Why It Takes So Long To Raise VC Funding: The Emperor Has No Close

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Why It Takes So Long To Raise VC Funding: The Emperor Has No Close


If you’ve ever attempted to raise VC for a startup, you likely know that it is a long process that takes months.  One thing I’ve found particularly intriguing is that outside of bubble-like times, the average time it takes a deal to get done (and money to exchange hands) doesn’t seem to change a lot.  Though many other industry sectors have shortened the delivery time of their offering in reaction to the fact that we live in a fast-faced society where timeliness trumps other factors, the VC industry doesn’t seem to have changed a whole lot.  Dell can ship you a custom computer faster, FedEx can deliver a package quicker and home loans can be approved more rapidly than what we have ever known before.  But, VCs still will take months to work through a deal and write a check.

My fundamental question is this:  Is the investment return a VC generates for its limited partners correlated somehow with the time spent in due diligence?  The reason I find this question interesting is that there is a sneaking suspicion I have that VCs, like other people, form very quick decisions on whether a startup is or is not funding-worthy.  If this is the case, and they’re forming their decisions early-on anyways, it seems inefficient to spend inordinate amounts of time on due diligence – as it likely will not change the original decision often-enough.  So, I asked VC friends as to why they do this.  Why spend months on due diligence if it is not likely to change the outcome?

The answer, paraphrased from VCs, goes something like this:  “It takes some amount of time to get “comfortable” with a startup before we write a check.  Not all of this time is spent doing deep due diligence.   A lot of the time is just spent letting the deal “bake” in our (the VCs) minds.  Often, it is during that “think” time that we’ll come up with insights into the business and market that we would not have otherwise.  Sometimes, it’s simply a matter of getting educated on the space, educated about the founders, etc.  Often, during this “due diligence” time (where often, not that much due diligence time is being spent), we’ll come up with good reasons not to do the deal.  These reasons would not have occurred to us in the early conversations.”

This actually makes pretty good sense.  If the VCs are not having to invest all that much time/energy in “deep” due diligence in the weeks and months that pass, and they do indeed “discover” things that cause them to filter out opportunities that are later determined not to be of sufficient value, then it seems that VCs should do exactly what they’re doing.  Why close a deal in days or weeks?  You sometimes have a small risk of losing the deal, but since everyone else behaves this way anyways, there’s little that an entrepreneur can do to accelerate the process.

From an entrepreneur’s perspective, the situation looks something like this:  The VC will likely make a spot decision (within a day or two) as to whether you’re worth even investing the time in.  But, you’re not going to get a direct “no” (I’ve written about this phenomenon before).  But, from the time that they make the mental decision to invest, they are looking to leave themselves enough time to talk themselves out of the deal.  If they fail to talk themselves out of the deal, they’ll close it. During this time, where there is no possible way they’re going to reach a “close”, VCs are likely to ask entrepreneurs for deeper, more exhaustive information.  The frustrating part is that not all of these requests are so they can learn more about the company, which will influence their decision.  .  Some of it is simply to ensure there is adequate time for them to talk themselves out of it.  Unfortunately, it’s hard to know the difference, you have to respond to all due diligence requests as if they are somehow going to change the outcome.  Such is the life of an entrepreneur raising money.

Interesting Idea From Left Field:  What if a new VC came along that offered entrepreneurs a quicker, less painful process to raise capital for their startup?  Would this VC be able to attract a better class of entrepreneur?  Entrepreneurs that would rather focus on their business and customers than on raising capital?  Or, would this new VC be doomed to failure because they were not allowing themselves sufficient “bake time”?  Could some of the risk be mitigated by having a “probationary” period for the capital.  For example, in a $4MM round, the VC has the ability to retract up to 90% of the investment within 90-120 days if the deal isn’t what they thought it was?  This kind of approach will likely never occur, but if you look at entrepreneurs as the “customer”, then I’m pretty sure there are a pool of customers out there that would like more rapid “service” than they’re getting now.  Will we see innovation in the VC sector anytime soon, or is it by design immune to the need for change?
If you are a VC, or play one on TV, would love to hear your thoughts on this.  What am I missing?

Posted by Dharmesh Shah on Fri, Aug 25, 2006


People like to think before spending US$ 10 millions: News at eleven!

Could you please post a link to your previous article about the VC's "no"? I am a regular reader of OnStartups but I don't remember seeing this particular article...

And isn't small amounts (well, at least smaller than millionary VC's money) called angel investiments? Someone that gives you 50K is an angel, isn't?

posted on Friday, August 25, 2006 at 12:12 PM by Julio Nobrega

The SBA has a program called the "low-doc" loan: the loan amount is capped, but the amount of paperwork and turnaround time required to get the loan is also reduced. You seem to be suggesting that VCs do something similar. It's an interesting idea.

