At least a few times a week, I get asked “are we too early to be raising money” by an entrepreneur.  This might be in the context of a company trying to raise their seed round, or a company that is further along that I’m giving feedback to about a series A, B, or C round.  Another related question I often get is “what do I need to accomplish to raise money from investor X?”

There are some rubrics that arise from time to time about what it takes to be “ready” to raise a round.  For example, there is sort of a magic number for SaaS businesses to achieve $100K MRR, which is usually a good benchmark for being able to raise a decent VC-led series A or B.  But overall, I think that this is a question that is very difficult to answer.  No matter where you draw the line in the sand, there are cases of companies that have raised capital way earlier with way less meat on the bones.  And at the same time, there will be companies that had way more meat on the bones, but struggled to raise.

Here’s my framework for how I (and I think many investors) think about how ready a company is to be funded. Think of this as sort of a sequel to my seed VC decision tree:

So, here’s what’s going on. As an investor, I am thinking about every opportunity in terms of my conviction around the team, product approach, and market opportunity. The final factor is usually deal terms and pricing, but usually, that gets figured out last. I’m smashing that all into some measure of “conviction” on the vertical axis.

At the same time, for any given company, there is a “burden of proof” that is required to get an investor to the point that they will want to invest.  These are all the proof points that the business is working, and can range from actual financial metrics to even subjective things like how industry experts and potential customers are perceiving the idea.

The kinks in the curve show the major milestones for most business.  The first kink is going from product-discovery to real product/market fit.  The reason it’s a sharp kink is that when you clear that threshold of “proof”, the conviction needed for investors to get interested drops significantly.  The same happens when you go from product/market fit to having an established, repeatable, business model and growth machine. This is the second kink in the curve.

This over-simplifies things of course, but generally speaking, seed rounds happen before product/market fit, series A’s (and some B’s) happen between PMF and figuring out the business/growth machine, and C’s and later happen after the machine is built.

The sad faces are any place under the curve, which basically represents when investors will say “no”.  A “no” happens because the burden of proof for the company is too high given the investor’s conviction.  You will notice that between the kinks, the curve is relatively flat.  This illustrates the reality that when investors lack conviction, the “proof” they need to eventually say “yes” is usually unreasonable.  To put it another way, an investor that has just a little less conviction than one who would be willing to say “yes” has a much higher burden of proof.

This is why sometimes entrepreneurs feel like “keeping investors up to date” just results in the goal posts being moved back more and more each time.   This is also why entrepreneurs are almost always kind of puzzled and disappointed when they ask an investor “what would we need to accomplish to get you interested”?

VC’s pretty much live in the unhappy area under the curve.  We consider thousands of potential investments each year, and the conclusion almost all the time is that our conviction around the opportunity relative to the proof don’t jive.  Even for companies that are far along, the valuation is the great equalizer.  An investor may love the team, product, and market, and be impressed by the proof points, but think that it’s just not a reasonable risk/return at a particular price.

If you assume that the startup market is approaching efficiency (which is increasingly less debatable) then the pricing of a deal should get bid up to a point that is essentially too expensive except for the investor with the most conviction.  Another way to think about this is from a quote from Mark Zuckerberg at the time when Facebook was approached by Yahoo to be acquired for $1B.  When discussing board conversation about turning down the offer, Peter Thiel described Zuckerberg’s argument in this way:

 “[Yahoo] had no definitive idea about the future. They did not properly value things that did not yet exist so they were therefore undervaluing the business.”

In a way, VC’s that actually pull the trigger on an investment are thinking in this way almost every time they do a deal.  They are committing to a future that is undefined, at a stage that most others think is too early, at a price that most others think is too high.   This is also why we always remind founders that fundraising is about “searching for true believers, not convincing skeptics.”  Skeptics are further down the conviction axis, and because of the slope of the curve, the burden of proof to get them over the hump is just impractical.

Note: This is not true for what some VC’s call “proprietary deals”.  The idea here is that some entrepreneurs will work with a VC at a price that many VC’s would love to invest, but because of a pre-existing relationship, that VC gets to win the deal at below market price.  This does happen, but realistically, I think is less than 20% of deals that are done.