Many founders I speak to often believed that a great product idea, proof of early traction and interest, or a brilliant marketing strategy was all they needed to raise VC funding. However, when I first became a VC scout, I was shocked at how differently founders and funders evaluated the same deals and ventures.
After having seen hundreds of start-ups in my various roles across different industries, I’ve noticed a few recurring conversations that VCs have when evaluating a start-up for an investment that leads them to decide against investing, even if they personally like the founder or the problem that they’re solving.
I’ve condensed some of those thoughts below for those looking to start their fundraising journey or who just aren’t getting that second meeting with a VC yet.
1. Their Market Size is Not Big Enough
I remember creating my first pitch deck for an investor without putting too much stock into my market size slide. Like all founders, I researched and listed the ever-important TAM, SAM, and SOM calculations, but I always felt like the real prize of my pitch deck was the slides dedicated to the product itself or our user feedback.
I only realized its importance once I started working with VCs on the other side of the table. I often heard them say they were passing on deals because they had doubts about the size of the market a start-up was expecting to enter.
Many VCs aim to invest in the next billion-dollar business. Hence, the start-up’s market must be big enough to achieve this realistically. One VC I worked with had a fun way of putting it:
“Even if a time traveler traveled back in time from the future and said that a start-up was guaranteed to 4X my returns, I wouldn’t be able to invest in them. We only even consider start-ups that we think can 10x our investment”.
If the math behind your market size doesn’t reflect this potential, it won't be easy to convince VCs.
2. Traction VS Time: Not Enough Traction for the Time They’ve Been Building
Another misconception I had was that the longer a start-up had been around, the better. As a founder, I believed that it exemplified grit, determination, and commitment - all essential for a start-up to succeed.
I began to realize that there was another side to this after speaking to several investors who all expressed a different point of view. Many would often look at the duration of a start-up’s operations and their traction in the same equation. If start-ups showed too little traction in the market, investors often saw it as a red flag. Understandably, they would favor start-ups that were able to show fast growth in a short amount of time and, hence, were believed to be able to produce faster returns after receiving an investment; I was surprised that investors turned away several revenue-generating start-ups that could have increased their scale by receiving an investment.
This was especially interesting to me given that many start-ups I met approached VCs with the mindset that they could not scale quickly due to a lack of funds and, thus, were raising a financing round to have the capital to accelerate their sales.
3. The Market is Too Saturated
Though many founders often feel like they’re on a roll after some early traction, continuous growth beyond the extent of their existing networks is not always guaranteed.
One of the primary considerations I have heard from VCs is how penetrable an existing market is, steering away from markets with too many existing competitors. Some VCs have even raised concerns that the founders in question may not have the skills, technology, or networks to out-compete the competition and, thus, would be unable to grow beyond a certain point.
One VC I spoke to said that a start-up needed “an unfair advantage” of capturing the market compared to competitors. He noted that most start-ups pitch the same customer acquisition strategies and channels that are vague and hypothetical, and thus, they fail to stand out. He said that the founders that caught their attention had to prove that their company had a distinct and specific advantage that others, such as particular contracts, connections, partnerships, etc, couldn’t replicate.
Start-ups must find ways to outperform other players in the market and effectively retain their customer base, which is even more challenging in a crowded sector.
Some Final Thoughts…
These are just some of the many concerns I’ve heard VCs express as reasons why they do not pursue great start-ups. As a founder, it’s easy to think that the sole driver of success is the product or person; however, communicating how to navigate these challenges is key to securing interest from investors.
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Harsha - thank you for a value packed post!