5 Reasons VC's Reject Startups

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Five Main Reasons VC's Reject Startups

When embarking on the journey of raising capital, you might expect to encounter multiple rejections from Investors, Angels and others - it's not an easy process.

Looking at our internal data alone, we see over 3,000 startups a year, taking meetings with over 750 founders and ultimately investing in around 15 companies a year. Due to this, we have to turn down a lot of great opportunities. The selection process for investors is tough and rigorous, given that VC's invest other peoples (their LPs') capital. If an investor decides not to invest in your company, don't be disheartened - you don't need a VC to validate your business and you may not need their money. Some of the most successful companies in the world were founded without any external funding.

In our efforts to be transparent as possible, we thought we would share some of the reason we decline startups. Before we dive into these reasons, it is worth mentioning that if you haven't given much thought to the investor you're reaching out to and whether or not they invest your type/stage of company... don't expect a response. It is better to focus on finding funds or investors who are active in your space instead of wasting your own time filling out numerous application forms on websites. Most funds have investment criteria on their websites.

Below are the 5 most common reasons we decline start-ups:

1. "Lack of Founder-Market Fit"

As an earlier stage fund, a lot of our time in the selection process is spent on understanding the founders and their motivations to launch a business. There are no two ways about it; building a company is hard, and an icon, industry-defining business harder still. No startup, including Amazon, Stripe, Twitter, Airbnb etc. has had a straight-forward journey and each of them will have reached life-threatening moments for their businesses along the way. What is important above all else is for us to see those founders have either a deep obsession with a problem (that they have most likely experienced themselves) or a group of customers/users (with who they understand well).

Elon Musk said it best:

Ultimately the journey is going to be life-defining and will hopefully take up most of your waking energy over the 5-10 years. If you need encouragement or aren't sure what problem to solve, then maybe you need to keep on looking.

2. "Size of Ambitions"

Not every start-up is a fit for venture capital funding. VC funds generally will target outlier returns, 10, 20, 200 and even 1000x multiples (such as those seen by early Uber investors). The growth prospects of some start-ups and the total addressable market they tend to go after is sometimes too small to ultimately return a fund. Now as a founder, this type of feedback might discourage you. It shouldn't. You have to remember that as an investor, we consider our investments very differently to your business. Investors are minority shareholders. Particularly at the seed stage, we are lucky to see our portfolio get to series A, B and so on. As this process happens, shares get diluted, positions get smaller and ultimately if you are of the very few that become a unicorn, a VC is lucky to be owning near 5% of that. 5% is only £50m of that £1bn valuation. Whilst this is a remarkable outcome for all parties involved. It is likely only returning a fund one times over, and VC's are targeting around 3x+. Hence, an investors mindset is sometimes different to that of a founders, as they must consider a portfolio of investments. Whilst you might be building a multi-million dollar business that will make you, the founder, very well off, it might not be a great fit for a VC... and that is okay.

3. "There's too much competition in the space"

At RLC, we don't like providing this as a reason for passing, as typically every start-up has an angle that will make it slightly unique or differentiated, even in a crowded market. Some products entering highly competitive markets have gone to gain significant market share in the past (see Zoom), although when seeing a lot of the same startups targeting the exact same problem for us, it becomes a matter of who and what as opposed to how and why. These overly-saturated markets aren't impenetrable, but it's either unclear who a winner may be or too tough a market to sell to, having seen many attempt it in the past. Metrics speak louder than words and going to an investor meeting with metrics and tangible evidence that what you are doing is working will ease fears of competition.

4. "Needs more traction"

Each VC has a particular investment strategy they follow, so the "we need to see more traction" response could mean different things depending on whom you're talking to. If you're an MVP or early revenue company reaching out to a growth-stage VC, you will likely be told to come back later with more traction. Likewise, if you are at the idea stage, you might be a little too early for most early-stage investors (Seed to Series A). The key here is to ensure your stage of growth and traction to-date matches the investment strategy of the VCs you are talking to, which you should be able to find on their website.

Here at RLC, we back early-stage founders. Although we typically look for companies with an MVP or some degree of commercial traction first. If this matches your profile, please feel free to reach out to us and apply for funding!

5. "We have a competing portfolio company"

As Marc Andreessen once said, startups and VC are a game of outliers. As such, VCs devote considerable resources to support their portfolio companies post-investment to ensure they have the greatest chance of success. So once a VC has invested in a startup within a particular space, it is unlikely they will invest in any similar startups without substantial differentiation as the success of one might destroy the probability of success for the other (see Sequoia giving away $21m over this issue). So before you reach out to a VC, ensure that you've taken a look through their portfolio to check whether they have already invested in a similar company to yours.

How to respond to a VC Rejection

Like most other areas in life, rejections are a part of the process - but there are a few key things you can do to maximise your chances of success following a rejection:

  1. Ask for feedback: in most cases, VCs will be happy to provide you with feedback regarding why they had to pass up on an opportunity to invest, so ensure you ask them for feedback. This can help you fix any potential flaws in your pitch or business model that will help you on the rest of your fundraising journey.
  2. Don't burn bridges: It might be worth keeping in contact with some of the VCs you talk to post-rejection, especially in the case where rejection has been made because of a mismatch in the funding stage or stage of traction. These investors could be useful in your future fundraising plans.
  3. Alternative sources of funding: It's important to remember that VC isn't the only form of financing for your company. From crowdfunding and self-funding to approaching venture builders and accelerators, there are a variety of excellent funding choices for founders to consider. We recommend reading our piece on alternative startup funding choices if you're eager to find out more.
  4. Don't raise yet: We see a lot of founders who are eager to raise capital in order to kickstart their businesses. Whilst the injection of capital can speed things up, your business is much better of once you've gone out to customers and validated some form of demand. Learning from your customers early on will position you to use the capital you do inject into the business effectively and efficiently.

If you're now keen to find out which early-stage VCs align with your goals, industry, and stage of development, feel free to check out our 2021 UK Startup Funding Guide, which contains all the information you need on the key players within the UK Early-stage Ecosystem.