A noticeable fraction of the thousands of startups I have looked at in the last seven years have made attacking a societal evil (e.g., hunger, homelessness, etc) a key part of why they exist. This is extremely laudable from a moral perspective. We should thank those people for their big hearts and open minds.
However, when trying to secure a venture investment to fund such an endeavor, these startups often fail to include an absolutely necessary section in the pitch deck: How is this investment going to make a bleeping lot of money for its institutional investors?
Failing to address this issue right up front leaves it to the imagination of the investors, which is not a recipe for success in attracting investment money; it is acutely a challenge since the purpose of venture investing is to make money – it is the reason institutional investors exist.
When an entrepreneur fails to show projected revenue, I am led to one of three conclusions: 1) there is no path to profits; 2) the entrepreneur has figured it out but did not think it was appropriate or important enough to put into a first deck; or 3) there may be a path to profits but the entrepreneur has not figured it out yet. Let me share how an investor thinks about each of those possibilities so one can realize just how big a hole one is digging when there is not a good answer to this important question. And let me share how one startup navigated this challenge well and received an investment from my firm.
The first case is the simplest; there will be no particular financial rewards from investing. That is a bad thing for institutional investors seeking a financial return, but it gets worse quickly. This entrepreneur has just taken an hour of several investors’ time to pitch something which is a non-starter for a venture investor. He has not taken the time to understand what motivates investors (and there are plenty of blogs from VCs on this topic). He has, in essence, wasted his and the investor’s time, albeit with good, naïve intentions.
What I am likely to take away from such a meeting is that the presenter was un-thoughtful, unprepared, and willfully disregarded the investor’s needs. I will conclude that I did not think this person thought about my needs as an investor, did not appreciate anyone who referred them to me, and generally will be very skeptical of any future investment (or any subsequent meeting regardless of the idea) because the person may not use my time wisely down the road.
The second case leads to the same ‘Pass’ outcome, but with slightly less reputational damage. In this case, it takes several questions from the investors to suss out that the entrepreneur does indeed have a null hypothesis about how investors will be rewarded. However, she has no slides to support this hypothesis and is doing this ad hoc. In this case she is highly dependent on receiving both good questions and these being asked in an order that reveals a logical syllogism that proves the hypothesis. I want to submit that as the number of questioners in the room increases, the odds of both of those benevolent conditions occurring decreases significantly.
After this meeting, I will conclude that like in the first case, my time was wasted. However, if the entrepreneur recovers during the questioning, I will probably mark it up to naivety and be willing to take a meeting from the same entrepreneur on a better idea down the road. Unlike the first case, I will not write her off as a person; just her idea for a new venture.
The third case does present us with a ray of opportunity. In this case the entrepreneur has not yet figured out how to make money, but does have a couple of ideas, and other organizations have been able to follow one or two of those paths to success. Provided he acknowledges upfront that he is still working on this part of his plan and that he knows it is super important to investors, I will keep an open mind. If he says that he is thinking through two alternatives and can outline them, but still needs help in figuring out the right path to go down, I will start thinking about referrals I can make from my network that might help. This entrepreneur has distinguished himself from the first by acknowledging that he knows this topic is paramount to us. He has been candid in admitting that he does not have the answer…yet. And he has asked for help with a bounded set of reasonable alternatives. Unlike the first entrepreneur, I am likely to recommend a second meeting with my teammates to help him figure out if there is a “there” there. And our first impressions will be that he “gets venture,” knows when to engage us, and will be respectful of our time.
This is not a theoretical example. We invested recently in a company in stealth mode attacking a health problem from which one hundred million Americans suffer. The entrepreneurs admitted upfront that the team had not yet decided on which of two alternatives to monetization they thought was best and asked us for our help figuring it out. And then they showed us jaw dropping test results compared to two other widely practiced approaches. I have used the service for four months and my results are consistent with their claims. I am a happy user and a happy investor. This team takes feedback and learns quickly. And although they did not have a clear path to profit, yet, it was pretty easy for us to get together on financial terms and start building what we think will be a world class service.
If the idea of how to reward investors is a “front and center” issue met head on by entrepreneurs, VCs might be open to non-traditional investment opportunities. However, failure not to do so, or to treat it with casual disdain, will lead to a waste of time for the entrepreneurs building companies that are primarily driven by social good. Dealing with it forthrightly, even if one’s thinking is incomplete, is the only real way forward to getting that term sheet and starting to build a distinctive startup.