The Truth Behind How Venture Capital Chooses Startups
Forget the pitch deck. This is the brutal reality.
If you only have 30s to spare, watch this video. It’s the brutal and condensed version.
If you have another five minutes, let me share with you the broader reality I’ve learned, having been on both sides of the negotiating table. None of the sugar-coated stuff for interviews and self-promoting internet articles. Here’s the truth behind how VCs really assess startups.
VCs should live in theme parks with hillbillies
We all know VCs love to flock around popular themes. It’s like kids in carnivals queuing up at the most popular rides. At the time of writing it’s Blockchain and AI. And because the money is flowing, startup founders also flock to such themes or try to position their ideas as one.
But to whom do the investments really go to? Ideas are aplenty. Chances are whatever you thought of, there are already other similar startups in the world. So why you?
This is where the VC world gets a bit ‘incestuous’. Like any other business, a lot relies on connections and who you know.
I have an old friend from middle school who is a bonafide billionaire founder. He’s been on the Forbes list since his startup went IPO. His brother founded a healthcare startup a few years ago. He basically went around canvassing for his brother among his contacts and millions flowed in. Not that his brother’s idea didn’t have merit, but it was that much easier.
A former client wanted VC money even though he was already quite affluent. He believed the right heavyweight VC would provide great connections and credibility. But the money manager world was new to him so he sought advice from high society and friends familiar with Silicon Valley. He basically concluded that it was all about your network — someone you knew from college fraternity or an ex-colleague from an investment bank etc. So he went about networking with the right people, and he eventually got funded.
But these are anecdotes, right? They are not statistically significant. Well, no one in the business is going to do a study and admit to something like this. But I did once ask a partner of a leading incubator and seed fund about this. He admitted that 70% of the startups they picked came from referrals and contacts. Only about 30% came from unsolicited pitch decks sent through the formal channels.
Which leads me to my next point…
We don’t have time for your grandmother stories
If you don’t have the connections to get through the door, then you are left with cold calls and pitch presentations or matching meets at startup events. Most of the time you only have one chance. If you botched it up its unlikely the same VC will listen to your pitch or open your email twice.
But most startups are really bad at this!
I won’t talk about writing business proposals or preparing PowerPoint pitch decks since it’s already all over the internet.
I’m going to talk about sending in unsolicited communication. I like to divide them into a few categories: the vague, the rant and the self-proclaimed unicorn. And oh, there’s also the Google translated…
Here’s a couple of extreme examples from my own Inbox.
This one came from some Italian guy who wanted to raise funds in China. He started off the email addressing me as “亲爱”, which translates literally to “Dear”, or “Honey”, and he ended with a sign-off that translates to “the best blessings”. Obviously the rest of the content was a bit laughable too. BTW, I’m not even sure why he sent it to me in Chinese. Maybe he thought Singapore was a village in China. Maybe because my last name sounded Chinese…
At least the previous dude was an Italian trying to operate in China. This one came from a native speaker in the UK who claimed to have two MBA’s and was operating as CEO of a company that helps entrepreneurs raise money. Would you want her representing you?
The extreme cases aside, please don’t write a long and tedious email explaining your grand idea, or one so short we have no idea what you do. I get these so often I was spoiled for choices below:
The truth is, VCs have no time to go to the links of videos, pitch decks and websites unless they are interested in the first place. Put your USP upfront! [UNIQUE SELLING POINT]
When I was a startup founder myself in my 20’s I was told by a VC he gets about 30 hard copy proposals a day and a pile sits under his desk. That was 15 yrs ago. It must be worse for VCs now that everything comes through email. They will glimpse through every one they get but you have to put your key point upfront to attract them to read on.
My recommendation is to try and do it in three short sentences. At the very most three short paragraphs if you really struggle to summarize. It should contain:
What you do and why it’s important
What’s the potential market size
Any other edge like team credentials/patent/proven prototype etc.
It’s perfectly possible to achieve. Here‘s a few more examples. Tap to enlarge.
But whatever you do, don’t tell them you are convinced your idea is the next unicorn. If you do have a moonshot idea a smart VC will see it straight away. All you have to do is explain your concept in a clear, succinct way and show them the numbers on the Total Available Market (TAM, aka Total Addressable Market) and they’ll work it out for themselves.
Life isn’t fair. Not all of us are born affluent or studied in Ivy League schools. So don’t sit around and sulk if despite your best efforts, no one replies to your unsolicited emails. An investor once told me, if an entrepreneur doesn’t have the resourcefulness to find a way to connect to me, then I probably shouldn’t invest in him. And that leads to my final point…
Most of all, it’s about…
If you’ve gotten through the door and they like your pitch, then the final consideration before giving you an investment Term Sheet is… You.
I’ve ranted on long enough. Let’s hear from the real VCs.
“When I back an early-stage company, I back the founder, first and foremost. It’s going to be a long and likely bumpy journey as you build your company. I want to understand why you are uniquely positioned to defy the odds and build a large and lasting company.”
— Stephanie Palmeri, Uncork Capital
I think one of the challenges today is that the entrepreneurial path is amazingly glamorized…A lot of what we look for is understanding the founder’s grit and resilience. Do the founders understand the risks that they’re about to take? Is it an informed process? A lot of it is an honest conversation about what they are signing up for, because I think many founders are often surprised by the struggle.”
— Josh Kopelman, First Round
“The startup idea you pursue should be one you’ve been unconsciously preparing for your whole life. It should be about your strengths, not just a gap you see in a market. The first thing you should ask yourself when you have an idea is, ‘Why am I the best person to start this?”
— Brian Scordato, Tacklebox Accelerator
There are many ways to make money, so I don’t believe in a fixed formula to success. But starting a successful business from zero is not easy indeed. After 16 years of wheeling and dealing, I too have noticed successful entrepreneurs do have certain features. This is the reason why some VCs think that assessing the person is far more important than the idea or business model.
Personally I believe exceptional entrepreneurs are born, not bred. The explanation is simple once you compare it to playing a piano or say, tennis. Any child can be taught to play the piano or tennis, but can anyone be trained to become a Beethoven or Roger Federer? There is a certain innate talent involved when a person rises to the very top of his field; and VCs are looking for the very best of entrepreneurship talent.
Highly successful entrepreneurs share certain traits — passion, grit, resourcefulness and risk appetites. I wrote about these common traits in a story inspired by a pilot I met who was having a mid-life crisis. He was inspired by Steve Jobs to start a business but he was clearly missing the traits that would make a successful entrepreneur. I’ll leave it to you to read the story if you are interested.
Otherwise, if you really believe you have what it takes to make it as a founder, good luck out there swimming with the sharks!
PS: In another story I talked about how I managed to raise seed funding in three days for my first startup when I was 26.
Thanks for staying till the end. Medium is my outlet for my lifelong passion of writing. I welcome responses related to this article and its views. In order to keep the article succinct, I’ve held back on many other anecdotes and issues. Please leave a response on what else you would like to know and I’ll get to it at some point.
But if it’s ‘business talk’, please connect with me on LinkedIn instead.