A year ago I became a venture capitalist after 23 years as a startup founder and early-stage startup executive. At the beginning of 2019 I joined btov Partners, one of Europe’s most established VC firms, as a full-time investing partner, and the experience has been quite eye-opening.
When you interact with VCs as a founder – be it during fundraising or later when they sit on your startup’s board of directors – there are many VC behavior patterns that seem a bit strange, sometimes confusing, downright annoying or simply surprising. It’s sometimes hard to understand for founders where these patterns might be coming from, and it’s easy to simply interpret them as “typical VC behavior” – which is rarely meant as a compliment. VCs are of course not the only stakeholder group that is hard to understand. Customers, employees or partner companies all have their idiosyncrasies too. But because VCs play such an essential role in a startup’s development, they might have an outsized importance in founders’ minds.
As is the case so often with attempts at empathy, it’s hard to understand other people’s position until you have walked in their shoes. And that’s exactly the experience I have had over the past twelve months. Once you do somebody else’s job, it suddenly becomes clear how some of their behavior patterns might be motivated.
That’s why I wanted to share some of my insights: to help founders understand a bit better why VCs are the way they are. Founders often think that VCs have an easy life compared to them. That’s not completely wrong in some aspects, but there are plenty of invisible challenges that come with this job. No need to feel sorry of course (being a VC is definitely one of the best jobs you can have in the startup world), but mutual understanding is typically a good thing.
VCs have a limited attention span because they have to context-switch so often
Founders just hate it: Sometimes VCs seem to barely be able to remember what you told them in that call just a week ago. They sit in pitch meetings and start typing on their phone after slide 3. And their eyes glaze over when you present that brilliant in-depth analysis of your technical USPs that you worked on so hard. Why do VCs seem to have such a short attention span?
The main reason is quite simple: because they look at so many very different things on any given day. That’s something that stretches even the best minds to their limits. As a VC I have roughly the same amount of meetings, calls and emails that I had as a startup CEO or CTO, but the difference is that each item comes from a very different context. If I talk to three existing portfolio companies and three potentially investable startups in a day, there are six different industries, six different business models, six different teams, six different sets of target customers. As a founder you more or less operate in the same context every day, even though there might be many different aspects of your company competing for your attention. But you rarely have to go through the deep and very frequent context switches that VCs are exposed to.
The result is that VCs have a limited attention span – because they can’t afford to have a much longer one if they want to have a chance at doing their jobs. VC to an extent is a numbers game: You have to look at a lot of opportunities to find the right ones that you want to invest in. A data point: Our firm looks at about 3500-4000 pitch decks every year, and we end up investing in about 20-30 companies out of those. Our fund team alone might discuss 30-50 incoming business plans every week. That’s a deep context switch every time, and you can imagine that only a limited amount of time and mental energy can be devoted to each startup at this early stage of the funnel. Even when you talk to startups at a more advanced stage of the selection process or to your existing portfolio companies, there’s a limit to how much time you can devote – because how do you know the next Google or Slack isn’t hiding in that pile of unread pitch decks?
For founders that means that in order to successfully pitch VCs (or work with them post investment), you need to get to the point very quickly. Think very hard about what the most compelling points of your story are. Find a precise way to articulate these points, how to visualize them and put them in context. That’s a very useful exercise anyway because many of the same simplified points will resonate with customers and future employees. When you talk to VCs, you can assume that they understand the basics of your industry (if not, they’re likely not the right partner for you anyway), but make sure you explain how you fit into the big picture. This will help with context-switching and open more attention resources for the details.
Again, no need to feel sorry for the poor VCs and their busy minds. But take them as a great test for how concise and compelling your communication really is. It will more than pay off in other contexts.
VCs have to make a lot of decisions with very incomplete information, and that’s why they are eager to get any data point they can
Of course it’s part of a founder’s daily work to make decisions with very little information – you hire people after just a couple of interviews, you make technical decisions without the time to do a deep evaluation, and you decide on pricing without any clue if the market will bear it, to name just a few typical situations.
