Start-up Entrepreneurs' Blog

A Dirty Little Secret about Venture Capital Funding

October 30, 2009

I was at a venture capital meeting last week and one of the VCs, Bill Reichert for Garage Technology Ventures made an interesting observation about venture capital funding – he called it one of the dirty little secrets. VCs fund projects they fall in love with and then they justify the project to their firms in retrospect. Instead of weighing the evidence and options, and then making a decision, people actually do the opposite.

Psychologists have concluded this is a typical manner in which people make decisions. They use their intuition to make a decision and then find the evidence to support the instinctive choice. Psychologists note that when decision makers are asked to articulate the reasons behind these intuitive decisions, they most often cannot do so easily. It’s gut instinct. I hate Brussels sprouts, but I can’t tell you specifically why I don’t like them, I just don’t. If I spend time thinking about it, I still can’t pin point or articulate the exact reasons behind my dislike for Brussels sprouts.

What does it take to fall in love? Think about the dirty little secret, VCs invest in projects they are familiar with. Most of the VCs are involved in digitizing the world – cleaning up the world – saving the world. The VCs already has a feel for the market and the cost of developing the technology. What they are looking for is the idea that sparks their attention, not because it’s forging new ground, but because it’s an AHA moment. Recently I tried to get some VCs to define the criteria for what they would invest in. The most common response was we’ll know we’ll like it when we see it, but we can’t define it even in a general sense. It’s love at first sight.

Stall tactics – like any other sales process – is never a good sign. If the potential customer wants to wait and see, the longer they wait, the less likely the deal. This is exactly how another VC described the funding process. He wanted to “date before getting married” and build a relationship with the entrepreneur and start-up. He wanted to get updates from the start-up over a period of 6 to 8 months before seriously considering the project.

Venture capitalists use past experience as their guide. I’ve listened to enough start-up pitches and feedback sessions to conclude that if an entrepreneur is proposing a technology that was a lackluster traction in the market before or the VC has had a bad experience with a start-up in the same market space; it’s going to be an uphill sale. Which is why new technology with no not market today is attractive – there is no past history.

Getting funding for a start-up is just another sales or business development process. The same principles apply to selling a business concept to an investor as it does to selling a widget to a customer. The twist is perhaps Venture Capitalists are from Mars and Entrepreneurs are from Venus.

Filed under: Start Up Funding

Tags: funding, hi-tech, high tech, start ups, venture capital