How VCs win hot deals and add value
One of the painful consequences of a more constrained venture market is that fewer startups are being funded. Venture investment across Europe was down 46% in 2023 compared to 2022.
But investors are also suffering. Fewer deals means that competition for the best opportunities has been steadily increasing. The evidence is clear. Even as investment levels tanked in 2023, deal sizes continued to increase and valuations broadly held firm.
This doesn’t mean to say that deals are happening faster. In fact, due diligence timelines have increased. Investors have reverted to a far more cautious approach following the wild spending spree of 2021/22.
But just as investors are moving with greater care and attention, so too are founders. As hot startups raise the bar on investor selection, investors that aren’t attentive to founder needs will lose out to those that are.
We are now firmly in the era of the ‘reverse pitch’, where investors are working harder to woo founders in the most sought-after deals. This means securing the emotional buying decision from the founder early in the relationship — and well before the term sheet is written.
How are investors doing this and does this lead to higher investor value-add?
The Reverse Pitch
Signature Block is an investor platform that crowdsources advice and learnings from experienced General Partners. This is a resource used by fund managers to share insights on fundraising, deal flow, portfolio construction and other matters that impact the operational effectiveness of their funds.
These submissions provide a rare, fly-on-the-wall view of the VC world. A recent article discussed how experienced investors get access to competitive deals. In other words, how they convince founders to take their money; the so-called ‘reverse pitch’.
The three big recommendations were:
- Your pitch needs to be relevant, differentiated, and authentic. The pitches that work best have all three.
- Start doing the job of an investor before investing. Investors that win competitive deals do more than just tell founders what they can help with, they show founders how they can help by providing support before securing an allocation.
- Offer a good “founder UX”. Investors who win, show up well-prepared, are responsive and run a transparent process. Investing is highly relationship-driven so the way an investor makes a founder feel matters a lot.
What experienced investors are saying to the broader community is clear; it’s about the relationship, not just the transaction. And this starts from the first conversation, which may happen months before a term sheet is even considered.
In other words, founder decision-making psychology is no different to investor decision-making psychology. We are all human. The emotional buying decision is made very quickly. “Is this someone I would really like to do business with?”
The rest of the buying process is spent justifying that initial gut call.
It’s not about (fund) size
We know that investors make all kinds of claims about how they add value. Study after study has shown the significant discrepancies between what investors claim and what founders actually experience.
The unexpected benefit of a longer due diligence period is that founders have the opportunity to witness investor behaviour well before they tie the knot. Investors that embrace the mantra of ‘doing the job of an investor before investing’ then truly stand out.
Comparing the approaches of different investors during recent campaigns has amplified this. Investors that founders have been drawn to have consistently demonstrated their willingness and ability to proactively support founders from the very first meeting.
The most valuable support has often come in the form of introductions to others in the ecosystem that can help the startup’s cause. This includes customers, industry experts, professional advisors, as well as other investors.
And this help hasn’t just come from prospective lead investors but from other, smaller investors that don’t have the means to lead. This help is freely given, with no strings attached. Value-add does not always relate to fund size.
In fact, we often see the most valuable support coming from some of the smallest investors, especially at Seed and Series A. As a result, these are the investors that will be invited by the founder to participate in future rounds, where they might have otherwise been crowded out by much bigger funds.
Founders want help
We know that one of the toughest aspects of becoming a founder is that it is an extreme test of mental resilience.
For those swapping the corporate world to become a CEO in the startup world, it can be especially hard. They are achievers. Almost everything they have done before has been successful — even if it may not have always been appreciated (perhaps providing the motivation to leave and do their own thing).
Now, in the startup, most of what they do is unsuccessful. Unsuccessful in the sense that, ultimately, 90% of startups fail.
Facing these brutal odds, experienced founders do everything possible to try and tip the scales in their favour. They are voracious learners. They hustle. They beg, borrow, and steal support from every quarter.
Most of all, they seek trusted relationships with people that can help raise their game. They learn to become great ‘people pickers’.
This is vital in the formative Seed stages. They must pick a great team, great advisors, great early adopter customers, and great investors. All these players must add value in their own particular way — and quickly.
But only the right kind of help
Problems occur when expectations and reality don’t match. Last week we were talking to an experienced founder we have worked closely with for some time. This CEO places investors into 1 of 3 ‘quality’ buckets:
Bucket 1: Great investors — those who invest and add consistent value
Bucket 2: Good investors — those who invest and then get out of the way
Bucket 3: Bad investors — those who invest and try to add value, but just get in the way.
‘Great’ investors are those you want to lead your funding rounds. They will be on the board and have a positive influence over others.
‘Good’ investors are also prized as they have no pretensions. In fact, their offer is “we’ll give you the money and then let you get on with it.” This willingness to simply get out of the way is their value-add.
‘Bad’ investors fail to deliver on expectations set. They claim to add value, but this doesn’t materialise in the way the founder expects. Their interventions can even be harmful if they are on the board and do not live up to their role.
Longer due diligence periods are helping founders make better investor choices. When evaluating a lead investor this is as much about assessing the individual partner as it is about the fund.
The partner’s standing in the fund can be crucial. This is especially so in funds that require full consensus decision-making at their Investment Committee. Any IC member, if so inclined, can always find a rational reason to say ‘no’. A partner that has the right gravitas and respect amongst their peers will be more likely to secure a ‘yes’.
In summary
We are now firmly in the era of the ‘reverse pitch’, where investors are working harder to woo founders on the most sought-after deals.
As hot startups raise the bar on investor selection, investors that aren’t attentive to founder needs will lose out to those that are.
The benefit of longer due diligence periods is that founders can witness investor behaviour well before they tie the knot.
Investors that embrace the mantra of ‘doing the job of an investor before investing’ will then truly stand out.
Weekly Briefing Note for Founders is a newsletter published by Duet Partners every Thursday. Back issues can be found on our website here where you can also subscribe for free.
