Learning From Passes

In the last year, I have been quite lucky to have had the opportunity to spend time being on the VC side and the startup side. Particularly, learning about the other side when not being in that role! However, while it is definitely too early to say that I can view things from both sides of the table, this opportunity has lead me to having a greater amount of empathy for both roles. One particular part of the system that I found myself thinking most about was around “passing”. Specifically, investors passing on entrepreneurs/their companies. If you are an entrepreneur passing on investors, kudos to you for being in that position.

Getting passed on is the default in the system; however, you may get passed on at different points of the funnel system [1] for seed funding. Every investor has their own process but based on what I’ve heard/ see/read, I’ve attached some numbers that I think are not too far off from reality with respect to drop-offs. Depending on when the drop off happens, your take away should be quite different IMO.

An immediate takeaway is that investors spend a large chunk of their time on reading decks and/or listening and meeting with entrepreneurs whom they are going to pass on. So when we went out to fundraise,  I knew there would be passes and lots of them, particularly since the funding environment was not so hot and space has a pretty big graveyard.  Having been on the VC side and getting to see this first hand, it allowed me to take passes in a non-personal way. Just for the record – every single pass still came with a little bit of pain.  Diagram 1 illustrates the different points you might get dropped off by an investor and how best to move in my humble opinion.

1. You need to get the investor’s attention to get passed on. So go get ’em, cause you miss 100% of the shots you don’t take!

2. About half the companies that VCs first encounter for an Introduction, they’re not going to spend any more time with. At this point, if you get passed on, it makes sense to just say thank you for their time and move on. It is unlikely that you will receive any feedback given the sheer volume of companies they see at this point – respect that! Also, as a friend who is an early stage VC points out, “The shitty thing about early-stage investing is that there isn’t always a reason. The reason can be super obscure. Like maybe a VC saw a company in this space 2 years ago, and it failed. So now they are hesitant to look at others”.  The good thing is that these people will likely pass early, like right now at stage 2.

3. While there is a pretty high chance you will make it to the Diligence I part, there is a pretty high chance that you will not make it any further. If you do not make it any further, it could mean a few things:

• The opportunity is not big enough
• The VCs do not believe in the same future that you believe in/ timing
• Timing is too early
• There needed to be more traction
• The VCs do not think you/your team is right for this business or this business is not right for you/your team (This one is personal and usually is not ever relayed back as feedback, but there is a high chance that this is the case.)

It would definitely be worth asking for feedback at this point & keeping a log of that feedback. They passed based on a certain set of information you provided them with and conclusions they drew from there. If there is something they see as obvious, it would be worth it to get their feedback. While you might get generic stuff like “we don’t think you can sell this to enough people to make a big business”, it’s definitely worth not dismissing it at a first glance. There could potentially be a problem that you would need to focus on first to solve, and it is possible that other VCs have the same concern. It might make sense to delve deeper to see if you do indeed run into these challenges and how you can take them on!

4. Now Diligence II is the most interesting part of the process IMO. At this point, your team may think they are close to getting a term sheet and your investor is excited about you as well. (You haven’t been dropped off like the other 90%. ) The investors are taking you/your thesis pretty seriously. If you get passed on at this point, IMO it comes down to one of two reasons:

• A red flag showed up that they cannot look past
• While everything is looking good, there is not one die-hard reason on why they should commit

I think that receiving feedback at this point is the most valuable. The investors have spent a good amount of time thinking and researching about what you’re up to, so get them to share their thoughts if they have decided to pass. It will help you build a better business 🙂 Also, it makes them more likely to help you out in the future either with this company, your next company, or your friends’ company. The investors that did give us feedback at this point had critical points and were the most likely candidates for us to send future updates regarding, lean on for potential help, and send more deals 🙂 Also, my personal thesis is that these investors are most likely to be helpful on whichever cap tables they are on.

5. Once you get the Term Sheet, the next move is in your hands! GG.

A point to keep in mind is that usually after an investor passes, there’s almost nothing you can do to change that and hence use the feedback constructively. Eric Peckham, an early stage investor and friend, echoes this point from speaking with other VCs over time; “many investors don’t give feedback – even though they might want to because they know it’s helpful – is that founders frequently use the feedback as ammunition to push back against the pass. They send counter-arguments to the weaknesses you raise and think they can still make you change your mind.”

Summary:

• Entrepreneurs: No matter who you are, you are going to get passed on. So use that opportunity to ASK for feedback – period. It does not matter if you agree with it or not, there is a chance you will learn something from it which will only help you in the long run
• Investors: If you took a potential investment all the way where you spent more than an hour with them, please allocate at least a couple minutes to give them useful feedback. We are all better for it!

If you disagree with everything I have said here, I would love to hear your thoughts in the comments or at me@varadhja.in!

[1] – Funnels at some existing venture firms: Homebrew, I will update you with more when I find the links!