How to make sense of “being too early” for VC
You were told that you are “too early”with your startup (idea) for a specific investor. But what do VCs consider too early and why looking for one-size-fits-all answers will mostly be in vain.
"The too early bird does not catch the worm"
Who is this article for?
Lately you have been thinking about approaching VCs for your first fundraising? You got rejected from investors so far, because your investment case is still “too early” and you don’t know what this explanation means? Or you want to develop a clearer understanding of what is the right time to ask for equity injections in general? Then, this blog post (btw my very first) is just the ticket for you!
[Disclaimer: The notion of this article is heavily influenced by my investment focus: consumer internet, marketplaces and software-enabled business models. If you are in a regulated industry such as health care or you are building hardware etc., the remarks are less applicable.]
The early stage — from a kaleidoscopic angle
Well, normally this should be a wildly active time for founders looking for funding. The simple reason is: there is more capital than ever before that needs to be invested and venture capital is a growing asset class, which is hitting new highs.
At the same time more and more investors start focusing on “early stage investments“ – or claim to do so — in a rather broad sense, because the label early stage can mean very different things, such as angel, pre-seed, seed or even series A investments. Put all of this together and it results in an inflation of the median deal size for early stage VC investments across Europe.
Despite the fact that more investors with bigger funds provide more early stage venture capital, many founders get rejected from investors on the grounds that they are “too early“ for an investment.
This post examines how those two contrary facts fit together and what being too early actually means? Furthermore, I will outline what we ourselves would consider to be too early, what I think is necessary in order to be “VC ready“ and why there is no absolute truth.
Decoding VC lingo
Unlike some colleagues from Pillar VC, who think it is never too early for VC, I am convinced that hearing the answer ”too early“ can mean 3 things:
- It is a way of beating around the bush and means the respective investor either does not like your case or is not convinced of its potential
- Your case is, in all objectivity, too early
- Your case is too early for this particular investor
Regarding the first point, it is just a flimsy excuse to turn down your case. A professional investor will refrain from doing that (although Robbie Allen already pointed out that VCs are often highly creative when it comes to saying “no”) and provides value-adding feedback explaining the motives why she thinks that there is no good fit between the investor and the startup instead.
First things first
In most cases it is pointless to look for VC funding, when all you have is an allegedly great idea and a pitch deck without having actually started your business. In situations when you are still looking for co-founders or you haven’t started building your prototype or you are still surveying potential customers and so on; it is highly unlikely to get the attention of institutional venture capitalists. So, remember Josh Kopel’s aphorism: Venture capital is like jet fuel, hence you need have already started to build your rocket before you pull over for your first VC pit stop.
Therefore, it is best to give up the notion that you can raise venture capital solely based on an idea unless you are a well-known, successful serial entrepreneur benefiting from prior VC relationships and a natural gift for fundraising. Note, however, that the expected level of personal financial commitment is substantially higher for serial entrepreneurs in contrast to first time founders. If you do not fall into this category, (no worries, only very, very few people do) you should consider other types of early stage funding. Useful funding options during the early days can range from family and friends providing initial capital, incubators or accelerator programs to business angels or subsidy programmes.
Use your first steps as an entrepreneur to ramp up your personal learning curve and show some resilience when faced with setbacks. The “pre-VC phase” is also a chance to show evidence that you are able to inspire other people to join your mission and to demonstrate that you can reach certain milestones.
Traction — a necessary evil
Let me say this right. There is neither a valid, universal answer to that nor a mystical (revenue) threshold that needs to be surpassed to qualify as “VC backable“ or anything like that when it comes to specifying the perfect time for your first VC round. However, there are preconditions and indications that are regarded as evidence that you are approaching VC readiness.
In my opinion, there are three basic requirements to be met: Firstly, you need to have a laser-sharp strategy on how you want to solve which problem for whom and a convincing operational plan to execute your mission. Secondly, phases of positive momentum stemming from an upward trajectory, positive press coverage, a successful key hire or well-known new customers etc. are good times to approach investors. Thirdly, you can articulate a well-thought-out equity story containing a set of milestones that can be reached with the particular financing round because you will spend the money on initiative X,Y and Z to achieve goal A, B and C.
Of course, the most obvious indicator that things are moving in the right direction is revenue growth. For reasons of simplification and proportionality, I am not going to refer to the fact that not all revenue is created equally, but you can find more on this topic here.
As I said before, there is no specific threshold but having won paying customers indicates that:
- Your current product/ MVP is working
- Your current sales process is good enough to convert leads into customers
- Your current product is adding so much value that your customers spend real money for it
- In case you already have several clients: There might be a scalable customer acquisition strategy — a so called “repeatable sales playbook“ — that can be leveraged
The product status, the numbers of clients, your current revenues, your sales pipeline, your team and so on is usually summarised as “traction“, which needs to reach a certain scale to turn your startup into an interesting investment target for VCs. In my opinion, growth rates, market potential, USPs and KPI development over time (just to name a few factors) are rather more interesting than absolute revenue levels because it reflects how fast and how efficiently your business can benefit from economies of scale and how big it can grow. Moreover, it is very necessary that your learnings explain how the cash injection leverages certain underlying business mechanics (customer acquisition) or help to reach certain milestones (e.g. product development, hiring) to accelerate growth.
