Rob Go: 

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The #2 Reason Why VC’s Say “No”

Rob Go
October 29, 2009 · 3  min.

VC’s pass on new investment opportunities more than 99% of the time.  My guess is that the clear #1 reason why we pass is because of the team.  This could mean a bunch of different things (eg. no confidence the team can execute well, personality clash, etc).  But I don’t think there will be much dispute that this is the main driver behind a “no” decision.

The #2 reason is NOT as obvious.  “Bad Product” or “Unattractive Market” are definitely up there.  But I will contend that the second most popular reason VC’s pass is because the company “can’t get big enough”.

This is something I hear all the time among VC’s and I know it must drive entrepreneurs crazy, because no one thinks that they are giving their time and energy into an idea that is not “big enough”.

What does big enough mean?

There has been a lot written about this so I won’t rehash the math.  But the basic idea is that startups have a high mortality rate.  And so the relatively small % of winners need to be significant enough to drive an impactful return for the fund.

Although a lot of posts speculate that VC’s block good outcomes because of this, I doubt that it’s as prevalent as it seems.  What is prevalent is that VC’s think very hard about whether the potential of the business is big enough relative to the time and capital investment required.  We also think very hard about whether the founder is interested in shooting for a big outcome.  If not, it’s a tough fit for a venture capital investment.

Why many entrepreneurs should accept this reality (and why some investors should take advantage of it)

The reality is that most businesses probably can’t get to the kind of scale that VC’s require.  Moreover, it’s damaging to the business to do unnatural things to try to get to that scale.  You may grow your team too quickly, forgo revenue for reach, hire expensive executives, etc.

These aren’t bad things, but they aren’t right for all businesses.  I think there are a lot of very rational businesses out there that can probably get to profitability and modest revenue and create a lot of personal wealth for those involved.  Building these businesses can look quite different from building a venture funded company, and the funding strategy ought to be different as well.  Funding may not come from the highest profile VC’s (at any round in the company’s life) but from wealthy individuals with deep domain knowledge in your sector, professional investors with a different set of economics and strategy, or good old fashioned cash flow.

I would say that I think there is a dearth of investors for this sort of company, and I think there is probably an opportunity in this sector of the market. I also don’t think such an investor is necessarily dooming themselves to mediocre returns in small companies.  If they invest in the right markets, I think 1 or 2 out of 10 companies might surprise them and actually yield traditional venture returns.

Why entrepreneurs shouldn’t lose hope in VC’s

Despite the reality that most businesses can’t get to venture scale, an entrepreneur may be absolutely convinced that their company is an exception.  If this is the case, don’t lose faith in VC’s!  If you think about a lot of very successful companies, many of them probably looked “too small for venture” in their very early days:

“Pez dispensers and collectables online?  Tiny market!”

“Free calls online?  How will Skype ever make money?  Too small!”

“A coffee shop with a goofy name and a mermaid logo?  Too competitive, can’t scale.”

The goal then, is to find an investor that shares your vision for how you can get big (and is willing to endure criticism from others who don’t see the same opportunity).  Sometimes, these investors just have a conviction about where markets will go.  Or they just have a love for what you do and unique ideas about how to win through better execution.  This takes some time to figure out, but it is getting easier as VC’s are becoming more transparent about their investments, themes, and thoughts on market evolution.

I also think that these are the VC’s who tend to be the leaders in the industry rather than the followers.  The first investors in category creating companies tend to look like idiots for a while before the company goes from “not big enough” to the clear leader in an emerging new sector.  Then the lemmings follow.

Rob Go
Rob is a co-founder and Partner at NextView. He tries to spend as much time as possible working with entrepreneurs to develop products that solve important problems for everyday people.