But the density and depth of such decisions is quite a bit higher in VC. As mentioned before, a fund team might decide on whether to go ahead with dozens of companies every week based on just the information from a short pitch deck. Before making a final investment decision, VCs spend dozens of hours on due diligence, but that of course still produces a very limited view of reality. And as opposed to typical startup management decisions, VC investment decisions are very hard to reverse. A founder can fire that salesperson that didn’t work out or change pricing if customers don’t like it, but a VC can’t simply back out of an investment once it’s made, at least not without significant damage to their performance and reputation. VCs have to make long-ranging decisions with often awfully limited information.
That’s why VCs try to get as many data points as they can from any source available. They will ask for references, they will independently talk to people who might have deeper insights, and they will do their own desk research. Most VCs are very meticulous about this process and are really making an effort to understand your market and how you might fit into it. The very best VCs are good at separating the signal from the noise, meaning they know which sources of information to take seriously and which to (mostly) ignore. For that reason, it helps if you talk to VCs who already understand your market well and therefore have an existing base of knowledge.
A frequent pattern in VC behavior is of course to talk to other VCs about their opinion on a particular startup. It’s easy to make fun of this: Most VCs claim to be independently thinking, contrarian, deep-conviction investors, but the first thing they do when evaluating a startup is call up their VC buddies to ask who saw the deal, who passed, and what everybody is thinking about the valuation (to be clear: not everybody does this, but many do). But again, this is just another way to collect information to build out the full picture. Early-stage investing is based on very weak signals about markets and companies, and sometimes somebody else’s perspective helps round out your own picture.
The best thing founders can do is to provide as much data as possible. Most VCs are very analytical people and professionally process large amounts of information. Don’t talk to them in the same simplified way you might talk to your B2B enterprise customers who probably prefer a more streamlined set of information. If they ask about how your technology works, actually tell them – don’t go for the pseudo-technical value proposition pitch you might use for your prospective customers. If your technology doesn’t fully work yet, tell them where you stand and where you want to go. VCs understand that you’re just building this thing and have not figured out everything yet, so a combination of honest realism and visionary ambition typically works best.
VCs like to take their time with their decisions because it’s a good idea to do so
For founders it can be maddening if VCs take weeks to come to a decision and months to close a deal. Since there is now a lot more venture capital available than in the past, you now have VC funds that try to set themselves apart by boasting about their very short decision process, and you often hear from founders “we want to run a very efficient process and expect to close within three weeks”.
That’s an understandable sentiment. Founders (rightfully) hate fundraising. It’s annoying and distracting, full of rejection, time-consuming travel and sometimes unnecessary busywork. Of course it seems like a good idea to get it over with as quickly as possible and go for the first investor who will give you a term sheet.
But – and I hate to use the usual semi-inappropriate dating metaphor, but in this case it really applies – would you marry someone after just three weeks of dating? Probably not. You are going to deal with your investors for a very long time, particularly the VCs you bring in at the seed stage. They will sit on your board of directors, you will talk to them frequently, and you will need their full support and enthusiasm to raise future rounds, let alone support you through your next pivot. Do you really want to go on that journey with someone whose main qualification was to decide quickly without understanding your business deeply?
Right. Thought so.
On balance, it’s a good idea for both sides to take their time to decide if they’re really a good match. Any given VC is not the perfect fit for every startup, and vice versa. You should both think about how you can add value to each other’s success.
And here’s some candid talk about “deal momentum”, a term I have come to hate from both sides of the funding table because it’s a blatant attempt at manipulation and leads to inefficient outcomes. Founders, if a VC gives you a tightly scheduled “exploding term sheet” and pretends that they will only invest if you agree by Monday night, tell them politely that you want to take your time to explore all available options in the best interest of your stakeholders, and you’re happy to take their offer into consideration without a specific deadline (or at least with a much longer one). Spoiler alert: if they really want the deal, they will do it whenever it’s available. Investors: if a founder tells you that they have this amazing offer from a SV-based fund that they have to take or reject by EOB tomorrow (PDT of course), and they still might consider you for a slightly higher valuation, wish them a nice life. It might be completely made up, or they just fell for the old exploding term sheet trick, but either way it doesn’t suggest that this is a particularly strong founder.
To qualify all of the above: No, of course you don’t want to drag out the fundraising process forever. It’s typically a good idea to get everybody to commit to realistic deadlines that move things along. But again, selecting your VCs is one of the most important decisions you will ever make as a founder, so choose wisely.
