You don’t have to look too far to find entrepreneurs that have had a tough time raising VC$. Despite the endless stream of funding announcements these days, most companies that want to raise VC, don’t. This is due to a variety of reasons, but one of the biggest, is that venture capital is a very specific thing. It’s not what all technology businesses should think of when they need capital.

It only really works for businesses with:

- High potential for escape velocity

- A large potential market

- A team capable of building a large company

Sounds easy, but most opportunities don’t hit those criteria. This is why most VCs fund around 1% of the deals that they see. So, that means most people are not getting funded.

To help you judge whether VC is right for you, here are my completely subjective top 10 reasons why a business would not be VC fundable:

Services, not product: While some great startups were services companies before becoming product companies, you cannot (usually) raise $ for a services business. Why? Hard to scale without adding lots of bodies. VCs look for highly scalable products.

You are a sole founder: VCs much prefer investing in co-founders vs. solo founders. If you don’t have a co-founder it will be tougher to raise $. And more importantly, it will be tougher to build your company.

You don’t know any VCs: VCs get so many deals shown to them that they rely on a variety of filters to screen them out. One of the biggest is the source of the deal. If you are submitting your business plan to info@scaryvc.com, you’re wasting your time. You need to either know the VCs your’re pitching or have a very trusted referral into them.

You have no traction: This is a biggy. So many people come in and pitch VCs when they are just starting out. And while there are many funds that do seed, including ours, even seed VCs have a strong preference for investing in startups with some market validation and users already. Nothing gets VCs to move faster than traction.

You have outsourced development: This is a complete killer for me. As soon as I hear this, I try and end the meeting. Why would you outsource product development as a technology company? Would you invest in a law firm run by non-lawyers? Me neither. All tech companies need to have lots of geeks.

You serve a niche market: While I always encourage startups to focus on a specific niche to start, the product you are building must¬†ultimately¬†serve a broad market in order to be of interest to VCs. The more specific niche you address (even if’s a big one), the more you need to raise capital from people and funds that understand that niche.

You don’t know the market: If VCs know more about your target market than you do, you’re in trouble.

You are disorganized: Speed is so important to tech startups. If you are slow to respond to due diligence requests that makes investors nervous. If you can’t be completely on top of things when your company is small, how will you be better as your company grows?

You move slowly: This relates to the previous point a bit. While some VC deals come together very quickly (those deals usually have massive traction), most evolve over a few months. If your business is not making huge progress over those months, then you likely will not get funded.

You lack that founder magic: This is by far the #1 killer. While it’s true that some of the biggest startup success (especially in direct to consumer companies) were run by 1st time founders, I’m pretty sure those founders had something special that made investors excited (or had traction). Mark Zuckerberg was a crazy developer (and had traction). Steve Jobs had an uncanny ability to place people inside his ‘reality distortion field’.

Whatever your magic skill is, it has to translate into a superior ability to build product, team or customer base. And if investors can’t see that, they will pass – always!

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  • microchap

    "You are a sole founder: " I never understand why this is so important to accelerator programs, this is SO dumb to me. I built a successful business and sold it and I was a sole founder.
    It was hard to find someone who was as passionate about the business and as hard working as I was. Why should i have to split the company with someone who I don't have a rapport with?

    Jeff Bezos, Pierre Omidyar and Craig Newmark were sole founders and they didnt need a co-founder. Thats what employees are for.

    • http://startupcfo.ca Mark MacLeod

      I'm not saying it can't be done solo. But VCs pattern match and have more data points than most. And that data clearly shows that co founders are on average more successful than solo founders. It's that simple

    • http://www.koegler.tw/module-tab.html Koegler

      Yes, Virgin, Ford, Volkswagen, Honda, Foxconn Hon Hai (the world biggest co by nber of employees 1 300 000 ;), BMW, Bosch, Grundig, Dell, the new and actual Apple from 1995 onwards ;) not the one previous who was nearly bankrupt, Porsche, Oracle, Walt Disney etc… no fundings as solo founders ;)

      • http://startupcfo.ca Mark MacLeod

        Apples and oranges. The fact is that venture backed businesses are artificially trying to create value in a very compressed period of time. This is what makes the success rate so low. Most of the examples that you cite don't fit that. Apple did raise venture capital btw

  • Brent

    In 20 years I have had 4 startups. One was a spectacular success, one a moderate success, one break-even and one broke me:)

    In none of these businesses did I seek outside capital. What I did do was focus on building a business each time.

