VC firms are predictable, and one common attribute I discovered among them is that the VC firm looks for reasons to say “no” to any entrepreneur doing a presentation. My favorite “no” reason is the one my former colleague explained to me: one of his favorite questions is to ask the entrepreneur if he/she had approached other VC firms prior to his. If the answer is “yes”, he would ask how long ago and how many and whether any of those firms have committed themselves. If the responses are significantlly positive for all, he would automatically conclude that there is something wrong with this company without considering the merits of the business plan.
Recently, I witnessed the same thought process on an interesting medical diagnostic company run by a very impressive management team. It would serve a great social purpose dealing with early cancer diagnosis. But when I asked the VC Director what he thought about the company, he replied that, indeed, the management team was great, the due diligence indicated that the founder was well known in the industry. However, he thought it strange that, given the founder’s personal network and industry recognition, why the founder has been taking so long to raise the $3 million required for so long – as if the business plan had some defect – although none existed.
In earlier blogs I address how VCs commit their capital (diversification theory) or how VCs choose companies to invest in (within their specialties) or why should entrepreneurs do some due diligence on the VC firms before pitching to them. And I have stated earlier, seeking capital is a marketing problem. Why did I state that? For the very reasons they look to say “no”. For example, if the entrepreneur’s company makes widgets and pitches to a VC firm with no interest in widgets, then the VC firm will “pass” on the deal. If the VC firm invested in 2 companies that already makes widgets, then it will “pass” on that deal. If the firm’s funds have depleted, yet it needs to keep itself busy, it will entertain the deal without investing — “pass” on the investment. These firms have stated no without considering the merit of the business plan. However, that company will now have the “scarlet letter” of being labeled as defective that will stigmatize the company’s efforts in seeking capital from other local VC firms.
The negative VC mindset stems from the suspicion that the VC guy at the end of a queue of rejections fears that something has been wrong with the company. He fears that an investment in a lemon will reflect on his ability to find an excellent deal. Still it doesn’t mean that company has some merit.
How should an entrepreneur avoid this negative trap? First, do the due diligence on the VC firm. Look at the website and research the history or portfolio of the VC firm’s companies. Are they in the same space as yours? Also, make a call and see whether the investment funds have been exhausted. If the funds are depleted for any investment with the type of company, then there is no reason why the entrepreneur should approach the firm. A simple call resolves that problem.
Another approach I prefer, if you are seeking capital, try to aggregate the schedules for meeting the VC firms as tight as possible. This approach mitigates the excuse that the firm you met “last month” that adds to the reason for saying “no”. By meeting the firms within a 2 week window certainly creates an additional incentive for the firm to say “yes” as the deal is so “hot” that the firm expresses a strong incentive to invest.
There are many great companies that should have raised capital, but, because the entrepreneur did not understand the VC fund raising algorithm, it can encounter a frustrating process. These companies should prepare themselves early by doing everything right before fund raising: a well written business plan, due diligence on the VC firms, compiling the list of VC firms related to the plan and having incentives to invest from the size and scope of the deal, and great presentation preparations. Or they will hit the invisible “no” wall.