Tuesday, February 28, 2012

Selecting, not filtering: Give me a reason to say yes

Raising money for my last startup was humbling, frustrating, time-consuming. But that part was okay: any highly selective process will be humbling, frustrating, and time-consuming. The part that really bothered me wasn't that it took so much time, but that so much of that time was a complete and total waste. In almost all of the VC meetings, we did not leave with a check. But in some 80% of the meetings we also did not leave with any insight as to why not*.

The best VCs listened to us and then gave us some insight into their thinking. Fred Wilson and Brad Burnham actually said no to us and then worked through their thinking about what we were doing in great and helpful detail. Josh Kopelman and Howard Morgan told us it wouldn't work, told us exactly why, then invested, and--after that--introduced us to people who helped us fix the flaws in the plan. But many others gave us either no response at all ("we'll get back to you") or generic non-responses ("we'd like to see more traction.")

We had a pretty firm idea of the problem we wanted to solve, but we were somewhat flexible about how we would solve it. We used the feedback from the money-raising process to hone our ideas. When we got no feedback, we felt we had given the VCs critical market intelligence and gotten nothing in return.

One of my ideals when I started investing was to always provide feedback when I said no. But here I am four years in, going through the pitches that piled up last week while I was on vacation. I'm finding it hard to live up to that ideal. I'm saying no to companies that I don't have a concrete reason to say no to. After a bit of introspection, I think that finding a reason to say no is not really how I make the hard decisions.

I have a tangible reason to say no to some 85% of the pitches I see, and I say yes to less than 2% (some of these I don't end up doing because we can't agree on a deal.) Here's a swag at how my dealflow works out:

  • 40%: No; I do not know your market well enough to help you succeed (also known as I do not know your market well enough to make a good decision about investing);
  • 20%: No; I do not think your idea will work and I can't see where else you will be able to put the technology you're building to work/you are completely inflexible about entertaining other potential markets for your technology/you are too flexible about where you will put your technology to work (the "we're a platform!" syndrome);
  • 10%: No; You are creating something merely better, not different;
  • 5%: No; You have the wrong team/your team does not seem to gel/you do not seem to think you need a team at all/you are coding in .NET;
  • 5%: No; Other explainable reasons;
  • 5%: No; Bad**;
  • 13%: Meh;
  • 2%: Like.
I always explain, in as much detail as the entrepreneur wants, my thinking behind the 85% where I can say no. And I am always happy to explain why I like the 2% I like.

The rub is in the penultimate 13%. These are companies that I don't have a real reason to say no to, companies where I analytically think they have a venture-capital-winner expected value but where I just can't get excited about them. The reality is that with these companies--and, in fact, with all companies--I am not looking for a reason to say no; I am looking for a reason to say yes. With the 85%, there is a glaring reason why I can't say yes. With the 13%, I just can't get the word to come out of my mouth.

For the companies I can easily say no to, some dimension of their plan (team, market, vision, product, customer, etc.) does not rise above my threshold of yes. For the 15%, all aspects do. Analytically the fitness function then necessarily also rises above my threshold.

The difference between the 'meh' and the 'like' is that the 'meh' companies are good enough in all aspects but not great in any of them. The 'like' companies are the ones where they really excel in at least a couple of ways: a great team, a big market, a compelling vision. I try to select not just for how good a company is, but how good it will be. It's easy to improve along one dimension, it's possible to improve along a couple of dimensions, but it's almost impossible to improve along all dimensions. The companies that are just good enough in all dimensions need to improve in all dimensions. The companies that are great in a few just need to improve in a few others, not all, to be great overall.

In fact, some of my favorite companies are the ones that may not even rise above the threshold in one or two dimensions but make up for it by having a superstar team or a gigantic market or a world-beating vision. These are the companies that have a shot at being legendary.

I don't know what to say to 'meh' companies after they pitch me. It's hard for you to recover from a "we're not so bad" pitch. But if you're dreaming up your startup right now my recommendation is to be good at everything, but to be insanely great at something. That's what gets me excited.