    The best advice I would give to anyone starting a business is that the lifeblood of any business is cash flow. To have good cash flow requires having great customers.

    If you take care of cash flow you will have no problem with a good exit, if you want it.

    • http://startupcfo.ca Mark MacLeod

      Your advise applies to the vast majority of businesses. But there are some with breakout growth potential where it makes sense to sacrifice short term profits and fund the cash gap with VC$. Those are the opportunities that VCs look for.

  • http://twitter.com/scottannan @scottannan

    Great post and all really relevant. Realistically, though, in today's frothy market, traction trumps all. IMO, WAY too many startups are wasting cycles on raising when they should be focusing all their attention on growth and custom acquisition.

    Doesn't great traction minimize the other points significantly? Not to say they're not still important, but showing you can convert users, and exponentially so, the killer ingredient?

    I think startups should get minimum viable users and some kind of growth machine before looking to raise outside of friends and family (or accelerators / early stage programs). I love founders who invest time on growth instead of trying to convince everyone of how awesome they'll be in the future.

    Go get users, the money to grow will follow.

    • http://startupcfo.ca Mark MacLeod

      Traction makes up for a great many shortcomings. And too many startups come through our doors with none of it. I agree with your advice

    • http://www.koegler.tw/module-tab.html Koegler Bruno

      Again, you generalize to web/apps/mobile/software biz. and by this you eliminate all other biz needed to make stuff you use to communicate, move yourself, on what you are sitting, what you eat (machinery needed etc), solar tech and other green to sustain the planet you live, oh and all what you need for your health or to gi it you back when you are in need (apparatus, drugs etc)

      • http://startupcfo.ca Mark MacLeod

        Completely agree that there are a number of sectors where you cannot have traction pre funding. But the bar is frankly even higher to get funded in them. So, if you don't like my list which does apply mainly to software and web, you won't like the list for those either.

  • http://twitter.com/timberezny @timberezny

    You ask "Why would you outsource product development as a technology company?".

    There are more than a few simple answers to this:
    1. You don't have VC or early stage funding yet.
    2. The founders are domain experts first, and technology experts second. This is especially true of "tech companies" that are solving non-"tech" problems. (e.g., health care, education, commerce, etc…)
    3. You are competing on design.

    • http://startupcfo.ca Mark MacLeod

      1 is an excuse. You get started with a small team that you already know and who trusts you and your vision and is thus willing to work for little to no $ (for a period of time).

      2 and 3. If you are going to build anything that is of sufficient scale to be of interest to VCs sooner rather than later you will need a tech team, even for a seemingly simple service.

      • http://twitter.com/georgefavvas @georgefavvas

        #2 is an excuse as well. If you're a tech company, you should have at least 1 technical cofounder.

  • http://www.sitmybaby.com Roger Duncan

    Great post Mark, thanks for pulling this together. So…is there some reasonably generally applicable definition for traction, or is it one of those things that you know it when you see it? More specifically, what kind of traction are VCs looking for…is it absolute number of Users…rate of increase in the User base, engagement at a certain level, etc.? If we're self-funded, and can remain so for the indefinite future, but will need VC-level capital to scale, what can I use as a rule-of-thumb target that says 'Yeah, we can go out and pitch for a Series A and not waste everyone's time.'?

    Thanks, any feedback along these lines would be really appreciated.

    • http://startupcfo.ca Mark MacLeod

      It is a bit subjective unfortunately, but general signs of traction are:
      – all numbers moving up and to the right (no matter the size of those numbers)
      – Strong organic acquisition (vs. paid)
      – Steadily improving retention (users are sticking around, proving you have built something people want)
      – Emergence of a potential early segment: out of those initial users, enough of them come from 1 segment enabling you to focus your marketing efforts.