That is why my attempt to provide a helpful answer to the question what exactly “big enough traction“ is for not being too early lead me to the following conclusion:
In a nutshell, you need to have a marketable product with a growing (user/) customer base; plus you have reached an inflection point of your growth momentum that can be leveraged with cash and you have a strong team willing to go all out in building a multi-million business. If you can tick all boxes, so to speak, then you are ready to approach VCs. But this also depends on which kind of VC you want to talk to because traction for some is not traction for others.
Too early is relative and must be seen in its context
Returning to the notion of being too early for a particular investor; this aspect illustrates that the current traction you have is not big enough for the respective investor to get them excited about your investment case. Hence, be selective, approach the right investor and do your homework diligently on the investment scope beforehand, because the investment scope truly determines whether an investor is a good fit or not. Keep in mind, every VC defines their investment scope as a mixture of relevant:
- Business models (DTC, marketplaces, enterprise SaaS, etc.)
- Themes (fintech, proptech, AI, blockchain, etc.)
- Geographies (Germany, GSA, EU, global),
- VC fund economics (fund size, ticket size, equity ownership targets, reserve allocation, portfolio construction, fund’s life cycle status)
- Investment stage (Seed, Series A, Late stage)
Assuming, that your startup operates in a relevant geography, within an interesting investment field and pursuing a favourable business model, then all that is left from the list above is VC fund economics and the investment stage.
To understand the VC fund economics, one has to remember the underlying business model of a venture capital fund and how the fund size influences the range of the ticket size and what the fund lifecycle has to do with the willingness to invest; and so on. Since this article has a limited scope, I would kindly point out the wonderful article by Elizabeth Yin which explains the (mathematical) mechanics of a VC fund, how VCs actually earn money and how the business model impacts their reasoning.
And if you want to learn more about a typical VC fund structure and its life cycle click here.
But the most important factor that needs to be considered from a founder’s perspective is the preferred investment stage of the respective investor, because expectations from investors strongly correlate with their stage focus. The following section provides a brief overview of what is expected for a pre-seed, seed or post-seed round in general.
If you are raising a pre-seed round you should have built an MVP (or a hardware prototype, a proof of principle and so on) which provides some level of validation — ideally with first real users or revenue traction as a logical result of addressing relevant customer needs. If you want to close a seed round, the expectations are higher. VCs want to see a strong MoM growth, interesting unit economics indicating how an investment can help scale customer acquisition and a vision on how to get customers profitable. In a post-seed phase, you should have reached product market fit, know your unit economics and acquisition channels and how to turn x-amount of VC euros into revenue and how further growth and profitability can eventually be reached. So for example, if you have some data validating your MVP but no reliable data on customer acquisition yet, there is no point in trying to raise venture capital from typical series A investors.
Moreover, keep in mind that the amount you want to raise has direct implications on your valuation to maintain a healthy cap table structure. However, to get a decent valuation you need enough traction to justify it, plus raising outsized rounds at (too) high valuations comes at substantial costs. So be strategic about your fundraising process and the investor communications!
I hope it has become a little bit clearer why being “too early“ is always relative depending on who you are talking with.
What is (not) too early for us
Having said the above, it seems reasonable to raise the question what would we @ IBB Bet. consider “too early“. Since we are a dedicated early stage VC, we like to evaluate investment cases early on their journey — depending on the business model (e.g. life science, hardware) the requirements can differ significantly — but
- You need to have founded your company (ideally a GmbH),
- You should have your first marketable product ready
- You are generating revenues at an increasing rate
- You are looking to raise at least EUR 500k (whereas, EUR 1m is much closer to our sweet spot; for further information concerning our investment scope click here)
This simplistic description implies that if your current status is pre-revenue you are very likely to be too early for us and if your current status is pre product then you are definitely too early. The previous statement is definitely not true for health care, life science or industry hardware businesses, so please remember my disclaimer above!
Yet, one thing is certain: Venture capital is still a people’s business so it does make sense to start your relationships with potential investors early on, ideally before you are in active fundraising mode. Establishing a strong relationship with VCs is particularly important, because if things work out well you will spend the next 5 to 10 years working together on your startup which is a pretty long time. You wouldn’t propose to a stranger in the street either, right? So why rush things in your professional life. Take your time and grow your relationships continuously. My pro tip: Listen carefully to the investor’s feedback and try to draw your lessons from it, whether it is good or bad news and keep potential future investors in the loop via an investor newsletter, which contains the most important facts about your latest progress. You can find some useful templates here and here.
As a final note, I want to underline that you can reach out to us even though you are “too early“ to raise money. So you can start by building a meaningful relationship with one of the most active VCs in Germany by sending an email to email@example.com or dm me on LinkedIn. If you are looking for funding, you can send us your deck here. Do you need some help with your fundraising documents? Follow the links to get some tips for your pitch deck and your financial model. Go ahead, drop us a line!