Which VC firm should I pitch?

A friend asked me the other day “Which VC firms should I pitch?” and I started to respond to him, but then realized that most of my knowledge of VC firms is already available online in the Which VC firm should I pitch? Hunch decision topic. That is the idea behind Hunch: to crowdsource the creation of decision trees, so that a group of knowledgeable people can get together and create a “virtual expert” that can be accessed by anyone.

Here is the VC chooser topic in embedded widget form (anything you create on Hunch can be embedded anywhere):

Which VC firm should I pitch? – make thousands more decisions on Hunch.com

Like everything on Hunch, this topic is completely user generated (“topic” is our word for what some people would call a “decision tree”). Users have full control over the questions it asks, the results (in this case VC firms), the descriptions, and a lot of more advanced functionality for “sculpting” the decision tree. If you go to the VC topic’s About page you can see that so far 7 people have contributed 86 firms and 5 questions to this topic (other topics have a much wider range of contributers, this one for example). The VC topic has been played (used by non contributors) 506 times, many of those users coming in via Google organic results for phrases related to pitching VC firms.

In addition, the results are all “trained” to be associated with responses to questions – meaning users have taught Hunch what to “believe” about each of the firms. For example, in red is what Hunch believes about Union Square Ventures:

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Users who find mistakes can just click and fix them, similar to how you fix things on Wikipedia.

So if you see anything missing or that you’d like to change, feel free to do so. I was one main people who worked on this particular topic so it is biased toward my tastes (e.g. Hunch’s own VCs – Bessemer and General Catalyst – rank extremely high).

If you don’t like Hunch’s Q&A process you can jump directly to the See All page, and then using the filters on the left to drill down.

If you are not logged into Hunch, the VC firms you see will be ranked by their popularity amongst all Hunch users. Hunch personalizes the rankings specifically for you if you create an account and answer what we call “Teach Hunch About You” questions. For example, when I am logged in and go to the Hunch page for Bessemer I see this on the right sidebar:
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Meaning that Hunch has learned to statistically correlate the questions I’ve answered about myself with liking Bessemer. At this point Hunch has statistically significant data (over 40M user feedbacks total) in most of our ~5000 topics so it usually works really well.

Information is the (other) currency of venture capital

Many seasoned entrepreneurs have had the following experience.  A VC eagerly wants to meet with you.  You have what seems like a very good meeting, and yet the VC’s excitement level drops noticeably in follow up conversations. Then he says “No” in VC language.  What just happened?

The answer is that besides cold hard cash the other currency in venture capital is information.  A VC will meet with pretty much anyone they deem “serious” in order to gather more information, which they can then use to discover interesting investments, do better diligence on potential investments, impress entrepreneurs and other VCs with their knowledge, gossip with other VCs about recent deals and trends, and give seemingly informed advice to their portfolio companies.

I’m not saying VCs are trying to take your trade secrets and give them to competitors.  The vast majority of VCs would never do this.  Instead, they are after much more general, innocuous information, like the rough valuations of recent financings, what companies and markets are “hot,” what products are getting popular, what marketing tactics are proving successful, and so on.

Imagine you were a professional sports bettor but none of the existing information sources – Internet, TV, etc – existed.   The only way you could get information was by talking to people who actually saw the sporting events live. This is kind of what it’s like to work in venture and why VCs are so desperate for information.  There is very little publicly written about what’s really going behind this scenes. Occasionally juicy tidbits will come out on blogs like TechCrunch, and some moderately useful stuff appears daily in peHUB and other VC newswires – but crucially missing are the valuations, cap tables, competitive offers, companies’ performance, and pretty much everything else people really want to know.

In the way they cross-polinate information, VCs play a role with startups similar to what consulting firms like McKinsey play in the Fortune 1000 world.  They spread best practices around from one firm to another, in the end, on average, making everyone more efficient and informed, while also reducing informational advantages

My advice to entrepreneurs is not to run and hide.  Instead, you need to learn to play the game.  Meet with as many VCs as you can.  They are great sources of high level information.  Such and such assets are cheap right now.   Startups are having success with a such and such marketing channel.  A certain venture firm is eager to deals in your space.  Staying in the information flow is one of the main reasons many serial entrepreneurs angel invest on the side.

Just go to these meetings with the proper expectations – the VC’s eagerness probably has more to do with gathering information than investing in your company.

VC’s care about the upside case, not the mean

The biggest mistake entrepreneurs make when pitching VCs is to argue that their startup is likely to succeed.  Instead, they should argue that there is a small probability their startup could be a billion dollar or greater exit.  There is a big difference between these arguments – the mean of the return distributions might be the same but what VCs care about is right side tail of the distribution.