  • http://www.tabillo.com Sanjeev Arora

    Great post and many relevant points that we desperately needed a clear explanation on, thank you Mark.

    I do however find Outsourcing dev should not be seen as a negative point. In our early days some angels loved the idea of us outsourcing under a Senior architects' direction & staying lean, keep bootstrapping until traction. Why build an expensive team or get developers/UI/UX & give up shares when you can hire PHDs to build your product at $30 an hour in Russia. VCs expects to see the business was not spending too much money, so being able to manage a team in another country should be taken as a positive Team/Product Management skill.

    Also, would love to learn what is more important to a VC, a product with customers or a startup with 2 founders & just a great idea or MVP, as I am sure if a solo founder bootstrapped, won clients (in Government) & has traction then he/she is not just going to leave the company in the midst after raising funds (which is as hard as getting the product out of the door).
    Look forward to your comment, Thank you

    • http://startupcfo.ca Mark MacLeod

      From a VC (and from an acquirer's perspective) the early value is in the team. Over time that changes. But early exits tend to be a multiple per engineer. If you outsource dev, what is an acquirer buying?

      And as for what's more important. We want both! We want the solid founding team and the market validation.

      • http://www.tabillo.com Sanjeev Arora

        Understood, but that value is really in the founder, his vision & the product. Building a team, who doesn't get paid for 1-2 years is very hard. So if a startup is funded they mostly know how to build a team from their network.

        • http://startupcfo.ca Mark MacLeod

          Put yourself in the shoes of an acquirer? What would they want to have? A founder with a supplier or a full team?

          And yes, it does often mean you put together the initial team from your network and they get shares in the company

        • http://www.tabillo.com Sanjeev Arora

          Point well taken, thank you Mark,

  • http://twitter.com/marcducas @marcducas

    Mark,
    Excellent post, yet this should be known from the start by any serious tech entrepreneur….
    I'd add this one; most entrepreneurs I know can't articulate VC's how the business will actually make money, both from traction revenues and the Exit strategy. As an entrepreneur, one should be able to sell this argument in the pitch.
    I am right?

    • http://startupcfo.ca Mark MacLeod

      For sure, even if you have a scalable product or other items that VCs are looking for, if you cannot clearly communicate your vision and how you will create value, you won't get funded.

  • http://twitter.com/chrisarsenault @chrisarsenault

    Mark, your summary hits it on the nose. The only missing one that comes to mind right now when reading your post is to understand that: "An Idea is not a Product, and a Product is not a Company. Many great entrepreneurs I know have, on their minds, 5 to10 great ideas in all times… But the only idea that truly matters is the one you are willing to devote all your attention, time, ressources and passion to.

    And once you've launched your startup, go one step further, and identify that one main reason why you are successful 5 years down the road, then bring that one main reason back to today and focus your heart and soul on it. Make it happen by focusing on the things that matter."

    • http://startupcfo.ca Mark MacLeod

      Great addition Chris. Thanks!

    • Tim Burke

      Great points Chris – also highlights the issue that many founders are seeking capital too early (idea only)…ideas aren't fundable, businesses are.

      • http://startupcfo.ca Mark MacLeod

        exactly! Even for us as a seed fund at Real Ventures, very rarely do we fund before something is built

  • http://www.koegler.tw/module-tab.html Koegler Bruno

    Short but great posting, it helps me a lot as it's my killer problem to grow my venture, the lack of grow capital or loan as it's lamost only for working capital.
    I was optimistic while reading the 3 intro neeeded "features" to be able to be screened by VC and those 3 we are very easy with. The 10 following signs, fail on 2.5 ;), and I wish to defend them:
    – sole founder, hey, Steve Jobs was with Steve Woz, and they found a great Co, but it was Steve Jobs ALONE who rescued an Apple Co which probably wouldn't exist anymore, he was somewhat the sole grow founder who make this amazing co like we know it now. Also, what do you think about Michael Dell, he is somewhat #2 or #3 ww in the IT industry, not that bad, and it seems he mange his own assets and shares/wealth and was on this side more successfull as Steve Jobs. The actual BMW carnaker was not founded by Mr Kant, but bought nearly as a bankrupt SME and he grow it ALONE and luckely his 2 children continued his lifework.

