Real Talk from Real Investors: Why You’re Too Early
Goldilocks and Venture Capitalists send the same messages.
What does “too early” mean to investors?
One of the most frustrating parts of the fundraising process is hearing that your company is “too early” and not understanding why. Hearing that you’re too early tends to sit differently than a simple “no” because it implies that you might have a chance if you make a few changes. Unfortunately, being “too early” creates more questions than answers for founders.
What does “too early” mean for this investor? Is it the same for everyone?
How do I fix whatever the problem is?
How much do I need to build for these investors to be satisfied?
How do I keep building without the funding to do so?
We talked to a few investors to understand their perspectives on this matter. But before we dive into their feedback, we want to provide a bit of high-level insight into the VC industry underpinnings that create a bit of context around investment decisions.
VCs have stakeholders.
First and foremost, venture capital is a career. While investors pursue this path for many different reasons, VCs want to be successful in their line of work, just like founders and small business owners. While this may seem obvious when spelled out, it gets a bit harder to remember with each “no” that a founder receives. Founders and investors share similar professional goals: growing their business, meeting the needs of their stakeholders, and hopefully earning a living along the way. A job is a job when all is said and done.
With that in mind, let’s talk about stakeholders. While some funds or family offices are created entirely from an individual’s wealth, most VCs receive their funding from various limited partners (LPs). LPs are investors in your investor, and as such, they expect to receive a return on their investments. This relationship is not dissimilar from the one you then have with your investors. LPs are to VCs what VCs are to founders: capital providers, advisors, and ultimately, stakeholders expecting to make a profit from the deal. When expectations aren’t met, it becomes challenging to continue a professional relationship, obtain more funding in the future, and make any personal profit along the way (this is a business, remember?).
A second aspect of VC funding that founders need to understand is the industry’s definition of “return on investment” (ROI). A VC’s ROI expectations differ from those of a founder, who invests more time than money at the early stages. While the figures may change with each fund, there is a general rule of thumb that VCs expect a 10X ROI on each investment. The reason we mentioned that (1) VCs want to be successful in their careers and (2) they are responsible for repaying their stakeholders is that not much of 10X ROI goes into the pocket of your VCs.
Let’s break that down.
A standard arrangement between VCs and LPs is that VCs get to keep 20% of the profits if the LPs’ investments are returned (this is also known as 20% carry). The LPs keep the other 80% of the profits and get their money back. Angelist has a straightforward breakdown of this, shown below for a sole LP that invests $1M into a fund with $3M in returns:
The LP gets $1M (initial investment) + 80% x $2M (profit) = $2.6M
The VC gets 20% * $2M (profit) = $400k
We highlight this breakdown to show some of the rationales behind why VCs are so selective with their portfolio companies and investments. They are on the hook for much more than what they actually make, just like most founders.
A Thought Experiment
A close friend gives you $100,000 to invest in a single company, and you have five years to return the investment with additional profit. In the arrangement, you have 20% carry to (hopefully) make something for your efforts. Here are the companies that have pitched to you.
GnarlyCoin: A brand new cryptocurrency that, in pristine market conditions, could provide a 20X return on your investment
Solana: A versatile and widely adopted mid-tier coin that still shows moderate subjectivity to market trends
Stellar: A stable and heavily adopted coin with a slow yet predictable return pattern
It’s easy to see which investment option would be the savviest and which would be the most “fun.” A 20X return is enticing, but with high reward comes a major risk profile. Are you willing to gamble knowing what is on the line?
GnarlyCoin represents a pre-seed, pre-revenue company with great potential and a high-risk profile. Solana is a Series A company, and it has been around for a while; however, we’re still learning about its staying power. Stellar represents a Series C company; we know it works. The returns are predictable, but they likely won’t be quick.
While the examples above are overly simplified, they demonstrate some of the care that goes into every investment decision a VC makes. While some investors are more comfortable with riskier ventures, they are still responsible for the agreements made with their stakeholders. Companies that are “pre-seed” are the riskiest investments, causing even the most adventurous investor to be highly selective. At the early stage, your company is a lot like GnarlyCoin. While you may firmly believe that the product will yield substantial returns, your investor has to place a bet on whether or not the company will thrive. And nobody likes to make a bad bet.