But what's in it for the VC? What benefit do they see from this process change?

posted on Friday, August 25, 2006 at 1:00 PM by fiat lux

These are great observations on the state of the VC process today. How about this:

1. A VC makes available a form on their website, allowing the entrepreneur to provide a short executive summary.
2. An associate or even a managing partner reviews it and gives a "no" within 24 hours if it does not fit their current investment criteria.
3. If the opportunity intrigues the VC they ask the entrepreneur to provide more documentation, a business plan or maybe a live demo. If that does not go well they give the entrepreneur a "no" right away.
4. Only then do they get into their extended think time.

I have always appreciated getting a "no" from a VC it saves everybody time and money.

One aspect that I think VC's miss out on is that the clock is ticking. If you wait six months that is six months of hiring, revenue, and development time that you will NEVER get back.
A lot of investors use that waiting time to see if the entrepreneur can make good on their timelines for customer acquisition and product development. While that reduces the risk they are exposed to it also increases the valuation, thus reducing the return to the investor.

posted on Friday, August 25, 2006 at 4:28 PM by Stiennon

What are you missing? You're missing the real role of the entrepreneur.

The entrepreneur is *not* the VC's customer. The VC's customer is the investor. The entrepreneur is the VC's "commodity" that needs "processing" by the "investment factory" the VC is running.

posted on Friday, August 25, 2006 at 4:49 PM by Loryn

Loryn said it first, the VC customer is the investor. A big part of "processing" is trust. Developing trust is not something you can rush or shorten. This is part of the human condition.

posted on Friday, August 25, 2006 at 6:18 PM by Charles Verge

I believe the "bake" time, as you call it, is extremely important for anyone who is about to devote a significant amount of energy and resources into an idea, project, etc. As someone once pointed out to me, "Never make a decision today that can reasonably be put off to tomorrow." Unfortunately for entrepreneurs, I do not think this mentality will change. However, I do favor this mentality overall, as I believe time allows for an idea to be honed and fine-tuned, and overall, will lead to a greater success.

posted on Friday, August 25, 2006 at 6:49 PM by

VCs take a long time. That is true.

To explain this by fuzzy psychological factors (getting comfortable with the team, etc etc) is to deceive onself.

They take a long time for two reasons.

(1) the longer they stall, the better deal they can get. Once when some VCs I worked with found out I wrote a personal check to a startup that was "just about to get funding" so we could make payroll, they moved really fast. They were hoping I would come to them begging for a bridge loan so they could get warrants or some such.

(2) they like the deals papered extensively. And they like this done by their downtown lawyers, who typically take 5%, and who you, the entrepreneur, will pay. You'll also need to use some of your proceeds to pay the VC's lawyers. If you ask them whether it's 5% they'll deny it, but figure on that amount anyway. The more complex the lawyers make the deal, the more money they make. I believe the lawyers make questionable changes to your articles of incorporation and other documents so they can run up the tab arguing with each other. I have to be careful here, because if I accuse this of doing this intentionally, I accuse them of the common-law crime called "maintenance."

So, term-sheet to money-in-bank = 45 days minimum. Anyone who tells you a shorter time is very likely incorrect. And any error in this time estimate will come out of the entrepreneurs's hide.

One other thing. When you sign up with your lawyer, make sure to write them a letter saying you want all bills presented no later than sixty days after the work is performed, and you want everything itemized, or you will not pay the bill. I have had downtown lawyers wait until money was running short and a second round was needed before billing. Guess what I had to do? beg for a bridge loan from the investors. Ugly.

The good news is the VCs need the entrepreneurs ... they need to invest their limited partners' money in startups.

posted on Friday, August 25, 2006 at 8:30 PM by Ollie Jones

I would hazard that any VC that has been approached with some new idea wants to research the market independent of the analysis offered by the client. If it is a not so new but 'up and comer' idea than the VC would want to take the time to assess the competitors vis a vis the upstart trying to muscle in.

The short title -- Risk Analysis. And 3 months to get that done is probably a reasonable average.

posted on Thursday, August 31, 2006 at 12:21 PM by john mcginnis

Any VC worth his (they're just about all men) salt will require the entrepreneur to do this research. And, as an enttrepreneur you have every incentive to do this research carefully, even ruthlessly. After all, you're about to give up your personal life for several years in pursuit of the business. More then anybody, you want it to be successful.

Sometimes a VC will offer a seed round of financing for this purpose, if the research is going to be costly and the basic idea is OK.

Make friends with somebody who has access to Forrester or Gartner type reports, and borrow them. They are a good source of independent data.

posted on Thursday, August 31, 2006 at 4:56 PM by Ollie Jones

As an ex-Gartner analyst I can attest to the fact that many VC's are customers of research firms and make use of direct calls to the analysts during their due diligence.

posted on Thursday, August 31, 2006 at 5:01 PM by stiennon


posted on Friday, December 28, 2007 at 3:40 PM by DR APURBA MUKHERJEE PH.D.

Bake time and Risk analysis = 45 days is a good period for entrepreneur and the VC.

posted on Saturday, February 23, 2008 at 6:23 AM by Kiran Teegala

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