    • http://www.koegler.tw/module-tab.html Koegler Bruno

      - traction: we have interested customers, they wait for the final product, and they plan to buy, but no proof hat those we know will buy, but the market is such huge, that we need less then 1 of 100000 (1 of ten thousand) to reach the break even point!
      More on my project ready to scale, but needs a bit fuel to take off, as it's manufacturing now, RandD finalized to 90%. A project overview is ready for pre-evaluation here : http://www.fb.com/notes/bruno-koegler/the-next-bi
      Thanks in advance for an eventual reading ;) and of course for advice or better referrals ;)
      Bruno Koegler / Taiwan 4koegler@gmail.com (and FB and LI …)
      Design, manufacturing and branding of e. g. high end tablet and All in One LCD PC TV (15"~26")

      • http://startupcfo.ca Mark MacLeod

        Interested customers = zero traction

        • http://www.koegler.tw/module-tab.html Koegler Bruno

          Ohhh, 2 from my 4 post get lost :(
          So you mean we have 0 traction because the customer don't buy a product we cannot sell him yet, as we don't have the tooling and working capital? We don't talk about a web/app/mobile start up, but a co who has physical prototypes ready, but need USD 5 M to produce the first 5 000 (problem of tooling, minimum of order of components etc) ? What would be your advice?

    • http://startupcfo.ca Mark MacLeod

      There are some great examples of companies with one founder, but as a rule, most successful startups have more than one founder. If I invest in a single founder and that person does not work out, I'm left with a company with no founders. That's a lot of risk for an investor.

      • http://www.koegler.tw/module-tab.html Koegler Bruno

        But you don't think that a bit a wrong problem, if it get funded, and can pay a minimum wage, it's easy to get some crazy peoples, but not if no wages, as only few peoples are ready to survive long time (in our case some years!) on savings and with low spending life ;)

        • http://startupcfo.ca Mark MacLeod

          All you're telling me are your problems. Why should an investor care about problems? You face the same chicken and egg problem of every company: you need money to build something that customers want. Hard to get funding for that. Time to find some rich friends and family. That is the best starting point for funding.

  • http://twitter.com/ponnappa @ponnappa

    I work at C42 Engineering in Bangalore, India which is bootstrapping RubyMonk while also building a premium Ruby/Rails consulting business.

    Many of our clients have said that they face the same problem with VCs that you've outlined in "You have outsourced development." What I fail to understand is: VCs seem to be ok with local contract staff/US consultancies, but not remote contract staff and consultancies – and this even though companies like SlideShare have successfully executed an onshore-offshore strategy. I understand that finding quality consultancies is tough – but that's true anywhere.

    If the founder is from a different country originally, then they understand that ecosystem well and can find the right partners in their countries of origin to get their product to a point where it makes sense to have full time engineering employees. In fact, they will want to set up a subsidiary there when this happens.

    TL;DR They're finding equivalent talent and at a substantially lower burn rate. But this still doesn't fly with VCs. What am I missing?

    • Archie

      Mark didn't make a distinction between offshore vs. onshore. Outsourcing is outsourcing. "All tech companies need to have lots of geeks." In the early days most of the value of the company is in the people.

      • http://startupcfo.ca Mark MacLeod

        Exactly!

    • http://startupcfo.ca Mark MacLeod

      Its not about onshore vs. offshore – its about not outsourcing key components of a business. If technology is core to your business you need permanent staff on it, not contractors. Whether those staff are in one or more locations is a separate matter

      • http://twitter.com/OyeSoni @OyeSoni

        What if a startup has one development office in India? So its not like hiring contractor but having your own office to reduce the cost!!