiently large business to meet our exit objectives.  We see lots of good ideas that can change the world in some narrow way, and even provide a nice “lifestyle” business for their founders, but can never grow big enough to go ipo or find a buyer willing to pay enough to justify the investment or the time expended by a VC investor.  This can apply to some funds but other funds will still be willing to invest.  And frequently, what isn't big enough for a VC may be plenty big enough for an angel investor.

5. You're at a stage that is too far from exit to meet the timeline of our venture fund.  Venture Capital funds usually have finite durations like 10-15 years.  That means the VCs have promised their LPs they won't tie their money up for longer than that period, and will start returning capital by then.  If you are presenting a firm a medical device deal that has a 5 year regulatory window in front of it, and the fund is already 4 years into its life, then a “no” answer may simply mean your timing is too long to meet the venture firm's now-foreshortened time window.

What “no response” Might Mean.

1. Any of the above reasons, combined with our being swamped. As I mentioned at the outset, we see hundreds of deals a year.  The common metaphor is that we “live at the end of a fire hose”. There are so many deals, and so little time.  So there is a premium placed on time management and in order to simply manage our time most efficiently, VCs have to make fairly quick triage decisions: “is this a deal that has a realistic chance of being funded by our firm?”  When the answer is no, and our time permits, it is polite to communicate this back to the entrepreneur in a constructive and helpful manner.  But frequently, the fire hose smothers that deal under layers of subsequent submissions. Some polite declines just don't get done.

2. Your submission was unsolicited or not introduced by a credible source. We get a large number of “over-the-transom” deals. Frequently, they have been blindly submitted without any effort made to see if this is an area we might invest in. Or the deal is referred to us by an individual we don't know or hold in poor regard. Or it comes from some remote location far from our offices. Or it comes from a “finder”, i.e. from a company that is contracted to help find venture funds for a start up. I must confess in those particular cases, I feel much less obligation to reply even negatively.  And most VCs are very reluctant to work with finders because they are typically compensated out of the proceeds, and the VC sees their commitment discounted at the outset — VCs don't like that.

3. We already have an investment addressing that market area. In some of these cases it is better (safer) if we say nothing at all. But I want to assure the entrepreneurs out there that reputable VCs do respect confidentiality notices on submissions. Our businesses run on trust and our reputations would be quickly damaged if we fed confidential information to another company we had an interest in. But that reinforces the importance of the entrepreneur researching venture firms and their partners, portfolios and focus areas, before blindly submitting their plan. Ideally, an entrepreneur should look for an investor that has some familiarity with a market and/or technology area, but isn't already invested in a directly competing business.

4. Or it may simply mean your submission went into my spam folder. Unfortunately that happens a few times a year. Avoid sending your submission from a Tongan web address, and avoid using the word “V1agra” in your text. Not much help there…

In summary, there is information to be drawn from a turn-down. Ideally, a good VC will try to give some constructive feedback with a decline message. But life at the end of the fire hose means we don't always have the time. I can guarantee one thing to every entrepreneur. You will hear more “no's” than “yes's” in your startup career. The key is to focus your efforts on putting together a credible story, an important market need, a technological advantage, a well-suited, complementary team, and then finding the RIGHT investor who gets it and then wants to help you make it happen. Think of it this way: there are an infinite number of ideas out there, an infinite number of possible partners out there, AND an infinite number of possible investors out there. Go find the right combo.