If you know anything about venture capital investing, you probably know that most plans that come across the desks of venture capitalists (and angels, for that matter) are not fundable. That is, they are of so little merit that no half-way competent investor would back them at any price.
While lots of plans get rejected because they are frankly bad, in my own experience as an entrepreneur, angel and institutional venture capitalist I have been struck by how many fundable deals get turned down by so many competent investors. (If you don’t believe me checkout http://www.bvp.com/portfolio/antiportfolio, where Bessemer Ventures reviews some of the ultimately hugely successful deals that they turned down over the years.) Herewith some of the reasons good venture investors turn down good deals.
Fundable deals are often turned down because a fund is out of dry powder, defined as fund capital not already invested in, or set aside for, current portfolio companies. The “set aside for” phrase here is the one that sometimes confounds entrepreneurs. When a (competent) venture investor puts say $X into a startup the investor almost certainly makes a mental note to reserve another dose of capital for future investment in the company. That number, let’s call it $Y, can vary from deal to deal, and over time as a particular portfolio company, and the fund’s portfolio, evolves. That said, a good rough assumption is that if a fund has actually invested 50% of the capital in its active portfolio companies the fund is likely “fully invested” and thus does not have any dry powder available to commit to a new deal, like yours.
(Why, you might ask, would a fund bother talking to an entrepreneur if the fund doesn’t have any dry powder available to do the deal in any event? First and foremost, because venture investors want to stay current on market conditions and deal flow wherever they are in terms of their own investing cycle. In terms of managing their current portfolio investments, keeping up with emerging competitive trends is, of course, useful as well. And in terms of thinking about raising their next fund, staying current is critical to their own fund raising pitch.)
Funds also commonly turn down a fundable deal because it doesn’t fit with the fund’s investment strategy or theme. Most fundable deals that are out of the comfort zone of a fund – say a biotech deal getting turned down by a fund that focuses on the IT space – get turned down without a time-wasting reading of the plan, much less a meeting. Now and then, however, it takes a fairly close look to see that a deal doesn’t quite hit a fund’s sweet spot.
Which leads to two other reasons fundable deals get turned down. First, a benign and quite common one. No one at the firm, after reading the plan and taking a meeting, is excited enough to do any more work. I am an investment adviser to a small angel fund, and a couple weeks back we looked at a pretty well put together plan for a business that was clearly in our sweet spot. Alas, while we liked the entrepreneur, and the plan was technically pretty solid, no one on the investment team was really excited about the deal. At a gut level, no one “got it.” That may not seem like a very good reason to turn a deal down (“yeah, well, I can’t really say why, but it just doesn’t excite us”), but it happens all the time. Good investors won’t do a deal just because they like it at a gut level, but they almost never do a deal that they don’t like at that level.
Next, something for the conspiracy theorists in the audience. Most venture investors that I have known, even many of those wearing more or less white hats, will happily spend some time with an entrepreneur who passes the blush test and also looks like a real or possible competitor of one of their portfolio companies. Most won’t try too hard to solicit information they shouldn’t, but neither will they tell a talkative entrepreneur to keep quiet. If that seems unfair, well, no one ever said life – or high impact entrepreneurship – is always fair. (If this makes you think you should get an NDA before you have a first meeting with a venture investor…., think again. For some good, bad and indifferent reasons, VCs don’t sign NDAs.)
Perhaps the “best” reason a fundable deal gets turned down, if also maybe the most frustrating for the entrepreneur, is the “really good deal … but we can only do so many deals and, well, we have another one we like just a little bit more” turn down. The fact is, even funds flush with cash can only do a limited number of deals. Both capital and people resources are finite, and the better the quality of a fund’s deal flow, the more good deals they turn down.
Finally, your deal might be one of those that get turned down because the venture investor in question just plain made a mistake. As, for example, Benchmark turned down PayPal.
So the next time your presumably fundable deal gets turned down, you can take some solace in the notion that most fundable deals get turned down. Indeed, unless you have a solid track record making money for venture investors before, you should plan on a lot of turn downs before someone recognizes yours as a deal that they just have to do.