What do investors mean when they say “too early?”
We have gathered opinions from three investors that work with pre-seed to seed stage companies. While this is not an exhaustive list, we identified three trends that lead to being told a company is “too early.”
The Founder: Are you the right person for the job?
The Vision: Is this idea genuinely revolutionary? Is the reward worth the risk?
The Traction: Is there any proof that this will work?
The Founder
Carey Ransom, Founder + Managing Partner at Operate and Managing Director of Banktech Ventures, is an expert at working with companies at the earliest stages of development. When asked what he looks for when he evaluates a founder, Carey shared the following:
When I meet a founder, I try to spend a fair bit understanding who they are and why they want to build a company in this particular area, solving this problem for these customers.
I ask myself if this person is as determined and tenacious as they will probably need to be to succeed.
Will they persevere when things get tough in the process?
Are they so committed to these people that they feel compelled to have to help them?
Can they be looked at by this market as an authentic leader? Have they discovered an insight that few others are likely to have about the situation?
Do they have a learning plan, curiosity, and obsession about it, such that they want to teach me all about what they’re learning?”
— Carey Ransom, Operate + BankTech Ventures
As a founder, it is your job to come prepared to provide concrete proof points that you are the right person for the job. Clearly showing your tenacity and ability to persevere in challenging situations can demonstrate that you are equipped to handle the trials and tribulations of a startup.
Humility also plays a significant role in this evaluation. Most founders happily talk about what they know but shy away from talking about the things they don’t know. Addressing your knowledge gaps indicates that you’ve done a good amount of research in the field and provides an opportunity to show investors how you will solve problems in the future. Demonstrating to your investors that you know the weaknesses of your company and your game plan to address them can go a long way at the early stage.
The Vision
Rich Maloy, Managing Partner at SpringTime Ventures and host of “The VC Minute” highlights another reason investors might pass on your early company: you haven’t sold the vision. If you are sure that you are talking to someone who invests at your stage and you have the traction they require, hearing that you are too early takes on a completely different meaning.
“When you’re talking to an investor that writes checks at your level, and they’re telling you that you’re too early, here’s the real problem: you haven’t sold them on your vision.”
— Rich Malloy, SpringTime Ventures
Rich emphasizes that founders must demonstrate what the future will look like with their products (check out the podcast here). While many parts of a pitch can undermine your vision, statements like “I will change the world” are simply not enough to win over your investors. You must tell a two-part story that shows both the outcome, should all go as planned, and the path you will take to get there.
The Traction
Drew Leahy, Managing Partner at Hawke Ventures, spoke about a third element that might be causing your early investors to say no: traction. Traction is the element of early-stage builds that challenges founders the most. How do you get traction without funding and funding without traction?
“Most of the time, it’s not because of the market, the customer, or the founder. Most of the time, it’s because there’s still too much execution risk. Not enough pilots, not enough data, not enough business model proof, not enough customers, not enough movement, not enough proof that this thing you started will be around in 1–2–3+ years.”
— Drew Leahy, Hawke Ventures
In the case of early-stage companies, execution risk is always high. It’s the founder’s job to find these proof points to assuage the concerns of your investors, even if you are pre-product or pre-revenue. While the expectations for validation tend to be a bit more flexible at the early stage, most founders still have to prove that their concept is needed in the market.
Revisit your thought experiment. What kind of due diligence would you do, as an investor, to decide between different companies? If you’re having trouble figuring out how to get traction and proof points at the early stage, check out some of our work on The Minimal Viable Concept.
So, you’re “too early?”
While “too early” can mean that you don’t have enough traction, it could also mean that you’re not demonstrating founder-problem fit or that the vision isn’t strong enough. If you have heard this frequently, spending time reflecting on your vision, validation, and personal strengths and weaknesses can be the turning points of your fundraising process. While it can be very humbling to sit down and identify where your company and pitch have room for improvement, addressing these weaknesses head-on will help you progress to where you’d like to be.
Found problems and not sure how to fix them? The Scientific Startup is here to help. We help you get the proof points needed to show your investors that you can and will change the world.
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