Two Worlds of Venture by Geri Kirilova

Over the weekend, I tweeted offhand about my frustration with the buzz around early stage venture rounds these days: there’s so much discussion of companies raising lots of money very quickly, when my observed reality from speaking with dozens of seed & pre-seed founders per week is the exact opposite:

This observation struck a nerve, both publicly and privately. Aside from sharing that they felt seen, lots of founders also reached out to me to ask why this is happening, so I thought I’d share some thoughts on the topic.

The notion that some founders raise money more easily than others is not a new phenomenon in and of itself. Fundamentally, if you are not able to close an investor (whether they’re an institutional fund or an individual angel investor) there is only one reason: they don’t trust you yet, and they don’t believe that you will build a venture-scale company. This is the objection that you have to overcome.

So, how do investors build trust & belief? At later stages (e.g. growth equity), investors typically have somewhat objective criteria and some amount of data to leverage such as revenue, growth rates, cohort retention, customer references, etc. They have some evidence that you have, at least in part, achieved what you had set out to achieve earlier in the life cycle of the business (though there’s probably a fair amount of voodoo and vibes at play here, too).

At the early stages (pre-seed, seed, and in some cases, Series A), I’m afraid most people will not like this answer: given the lack of data on the business itself, investors place an extremely heavy emphasis on the founder & the story they’re telling.

*deep breath*

I know this is frustrating to many people, in part because it is so subjective and unspecific. How do investors determine if they “trust” and “believe” the “founder” and the “story”?

Your mileage may vary depending on the investor, but here are my observations on what venture investors frequently prioritize in making these judgments, in order of importance:

1. Personal familiarity, or first-degree connections: investing in founders they already personally know through some prior experience. Maybe they backed the founder’s previous company, worked together at a previous job, or went to college together, but through something, they already have a high level of trust. (Unsurprisingly, when companies raise big rounds out of the gate, this is often the case.)

2. References/vouching/warm introductions, or second-degree connections: investing in founders whom someone they trust already trusts. Maybe a close co-investor at a different firm backed this founder’s previous company; or maybe the founder was an employee at a company that the investor has already backed, and the co-founder/CEO has provided a glowing recommendation (and possibly has invested in this new company themself!). Absent first-degree connection, trust by association goes a long way.

3. Signaling, or prestigious heuristics: This is sort of analogous to “Nobody gets fired for choosing IBM”; in venture, as far as I know, no one has gotten fired for choosing a YC, Stanford, or ex-unicorn founder.

4. Credibility: Failing the above, investors will seek comfort in a convincing narrative and some form of “traction”. VCs seek alignment between the founder’s story and their own upside expectations (could this be a billion dollar business?), as well as a clear articulation of the path to building such a business within existing (and future) industry dynamics (how do you get there?). In conjunction with a clear vision, investors search for early proof points, which could be undeniable user/revenue growth, referenceable customers, formal recognition of the founder as an industry leader, or more. But there’s got to be something that, in the eyes of the investor, makes this founder’s story, vision, and momentum stand out above the rest.

At the risk of beating a dead horse, I can’t help highlighting that the heavy reliance on 1-3 above is a major driving factor for the homogeneity of VC-backed startup founders, given that historically, prominent elite institutions skew demographically toward those who are white, male, and wealthy. If you’ve ever heard the saying that underrepresented founders have to be twice as good to get half as much, this is why: without the advantage of circumstantial privilege & long-standing personal relationships, undeniable performance (#4) is often their only way to get investors over the trust & belief hurdles.

(Slight aside: You might be thinking, aren’t VCs supposed to be risk-takers? And who’s to say that funding ex-Ivy League, ex-unicorn founders will even result in good returns?!? Not to defend VCs’ reliance on elitism, but this is as good a time as any for a reminder that VCs are fiduciaries managing other people’s money. They have convinced numerous people & institutions to entrust them with a pool of capital to deploy into an undetermined portfolio of high-risk companies. So at minimum, VCs generally need some amount of plausible deniability that they’re not recklessly flinging cash … even though the more we go down this rabbit hole, the less that sounds like a bad idea … )

Alas, back to reality. This is the current state of venture investing. If you are a founder who is not already buddies with tons of GPs or an obvious fit for VCs’ “pattern matching”, what do you do?

