Getting to Yes and why VCs default to No 99% of the time
When I was at Facebook, the Platform team had a mantra that signaled our desire to engage with a broad set of developers to prove the value of Facebook as a development and distribution environment while realizing that our small team could not support the number of requests we received for help and insight. We called it “Saying Yes at scale.” Over the past year as we have evolved White Star Capital, I have come to realize that the same mantra applies.
Vinod Khosla recently published a deck to help entrepreneurs “Pitch like VCs think” (I strongly recommend entrepreneurs to read it). Underlying the deck (and my mantra above) is the reality that Venture Capitalists are, by definition, going to say “No” to the majority of the investments opportunities that are presented to them.
It starts with absolute numbers: Passion Capital has a great infographic outlining their dealflow: close to 2,000 businesses plans received in a year and 35 investments made or around 1 in 55. Satya Patel of Homebrew also outlined their funnel of the close to 900 opportunities they reviewed in 2013, and the 9 investments Homebrew made (1 investment per 100 deals reviewed). White Star’s own ratio in the last year is also close to 1 to 100 with active deal flow from both sides of the Atlantic.
As we have scaled our team and deal flow we have tried to actively manage the opportunities presented to us and try to be as responsive as possible to entrepreneurs (and I am the first to admit we have not gotten it 100% right but we actively track the data to keep us honest).
So, in an effort at transparency, and with hopefully some insight for entrepreneurs, how could you help a VC go from a default No to a Yes?
-Is the deal at an appropriate stage for the fund? White Star is an early stage investor focused on Seed and Series A opportunities. We see some deals too early (raising an Angel round) and sometimes too late (raising a Series B where buying into the deal is prohibitive for our size of fund). We will pass on those but ideally track the Angel deals as they get ready for their Seed round.
Advice to entrepreneurs: Do some research on Crunchbase to determine at what stage funds have invested in the past.
-Is the deal in the geographies where we are active? We have reviewed business plans from Vietnam to Hong Kong, Argentina to El Salvador, Qatar to Jordan along with Berlin, London, New York and Montreal. Some of these were great ideas, but simply not in the geographic markets in which we operate (mainly North America, with an office in NY, and Western Europe with a presence in London). This does not mean that we will not invest selectively in other geographies, but that it will simply naturally lead us more towards the “No” camp. Some early stage funds will only invest in the Valley, or New York, or the UK be it because they want to be physically close to their investments or because their investor base demands that they deploy funds in a specific geography.
Advice to entrepreneurs: Understand whether funds have geographic constraints either imposed by their own investors or self-imposed in terms of focus.
-Does your idea have scale: VCs have shareholders, their Limited Partners, who have entrusted them with their money under the expectation that will generate significant returns. These returns are usually predicated on a small number of deals having very high returns (Black Swans, Unicorns, Ten-baggers, etc). Matt Oguz lays out the distribution behind VC returns in this great TechCrunch post.
So very early on a VC will be evaluating whether the business plan you are proposing is addressing a large enough market to have significant scale for a potential outlier exit. This is made harder by the fact that we are, by definition, in the business of funding businesses that could create new markets so the size of the potential market is hard to grasp (see AirBnB as a great example).
Advice to entrepreneurs: Are you building a VC-backable business or a “lifestyle” business and if so is VC the best way to fund your idea?
-Can the team pull it off: Early stage startups are fraught with risk (industry stats indicate that failure rate is over 50% for Seed stage startups). One key area that we focus on is the founding team, their experience, their technical and business acumen and their vision and passion for the business. You are backing the founders as much, if not more, than the business as a pivot is highly likely and as the product-market fit gets defined. Look at Instagram, which was initially funded by A16Z when it was called Burbn and was a location-sharing app before it pivoted to pictures. They backed Burb, but they also backed Kevin Systrom and supported him through his pivot (but famously did not invest further after the Pivot when Instagram became competitive with another portfolio company).
Advice to entrepreneurs: Convince me early on that you and your team are the right ones to devote your time and passion to your ambitious idea but also that you will have the openness to accept market feedback and identify the right product and tactics to get you there.
-Bandwidth, dry powder and portfolio construction: One reason for a “No” is completely out of the entrepreneurs’ control. It involves the maturity of the fund and its ability to deploy capital into new opportunities (ie “dry powder”). It also involves the ability for the Partner to devote bandwidth and time to a new deal (on top of others he or she might be working on, plus portfolio company management, Board meetings, Investment Memos, LP relationships, etc). The answer might really be “Interested, but not now.” And finally there is Portfolio Construction which is VC speak for how to allocate fund resources across companies at different stages of maturity to try and time when exits will happen and funds will start being returned to their investors.
Advice to entrepreneurs: Do some research on when the VC raised their last fund. If it was over 3 years ago it is likely they will be running out of dry powder as they focus remaining funds on existing portfolio companies. Read the signals from the investor on other deals he or she might be working on in parallel and, if you really want to mess with our heads, invoke the Fear of Missing Out (FOMO) by signaling the momentum [I say that last one half in jest].
At the end of the day the process through which a default No turns into a Yes is much more art than science and involves a number of factors many of which are not completely in the control of the entrepreneur (or the VC in some cases). Understand the ratios and the drivers… and continue passionately telling people about your vision. That is the single biggest driver for you finally Getting to Yes.
