# Understanding the Phrase: "This Isn't Venture-Backable"
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Chapter 1: The Challenge of VC Feedback
In this segment of Deciphering, we delve into a common phrase encountered by entrepreneurs: "I don't believe this is venture-backable." This statement often leaves founders feeling hurt, confused, and frustrated, as it typically lacks further explanation. Recently, numerous founders have reached out to express their bewilderment, asking, "How can they say this? What do they mean? Just look at the significant pain points for our customers! We have an outstanding product! Plus, my track record speaks for itself with current and potential revenue!"
It’s understandable that someone who has identified a genuine market need, developed a strong product, and achieved revenue growth would be perplexed and even annoyed by such feedback. With all these accomplishments, it raises the question: what do investors truly mean when they declare a business "not VC-backable"?
What It Actually Signifies
Firstly, when an investor claims a company isn’t venture-backable, they are NOT implying:
- There’s no market demand for your offering
- Your product is subpar
- You lack the skills to lead your business
- Or even… your business model is flawed
Essentially, they’re communicating that they believe investing in your company does not align with their investment strategy.
To clarify, they may indeed think your business model isn’t sound enough for their criteria, but this statement also reflects their skepticism regarding whether your venture can scale to a level that will yield substantial returns fitting the VC model.
Understanding the VC Model
It’s crucial to remember that the venture capital business model is an exception rather than the norm. Venture capitalists invest in a variety of early-stage startups, expecting most of these ventures to fail. For their strategy to succeed, any single investment must possess the potential to generate significant returns. Thus, if an investment does not demonstrate the capacity to grow large enough, it’s seen as a lost opportunity.
For example, if a founder raises $4 million from a VC and sells their company for $50 million, pocketing approximately $25 million, that’s a remarkable achievement for the founder. However, from the VC's perspective, this outcome might be negligible, as it doesn’t significantly impact their overall portfolio.
Let’s break down the numbers:
Assuming a fund aims to make 25 investments at an average initial check size of $4 million, with all funds reserved for follow-on investments, this amounts to a $200 million fund. If the fund owns 20% of a company at the time of sale, it would receive $10 million from that exit (2.5 times its investment).
While 2.5x might seem appealing, for a $200 million fund, achieving just one exit of this nature among 25 investments isn’t enough to break even. This doesn't even account for management fees!
A Successful Investment Case
Now, consider a scenario where the firm invests in a company that ultimately sells for $20 billion. If, after multiple dilution rounds, they maintain a 5% stake, they would then generate $1 billion from that single deal. Any prior investments that result in zero returns become irrelevant in this context. In this model, each investment must have the potential for colossal outcomes, such as a $20 billion exit.
Consequently, even if your business is excellent, it won't qualify for venture backing unless it aligns with this financial strategy.
Next Steps After Receiving Such Feedback
When faced with this feedback, take a moment to reflect. Is there any validity to their assessment? If you truly believe your business could achieve massive success, consider why the investor might have misunderstood your vision. Was there a communication breakdown? Did they not trust your assumptions? Were there concerns about specific factors in your business model?
If, after thorough self-assessment, you recognize that your business may not align with the VC model, there’s no need to be disheartened. If your business is functioning well but does not fit the VC mold, continue to pursue your goals. Venture capital is not the sole avenue for funding. Focus on generating revenue organically (bootstrapping) and explore alternative financing options like loans or other credit sources.
Realizing that raising venture capital may not be the right path early on is a valuable insight—embrace the journey that best suits your vision.
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