• First, consider whether raising venture capital is even the right move for your business. This is a topic for an entirely separate post, but really think about whether capital is the gating factor to your business’ growth and whether acceleration is critical to the ultimate success of your business. If money is not the bottleneck and time is not of the essence, there are likely better uses of your time than fundraising.

• If you are convinced that raising venture capital is the right path for your company, you will likely need to rely on self-funding and non-VC funding to get to certain milestones (the credibility piece mentioned above) before you can raise from venture funds. (How do I raise an angel round if I don’t know anyone who can write a $25k check? Great question, and a topic for another blog.)

• Plan to meet people early, whether they’re angels, advisors, or VC funds, with the intention of building relationships with them over time, so that you can establish mutual trust. Mark Suster wrote about investing in “lines, not dots” a decade ago; this framework remains true today. If you do this well, over time, you end up with the coveted personal familiarity that investors value so strongly, and you will be in a strong position to then run a tight fundraising process. (For reference, at Laconia, I could not tell you offhand where most of our founders went to college, but I can confirm that we got to know most of them over 6+ months prior to writing a check. Sometimes, there are no shortcuts, and thoughtful, long-term relationship-building can be the most powerful lever to bridging network gaps.)

• As you meet with investors, be sure to ask what concerns they have or what gives them pause about your company. Take each individual answer with a grain of salt, and try to spot recurring feedback to refine your pitch over time.

• Fiercely protect your time and trust your instincts. In your research and early conversations, qualify investors and ensure that they are a relevant fit for your business at all based on their investment strategy, fund size, and check size. Separately, some investors, for whatever reason, will be insurmountably biased against you or your business. They may be implicitly or explicitly sexist, racist, xenophobic, otherwise discriminatory, or just flat-out allergic to the sector you’re operating in. The best thing you can do in this situation is trust your gut and waste as little time as possible with them. Your time is better spent finding the people who are real prospects for you than convincing the ones who aren’t.

But Geri, isn’t there so much more capital out there now than there was before? I keep hearing that capital is cheaper than ever, yields are low, funds are huge, and money needs a place to go, so shouldn’t it be easier to raise now? 

This line of logic is conflating multiple things. Yes, there is more venture capital to be deployed, but the distribution of this capital is by no means evenly distributed. All the data I’ve seen shows that at a fund level, this capital is disproportionately concentrated in a relatively small number of very large funds, which does not bode well for founders who are raising their earliest rounds and/or not well connected within the relatively insular ecosystem benefiting most from this boon. The fact that an “in network” founder who could easily raise $1M pre-product ten years ago could probably raise $10M pre-product now thanks to the influx of new capital does not necessarily mean that an “out of network” founder who struggled to raise $500K ten years ago would have any easier of a time now. If anything, the widening of the barbell makes it even harder, as “in network” competitors consolidate war chests faster than ever before. This acceleration does not mean the first-movers will ultimately win, but it can certainly make underdogs’ early fundraising efforts harder in the meantime.

Of course, there is only so much that founders can do to overcome these structural barriers. I recognize that many investors, especially those writing bigger checks, do not necessarily have a goal of identifying opportunities that don’t fit the typical mold at the earlier stages, rather than “chasing hot deals”. But for those who do have this goal, the onus is on us to change our processes:

• Prioritize proactively meeting founders outside of our immediate networks. At Laconia, we evaluate all cold inbound pitches and have been doing open office hours every week for 3+ years, through which we’ve met hundreds of founders whom we’d likely never have encountered otherwise; 10/10 recommend this, I hear it’s even trendy now!

• Push for more objective decision-making/benchmarking. Are you applying your investment criteria uniformly? Are you evaluating founders from different backgrounds in comparable ways, while still being mindful of potential differences in context and culture?

• The early stage venture industry needs more people, with more diverse backgrounds, to play a role in spotting and supporting true outliers. How can we create more seats at the table beyond the constraints of traditional VC job structures, which are limited in both number and scope?

Ultimately, the data will show if we’re making any meaningful progress. If 2020 was any indication, in times of uncertainty, VCs double down on their existing networks rather than expanding their reach (e.g. here and here). We have 9 months left in 2021 to move forward instead.

If you’re still with me, thanks for reading! As always, I’m at [email protected] and geri_kirilova on the dreaded bird site.