When Noah Kraft was looking for a VC to invest in his startup, Doppler Labs, he focused on what most first-time entrepreneurs fixate on: raising as much money as possible at the best possible terms from the most famous firm that would have him.
Eventually, his company, which made a wearable ear-based computer until it closed shop in late 2017, raised $51 million from a range of investment firms.
"The ideal investment partner is someone that's completely aligned with your best interests."
Looking back, he says his original wish-list was too simplistic. Fit is just as important as dollars, valuation or prestige. The ideal investment partner, says Kraft, is "someone that's completely aligned with your best interests."
Specifically, that means finding a VC with deep expertise in the market you're targeting, and a financial model that can benefit from a company like yours. It also means looking beyond the name of the VC firm to make sure you can have a good working relationship with the particular individuals who will oversee the investment.
"Having a top-five firm may have optical benefits, but it's not everything."
"Having a top-five firm may have optical benefits, but it's not everything," says Kraft. "I'd advise any new entrepreneur to focus more on what the partner can bring besides just a valuation."
How do you find a VC that's a good fit for you and your business? Here are some tips to help you find the right investor.
Is venture capital even right for your business?
As a startup founder, you may think snagging your first round of venture capital is an essential rite of passage—a victory in and of itself. But it may not always be the right move.
"The reality is that venture capital is a great funding source for a very small number of businesses and a terrible one for everything else," says Hunter Walk, a partner at Homebrew, a San Francisco-based seed stage venture fund.
To understand why, it helps to know a bit about how venture capital works.
VCs raise money from investors called limited partners and use the money to back risky startups. They make money when a startup has an "exit," meaning it's sold at a premium or goes public, which makes its shares tradable. (VCs also earn management fees, but those are paid by the limited partners.)
Early-stage investing is a high-risk game. Various reports peg the startup failure rate at between 60% and 90%. Regardless of the exact figure, for the VC model to work, the startups that succeed must make up for those that don't. And given that the majority fail, the ones that make it must make it big.
How big depends to a large extent on the size of the fund a VC is drawing from. A $1 million investment that turns into a $5 million exit may be good for a $50 million VC fund but won't move the needle at a $500 million fund.
That means a few of things for the entrepreneur. First, if your business doesn't have the potential for a 5x, 10x or even bigger return, venture capital is probably not the right route for you. Second, if you decide a venture investment is right for you, make sure you approach funds whose size make sense for the investment you're seeking.
"When you take VC money, you're committing yourself to a path of fast growth."
Most important, understand that when you take VC money, you're committing yourself to a path of fast growth. You're going to get a lot of money, but you're also giving up a substantial amount of equity to one party. Unlike with angel or friends-and-family money, you're going to lose some freedom in how you run the company.
Finding your right VC fit
If someone else is going to have a big say in how you run the business, you'll want it to be someone you work well with and who can help you grow.
The right investors will get you more than money out of the deal. They'll loop you into the right networks, offer advice on how to grow and scale the company and share expertise in your field.
Before approaching a VC, do your homework about the firm to understand its mission and target investment size. "Like startups, you can't paint VCs with the same brush," says Milad Alucozai, founding partner at Good AI Capital. "Founders should know that every fund has its unique characteristics whether it's their mandate or the backgrounds of the partners."
For instance, Alucozai's firm specializes in early stage AI companies. Other firms focus on hardware, fintech, or even medical devices.
"Ideally, by the time you need funding, you'll have begun building connections with VCs."
It's never too early to start doing that research or to foster relationships with the right VCs. Ideally, by the time you need funding, you'll have begun building connections with VCs that understand and are interested in your company's field, Alucozai says.
Researching VCs is not always easy. Historically, many firms have held their cards close to their vests, and lots of VC websites remain sparse. But that's beginning to change, as competition for deals heats up, and firms look to streamline their communications with founders. As some funds publish more information on their sites, others aim for even greater transparency.
"Transparency is the most effective way to build trust."
In November, for example, Bloomberg Beta published its entire operating manual, including actual investment documents, on GitHub. "We believe transparency is the most effective way to build trust," the firm wrote.
Another effective way to research a VC is by talking with its portfolio companies. Alucozai recommends asking fellow founders about their experience working with a particular VC. Those discussions may well lead to a prized introduction, and a more targeted conversation once an introduction has been made. "The more focused the ask, the better we can do on our side to help," Alucozai says.
Kraft, the Doppler Labs founder, says these conversations with other founders are also an important way to get a sense of the investor—the person you'll spend the next several years with—and not just the firm. Among the questions to ask founders who have worked with the investor: What are they like as a partner? What are their values? How did they treat you during tough times?
"I've had people say ‘Sure, we made some money together, but I thought he was a jerk.'"
"Founders tend to be pretty honest about these things," Kraft says. "I've had people say ‘Sure, we made some money together, but I thought he was a jerk.'"
VCs are also looking for a fit
If you're fortunate enough to get a meeting with a VC who might be a good fit for your company, it's important to be prepared. That means knowing what the VC wants to get out of the meeting.
In many cases, they'll focus less on your product and more on your idea, with the goal of probing your subject-area knowledge, as well as your passion and commitment.
"Typically in pitches, first-time founders spend way too much time telling me how their technology works and not enough time explaining why they are developing the technology, who the user is and their road to market strategy," says Alucozai.
Adds Walk: "We're in the business of taking a risk, so convince us this is a problem worth solving."
Also be prepared to talk about your goals. VCs will want to know if you're trying to grow an independent company or if you want to develop a technology or service that someone else will want to acquire. This helps them gauge whether you're up for the sort of growth they need to make a reasonable return on their investment.
VCs may also probe how well you've thought through the business side of things: Can you explain your capital needs? Can you credibly predict the market opportunity? The cost of acquiring a customer and the revenue each customer will produce? Those are all fair—and likely—questions, says Bob Kocher, a partner at Venrock.
Yes, it's all a test. But you don't necessarily pass by knowing all the answers. Be honest about any potential problems and challenges you might face. Don't oversell. And if you don't know the answer to something, don't pretend you do.
"We're trying to figure out what it would be like to work together," says Walk. "If you're not open and honest with us from the start, it's not going to be a great relationship."
"Like you, VCs are looking for a fit."
Like you, VCs are looking for a fit. So like with any other long term relationship, they'll want to make sure you are compatible.
"We care a lot about the character of the founders, their motivations and values," says Alucozai. "We find these personal attributes equally if not more critical to the success of the startup."
Most founders think of VC funding as the path to success. But like so much else about running a tech startup, it isn't that simple. Raising money during those early formative stages is often less important than who you raise it from. The right founder-investor pairing can propel a high growth tech company to unimagined heights while a bad one can hasten an unfortunate end.
We talked to founders and investors about why fit matters. Here's their advice on what startups should look for in a VC, how to approach first meetings, and how to tell whether you've found a good match.
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