Investor sentiment, the old saying goes, is a horse race between fear and greed.  The fear and greed in venture capital is all about investing in or missing out on the next Google.  No VC stays up at night worrying about missing the next startup that’s flipped to Google.  The way you get VCs interested is to convince them there’s a small but non-negligible chance you’ll create a billion dollar (valuation) business.

I’ve learned this lesson first hand on both sides of the table.  One example:  A good friend of mine was starting a company a few years ago.  I was excited about the idea and tried to help him raise venture money.  After the entrepreneur pitched some VC friends of mine, I was surprised when the they came back to me to say they are passing because “it seems like a smallish, ‘lifestyle’ business.”

The entrepreneur had made a very good pitch for why his product was valuable, why he could create a profitable business, that he was very smart and well prepared, and so on.   What he needed but failed to do was leave the VC with the nagging thought that this could be the “the next big thing.” Part of this was because of the entrepreneur’s natural modesty.  Some people don’t have the chutzpah to aggressively assert that their idea is the next big thing, even when, deep down, they truly believe it.  In everyday life, this kind of modesty is a virtue. When pitching VC’s, it is the single worst thing you can do.  (If deep down, you don’t believe your idea will be the next big thing – don’t raise VC money.  Once you raise VC you are committed to going for the billion dollar exit whether you like it or not.)

I don’t know if this obsession with the upside outlier case is a good strategy from the VC’s perspective or not.  Granular VC return data is hard to come by.  I tend to think it is a good strategy – one Google or Facebook (and a lot of other billion dollar exits that aren’t nearly as famous) can make up for a ton of misfires.  And the anecdotal return numbers I’ve heard from VCs suggests it works.   But I don’t really know.

Pitching the VC partnership

The last step to raising venture capital is normally a 1 hour pitch to the whole partnership during their weekly monday meeting.  This is often described to entrepreneurs as a formality, but at least in my experience, for early stage deals, I would say there is probably a 25% chance of you getting a term sheet afterwards and a 75% chance of you getting rejected (although it will rarely come in the form of an actual “no”) .

The reason the odds of you getting dinged are that high are:

1) In most VC firms all it takes is one partner to say “This is really stupid – I hate it” to kill a deal.

2) Although by the time you pitch, the lead partner has probably told the other partners about you and probably sent around a memo, the non-lead partners probably didn’t pay attention, and only really do when you are presenting.

Good VCs have a much lower post-partnership ding ratio, because they work hard to socialize a deal and really get their partners to focus on it before asking the entrepreneur to present.   For example, I used to work for Rob Stavis at Bessemer and he had a much lower post-meeting ding rate.  This was because he spent a lot of time talking to his partners beforehand (“socializing the deal”), and if they had good objections he got them early on.  (Ps. Hopefully the VC will work extra hard to pre-sell the deal if they ask the entrepreneur to drop everything and fly across the country.)

The very worst thing that can happen in a partnership meeting is what I call the “partner ambush.”  Basically this is when the partner who brought you in (the “lead” partner), who you’ve met with for many hours and fully understands your company and is excited about investing in it, realizes midway through the meeting things are going badly and decides to try to save face by turning on the entrepreneur.

I had this happen to me when I was raising money for my last startup, SiteAdvisor.   Basically what happened is me and my co-founder Tom Pinckney walked into this big, well known VC firm at 4pm to a room of very tired looking guys (yes, they are all male) who had been hearing back-to-back pitches all day (side note:  always try to present in the morning).  No one introduced themselves or said hello, which was a bit unnerving.   The first questions were clearly hostile to the very idea of a consumer security startups (for a bunch of bad reasons, most VCs vastly prefer enterprise to consumer security – especially on the east coast and back in 2005).   One of them literally laughed at the idea of marketing via search engines (this is the east coast – believe it or not many VCs our here still don’t know what (white hat) SEO is and how important it can be).   Then the partner who brought me in said “Well, Chris, why not make SiteAdvisor into an enterprise product” basically turning on me and the whole concept of the company.  Things went downward from there.  To add insult and injury, the lead partner never even bothered to call me to ding me afterwards – in fact I haven’t heard from him to this day.

In retrospect, that would have actually have been a very good investment for the VC if they had actually given our pitch a fair hearing.  Which gets me to my final point:  I think VCs are making a mistake by putting so much emphasis on the partnership pitch.  There is some positive correlation between presenting to a room full of (sometimes hostile) VCs and building a successful startup, but not a very high one.

Besides missing good investments, the emphasis on the partner pitch leads VCs to invest in bad companies.  An investor friend of mine was recently talking about a failed startup he invested in:

Toward the end of the company, when things were going very badly, I went in and spent a day sitting with the entrepreneur and watching him work.  At that point I realized his one skill in life was pitching investors.  He had no idea how to manage people, build a product, get stuff done, etc.

The current early-stage VC process is optimized to favor people who are good at pitching partnerships, not necessarily people good at creating successful startups.