No, VCs really don’t like to say “no”
Almost all VCs I know are in the industry because they are fascinated by innovative new technologies and by the founders who create them. Working with talented startup teams and helping them implement their dreams is what gets us out of bed every morning. And one of the best moments is when you identify and fund that nascent company that just figured out something amazing and might turn into the next unicorn that changes the world a bit for the better. Sorry if that sounds corny, but that’s really how it feels. The good VCs brag about the companies they helped grow, not about their IRR.
Because of that, telling a founder that you won’t invest in their startup is by far the hardest part of the job. It might not seem that way to founders when they get a short and obviously standardized rejection email. Yes, there are rejection statements that are less than helpful. “It’s too early for us” is a classic, “it’s not in our investment focus” (oh, you found that out just after our third meeting?) is another. Of course there are often deeper reasons behind these superficial points that are harder to explain. But the true reason many VCs use these simple rejections is because they don’t want to hurt founders’ feelings. Telling somebody that you don’t think their baby is the most beautiful in the world is never easy.
However, once you go through a deeper process with a VC firm, you deserve (and should ask for) a more detailed reason for the rejection. Most VCs are willing to provide that, and it is often some of the most helpful feedback you can get. In my own career as a founder I experienced that often the very best VC firms provided the most thoughtful reasons for a rejection. It still hurts to be rejected, but at least you get a very qualified opinion that you can use to improve your pitch and value proposition.
Founders often feel the need to respond to a rejection with detailed counterpoints about why the VC clearly misunderstood something. It’s OK if you feel the need to do that, but don’t expect it to change the decision. That’s not about vanity (VCs professionally expect to be wrong most of the time – that’s why 60-80% of startup investments fail) but because a disciplined decision process is key for a VC firm’s functioning. Once the VC invests a certain amount of time and effort in any given startup, that’s it, and everybody needs to move on.
VCs don’t offer moderate valuations because they’re greedy and want to trick you
The valuation you can get in a funding round is the most dominant variable in founders’ minds when it comes to a VC deal. That’s understandable: This single number determines how much you are going to dilute your own share in the company. It’s also to some extent a vanity number that seems to signal the value of what you have created and how strong you are as a negotiator.
Most founders think that setting a valuation is a zero-sum game: It’s about how much you get to keep vs. have to give to investors, so naturally most founders tend to take the offer with the highest valuation. They also think that the VCs who offered lower valuations are just greedy and tried to snatch a higher percentage of the company for little money. Makes sense, right?
There are three things wrong with that perspective: First, higher valuations often come with conditions that might be detrimental to a founding team’s ultimate financial success, particularly when things don’t go perfectly. Higher liquidation preferences, anti-dilution provisions, stricter governance clauses etc. are fairly common in term sheets with higher valuations, and many founders don’t think about these factors when they pick an investor.
Second, VC is as much subject to supply and demand as any other market. The best VCs and particularly those who can add real value to your startup are probably not those who are forced to offer the highest valuation. A lot of money has flown into VC in recent years, and a lot of new funds are fighting over deals. Valuation is the most obvious lever for VCs who are less than ideally positioned to win deals. But think about it: Is that really who you want to bet your company’s future on?
Third, startups typically have to grow into their valuation, and that’s hard even under the best conditions. The valuation in most funding rounds is not an expression of your company’s value here and now, but of expectations for the near future. For your next funding round you will be judged by whether you were able to at least double or triple your startup’s value since the last round. Investors expect to see that kind of progress. So if you managed to squeeze out a very high valuation in this round, getting to the right kind of success story for the next round will be all that much harder. Different investors will look at your company with fresh eyes, and the math has to make sense. That’s why valuation success now can increase your risk of failure very significantly.
The best VCs are not cheap because they understand that the best founders don’t have to take money at very low valuations. But they understand the dynamics of valuations and their relevance for future company growth (and, of course, their own investment returns), so they will pass on overly expensive deals. They will tend to offer a reasonable valuation with transparent and fair conditions, and that’s usually the best deal you can get. As so often in life, the trick is in finding the right balance, not in overoptimizing for one single variable.
