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

Posted by Dharmesh Shah on August 25, 2006 in startups funding vc venturecapital 24 Comments


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?