* And, I should note, the founding team knew the venture market inside and out. We had done our research on which firms to approach based on what they were interested in, which partners to approach, had pre-sold the idea before the physical meeting, had customized the deck to highlight the aspects that particular firm/partner could grab onto most quickly, etc. Highly suggested in any case.

** My dealflow right now is pretty highly curated so I don't get a lot of pitches that are just, well, bad. Not to be judgemental. Bad, to me, is a founder who simply does not know what they're doing: a non-coder trying to enter a market either (i) that they just don't know anything about--generally where they've had a bad customer experience but have not done the research to understand the institutional framework behind the root cause, (ii) where there are great companies already doing exactly what they want to do and they've never heard of them, or (iii) that is so small that even revolutionizing it will create almost no societal value. Or, they could give a damn about creating societal value, they just want to make some money quick.


Kevin Jemison said...

Thanks for the insight on your thought process Jerry. You mentioned how the time consuming nature of fund raising was such a big frustration, have you tried to address that in your current investing process as well?

Kevin Jemison

Jerry Neumann said...


I don't think that the VC process can be anything but time-consuming in its current framework, a different framework/process/mindset would be needed. I am not trying to change this, mainly because I'm not so very interested in the Venture Capital business as a business. I'd rather spend my time helping entrepreneurs build revolutionary tech companies than spending it on reimagining a tiny professional services business.

Also, and I know this won't be a popular answer for the entrepreneurs, but given that there are only a few thousand funded companies a year and each of them wastes maybe a thousand hours on the inefficient VC process, the total societal inefficiency is just not that big overall. Solving rubbernecking would have an effect that would monumentally dwarf that of solving VC. There are probably second-order effects that I'm discounting, but I don't think they're that big.

Anyway, maybe I'm wrong. The shoemaker's children have no shoes, after all. Happy to listen to a pitch on how you'd solve VC.


Kevin Jemison said...

I don't have the level of clarity on the problems with VC investing, having not gone through a funding round myself, to speculate on to solutions. (Not to mention I have enough on my mental plate trying to build a business and navigate the funding process myself.)
Though I will be interested to see how crowd funding, if it becomes legally acceptable and widely used, impacts fundraising. Market dynamics from more participants should reduce some of the information asymmetries that define the current process. However, who knows what the consequences of that will be.

Kevin Jemison

Jerry Neumann said...

Not to be cynical (ok, maybe just a bit) re crowdsourcing, but I think amateurs will fare as well in VC as they do in the public markets: they will be able to manage beta, but not alpha. And many of them will get fleeced. As a long-time advocate of index funds for anyone who is not a full-time stock picker, it would be hard for me to think crowdsourcing will end well.

Kevin Jemison said...

Definitely, I 100% agree that folly that often comes when herd mentality and public markets combine. Past years of working for Big Bank & Co gave me a front row seat for alot of our most recent mass-folly.
However, I think the larger potential benefit for crowdfunding is two-fold. First,the benefits of general democratization that the internet has enabled at large, which our conversation is a good example of, when applied to seed funding will inevitably produce some valuable goods and services that wouldn't have seen the light of day otherwise, along with many piles of cash burned up and flushed away. But hopefully the benefit will outweigh the waste.
Second, I do think 'sunlight is the best disinfectant' as the saying goes. With more options should come less opportunity for bad actors and more opportunity for investors such as yourself, Brad, and others that really add a lot of value and make a huge difference in the success of the companies they invest in. I think its a potential win both ways. Too bad reality is often far from theory.

Kevin Jemison

Anonymous said...

Good post Jerry!

although I am glad we didn't tell you about our .NET prototype ;-)


bhalliburton said...

Nice use of the word "penultimate"!

Rare to find an appropriate moment for a good word.

bhalliburton said...

I would actually add to the comment stream that Jerry has done something about the time-consuming nature: Jerry is a quick "yes" or "no". Angels that need to do 6 months of due diligence are not as much fun as Jerry!