At seed stage, the odds of meeting a good founding team, with a fully tested product and early signs of traction are usually fairly high. At pre-seed, it’s a different ball game and you are far less likely to find a founder who's made the same progress. This means that pre-seed founders almost need to work harder when pitching for investment.
At Forward, we host a monthly founder programme called, Office Hours, where they are invited to pitch to one of our investors. For further context around how tough raising at pre-seed is, we receive approximately 150 applications per month, of which 10% get through to a 15-minute meeting and 1–2% progress to a later stage in our investment process.
We've analysed the data we collect from the Office Hours sessions, to summarise the 4 key reasons why we may not invite a founder to the next stage in the investment journey.
Understand the “differentiation challenge”.
Startups, by their very nature, should offer something new and exciting. It therefore seems surprising that 32% (the highest number of opportunities) are lost because they fail to differentiate their offering versus what already exists.
We appreciate it’s not easy to make a new product, vision or business model stand out, or indeed to build credibility in crowded markets. Our guide to evaluating your startup idea provides a hands-on approach to testing whether founders have developed a differentiated product by putting it directly into the hands of customers.
A particular challenge we observe from Office Hours submissions is the “feature trap”, where applicants pitch a new tool or a small tweak to existing solutions, but don’t have enough on which to build a differentiated business.
The founder’s ‘differentiation challenge’ is to set apart their company as a whole, as opposed to staking their future on one or two isolated features.
Markets that deliver “venture scale” outcomes.
Many Office Hours applications pitch perfectly good businesses, which have every chance of succeeding by gaining traction in small, but limited market segments. These businesses often succeed with organic growth or raising investment from angels, whose cost of capital, (and required rate of return) is lower due to tax breaks and incentive schemes.
However, this article on the Equity Kicker explains why VCs must do the maths on the market and the potential exit outcomes when evaluating an investment. Due to VC fund economics (a subtle way of calling out the difficulty of predicting the success rate of startups), each investment we make must have the potential to return the entire fund back to our own investors (in Forward Partners’ case, that’s £60m). That means if we have a 10% stake, the exit value should be £600m or if we have a 25% stake it should be £240m.
Assuming this outcome is based on a 3–4x revenue multiple (£60-£80m revenue in the exit year), and the startup has captured 10% of a given market, the total size of the addressable market needs to be £600m+.
If founders are going after a large market (or starting with a small bridgehead before expanding into adjacent ones), it is equally important for founders to articulate the way in which their vision could deliver venture scale outcomes. This might involve setting out a clear plan on how to scale their marketing channels, or the unit economics behind achieving that kind of growth.
Fit with a VC’s investment strategy.
Whether your startup is on / off strategy is a binary outcome (affecting 20% of all inbound). If a startup doesn’t fit with the fund’s focus or investment stage (9.7%), no matter how awesome it is, it’s unlikely to get a second look.
In this article on getting to a first meeting with VCs, we explain how to target funds that are the best fit for your business. However, the best way to get a sense of a VC’s investment strategy is to look at their current portfolio or read thought pieces by their Managing Partner(s). For instance, Nic Brisbourne outlines Forward Partners’ investment strategy for Fund II here.
Similarly, it is important to pick the right VC targets. It makes no sense to send an application to a VC if you are too early (or in our case, more often too late) for their stage focus.
Articulate a crystal clear use case with proven pain points.
Few applications (9.8%) are rejected on the basis of a poor use case, though this loss reason has been increasing over time. Cutting the data by “sector” or “category” suggests this correlates with our “Applied AI” investment strategy.
In areas such as artificial intelligence, there are many technologies looking for a problem to solve but it’s important to address a clear market pain point with the solution you have built.
When you’re trying to get us excited about investing in you, we need to see that you live and breathe the industry. Understand what makes your company stand out. Know your market. Take the time to prepare your pitch. That’s how you beat the odds.