The normal probability of receiving funding from a VC meeting is between 1% and 10% – here is how to change that

Fundraising is one of the most difficult tasks for a founder. It often requires going against your instincts and avoiding common mistakes as much as following best practices. Rather than relying on traditional methods, it is the counterintuitive insights that will lead to greater learning, influence, and ultimately, the best founder-investor relationships and long-term success.

Fundraising is intentionally challenging. It serves as a filter for identifying exceptional ideas and founders. The statistics reveal the difficulty of fundraising. The probability of receiving funding from a VC meeting is between 1% and 10%. Less than half of companies raise a second round, and nearly half fail to raise funds in subsequent rounds. If it were simple, everyone would do it.

Fundraising, like many other skills, is not inherent and requires development. To succeed, you must practice and develop your fundraising skills. The fundraising process will consume a significant amount of your time, energy, and attention. You will make mistakes along the way. However, as a startup founder, you must master this strategic skill; otherwise, you may be unable to build a successful company. Mastery comes from rapid learning and seeing what others miss, which is why this guide was written.

How VC’s make money

To effectively negotiate with investors, it is crucial to understand their financial motivations. Venture capitalists (VCs) charge their investors, known as limited partners (LPs), an annual management fee of 2-2.5% on the invested capital. This fee covers the firm’s operating expenses, such as salaries and office space.

In addition to the management fee, VCs also receive a share of the profits, known as carried interest, from successful exits of their portfolio companies. This carried interest is typically 20% of the profits, but it can be slightly higher when returns are exceptionally strong. The carried interest is calculated after a hurdle rate, which is the minimum return that LPs must receive before VCs can share in the profits.

To achieve a successful outcome like a 3x return on a $100 million fund, VCs typically expect a portfolio of 10 investments to produce 1-2 “home runs” with exceptional returns, 3-4 investments with modest positive returns, and 4-5 investments that result in no return.

What drives investors?

Investors are primarily driven by three psychological factors:

  • Fear of Missing Out (FOMO): Investors constantly worry about missing out on a company that becomes a success or failing to participate in a deal that their competitors secured. This is a significant psychological motivator, both for financial reasons (missing out on the big hit means losing the opportunity for outsized returns) and due to the competitive nature of venture capital. Consider an investor who passed on investing in Facebook or Tesla early on.
  • Fear of Looking Stupid (FOLS): Investors avoid making investments that might make them appear foolish in the eyes of their peers. This is particularly challenging for less established VCs, as investing in risky companies or unfashionable sectors can damage their reputation if the company fails. Investing in such opportunities typically requires a strong conviction or a well-established reputation.
  • Venture capitalists (VCs) are strongly motivated to minimize risk when evaluating investment opportunities. They seek investments that offer a compelling combination of low risk and high return. Ideally, they want to secure deals that have the potential for significant returns but are priced as if they were highly risky. To achieve this, VCs conduct thorough due diligence, seeking input from various sources to gain confidence in the deal’s potential and reduce their perceived risk.

Angel investors

Apart from venture capitalists (VCs), angel investors represent another significant source of funding, particularly for startups in their earliest stages of development (seed or pre-seed).

Angel investors can be a valuable option, either as standalone investors or as part of a VC round. The most experienced and well-connected angel investors can significantly contribute to a company’s success. While they share similarities with VCs, there are key distinctions: angel investors typically invest smaller amounts and may be more open to businesses with more modest total addressable markets (TAMs) as they are not bound by the same return expectations or hurdle rates as VCs. However, don’t underestimate their influence – we have seen that many angel investors hold considerable sway and possess extensive networks.

Therefore, we approach angel investors before VCs, as they may be more approachable, have a simpler decision-making process, and require convincing only one individual rather than an entire partnership. While angel investors, like VCs, can change their minds without clear reasons, having a reputable angel investor commit to your funding round can significantly enhance your credibility with VCs.

How to pitch

We often see entrepreneurs listing the features and functions of their product or service. Remember that, when it comes to pitching, you are ‘selling’ your company as a whole.

  • Ground your statements in data: Use specific numbers and metrics to support your claims rather than relying on vague generalizations.
  • Energize your presentation: Engage your audience with an energetic and dynamic delivery. Move around the room, utilize visuals, and leverage tools like whiteboards or slide presentations to enhance your message. Adapt your approach for remote pitches as needed.
  • Visualize your message: Employ diagrams and visual aids to effectively communicate complex ideas and increase the information density of your pitch.
  • Prepare investors beforehand: Share your Company Brief and relevant materials in advance to ensure meetings focus on addressing specific concerns and interests rather than rehashing basics.
  • Demonstrate passion: Don’t just talk about your passion for the business; let it shine through your presentation. Convey your determination and drive to succeed.
  • Dress professionally: Maintain a professional appearance, even in virtual settings, to convey your seriousness and commitment.
  • Choose your team wisely: Only include team members who are strong presenters and have a defined role in the pitch.
  • Prioritize discussion: Allocate a larger portion of the meeting time for questions and discussions rather than solely focusing on your presentation. Prepare a list of questions for investors and have backup slides ready to address inquiries promptly and thoroughly.

How to respond to VC’s questions

Below, we list some effective responses for our clients regarding common VC negotiation tactics.

Asking you to name the price

  • VC’s tactic: Requesting founders to set the price.
  • Your response: Politely defer setting a price and let the market determine it. Ask SCCN to provide you with an independent valuation.

Lowballing upfront

  • VC’s tactic: Offering a low initial valuation.
  • Your response: Acknowledge the offer, express your concern about the low valuation, and slow down the process. Leverage other VC interest to negotiate a better valuation.

Being nice, then lowballing later

  • VC’s tactic: Offering a lowball offer after a friendly meeting.
  • Your response: Separate friendliness from valuation. Express appreciation for the meeting but firmly address the low valuation.

A conditional “yes”

  • VC’s tactic: Committing to invest but with contingencies.
  • Your response: Recognize it as a tentative “maybe” and prioritize investors who commit without contingencies.

Asking you to talk to a portfolio company

  • VC’s tactic: Requesting a meeting with a portfolio company in the same space.
  • Your response: If the company poses a competitive threat, politely decline and suggest alternative experts. If not, use the opportunity to assess the VC’s working relationship with their portfolio companies.

An offer with a short deadline

  • VC’s tactic: Presenting a term sheet with a very short deadline.
  • Your response: Push back on unreasonable deadlines and seek additional offers to strengthen your negotiation position. Consider if such aggressive behaviour aligns with your long-term partnership goals.

Source: NFX