Top 10 Reasons, Why Investors Pass?


Are investors or venture capitalists not responding to your funding requests?

Or, do they politely pass with a NO?

If either of the above is a YES, this post is just for you


Let's start with some hard-hitting facts:

  • You (as a founder) should be prepared for lots of NOs from the investors.

  • You’re more likely to hear about other startups raising big funding rounds or turning out to be unicorns, all the while scratching your head on where are you going wrong!

  • A bit of motivation, you aren't alone in this i.e. on a average, some of the best unicorns faced at least 40 rejections, before being funded.


First things first, getting a NO along with reason/s is a lot better than "no response," it means you're heading in the right direction!


Now, the investors aren't obliged to give you any reason/s for rejection, most of them do because they are genuinely keen to help you. Not to say that some of the pitched investors may not ever respond to you or keep radio silence.


However, if you find that investors are ghosting (not responding) or whether the declining reasons are really genuine or just flimsy?


Ask them, "if we reach xx or resolve xx, will you offer the term sheet?" and this should guide you whether to keep them updated about your progress.



So, Why do Investors Say No to Startups?


Most of the time you would hear investors (that you pitched) often revert with vague sentences (standard codes of rejection) like “you're too early for us” or "we would like to wait till you reach more milestones ..." despite you having the best of traction and/or customer love.


The reason is simple, investors often feel the pressure to clearly spell out one or more discrete reasons for saying “no,” and that's why they use such words to avoid any confrontation with the founders.


Truth is that investors consider several aspects to judge whether a startup is truly investible (worth investing) based on their personal experiences (history), interests, emotions, and investment thesis (compulsions) when considering an investment.


First, the basic premise for this post is that your startup has a scalable product, and shows a good amount of traction. Post Covid-19 it's imperative for the startups to show traction as a “proof of concept."


However, if you're at a pre-revenue (or idea) stage, highly recommend instead opting for the accelerators, here's a detailed post on it.


Based on my close association with 100s of fund raises by the early-stage startups (raising Pre-seed, Seed, Series A) here are the top 10 key reasons, why investors decline startups for funding.



1. Founding Team Related

Investors don't have the confidence in the team's expertise and/or ability or wherewithal to execute and build a long-term enduring business.

Investors sense a lack of complementary skill sets. vision, passion, coachability, or the chemistry within the founding team, are dangerous red flags.

In contrast, investors could perceive that your competitors are well-trenched (better traction, well-funded,) and stand a better chance of winning against you.

They’d rather wait & watch to see if this team can truly execute and achieve a few milestones before exploring further.


Startups are risky, but most of them fail because of the founders - Nicolas Cole, Inc.com


2. Limited or Niche Market Size

Investors have this strong liking to invest in those startups that can quickly scale up to become massive ($1+ Bn) unicorns.

A niche or a limited market or a sustainable and profitable business isn't enticing enough for the investors or VCs.

Investors get excited with a large enough market where the economies of scale can improve the operational efficiency, gross margins as well as generate profits that are needed to attract investors during the subsequent rounds.

Primarily, this is a key reason, why investors continue to fund their non-profitable portfolio companies (despite a few of them growing un-sustainably.)

Often they'd prefer to wait till they become sure that the TAM (Total Available Market) gets large enough to show the signs of a possible soonicorn.



3. Missing Defensibility or Moat

Often, I've seen founders often confuse this with product differentiation or value proposition, in my view both are complementary and yet different.

Value proposition pretty much summarises, why a customer would choose your product or service over the competitors.


Defensibility or Moat sums up how well a startup's competitive advantage (i.e. offering clients better/greater value proposition) holds up against several competitors or potential entrants, for a long-term duration.

A patent can serve as a moat, potentially if you have a first-mover advantage, however, it's pretty easy for competitors to have a way around it.

Lack of defensibility or moat is perceived as quite risky by the investors.

Often they'd prefer to wait till the composition of the team, strong go-to-market strategy, or key partnerships help establish the moat!



4. Strong Competition

The competitive landscape is too large or too many players exist in this space.

Investors are generally averse to highly competitive markets, where the customer acquisition costs are too high, depleting market share and retention is usually sketchy on account of little/missing differentiation.

There could be multiple problems (e.g. regulations) associated with this market.

Or if any of a known (and funded) startup had failed, dissuading them from investing in a similar company.

This is where the quality of the team and competitive advantage plays a strong role in the investment.


Deadly Blow: When a startup lacks both a strong/unique value proposition as well as Moat (defensibility) in any given market.



5. Lack of Business Model

Lack of a viable business model, where the targeted customers are unwilling to pay for the product/service or startups working on a freemium model (dependant on ads or complementary services) is a strict no-no for most investors.

Absolute focus on monetization is a necessity (more so, post Covid-19.)

Can this startup create a large enough monetization model to justify the current and future investments?



6. Poor Unit Economics

If a startup has poor unit economics (i.e. spending $2 to generate $1 of value), along with no plans for improvement in the future, then it's usually a pass from the investors.

At an early stage, startups must grow at a healthy rate and also need to be profitable.

Founders also need to track the right metrics (customer acquisition, customer lifetime value, gross margins) and take relevant steps to build a viable long-term business.

I've seen too many founders focus on the wrong metrics, demonstrating their lack of financial knowledge, and decimating their fundraising.



7. Limited Scalability

Investors perceive there are several challenges in scaling this venture to be able to build a large company. This is more prominent with startups involved in the hardware or services domain, which are heavy on operations.



8. Limited Traction

Investors also expect a certain amount of traction as proof of significant momentum.

Often they'd prefer to wait till the startup shows consistent growth in terms of a number of customers (every month), such that the existing infrastructure and team can't cope up in hand holding them.



9. No Clarity on Go-to-Market Strategy

Founders lack a dedicated strategy to acquire more customers (how to generate more leads, which channels to use, how much to spend, etc.)

This is more prominent with those founders having limited or no sales experience.

Often this is revealed, where large milestones are defined, however the strategic plan to achieve these milestones isn't convincing enough for the investors.


Deadly Blow: When a startup lacks a strong go-to-market strategy accompanied by a high customer churn at regular intervals.



10. Investors (thesis) Mismatch

All investors have their deep focus on specific sectors and stages/rounds that they prefer to invest in. For example. pitching an e-commerce/D2C brand to a Fintech-focused VC is a waste of time for both.

Most investors have specific geographies in which they would and won’t invest.

Not aligning within their investment thesis is one of the most common reasons for a pass.

Do your homework well, source the investors' website to get to know their investment thesis before pitching.



Conclusion


98% of startups were declined for funding, due to the 2 or more of above reasons.


Wear an investor's hat assess your investment readiness i.e. honestly review/audit your own startup against these 10 reasons or gaps!


For free assessment of your startup, connect or chat live with us!

To know, how we help early-stage startups be investible (fundable), click here.

 

Resources

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