
How Do Venture Capitalists Make Decisions? - abuteau
https://medium.com/pnr-paper/venture-capital-decision-making-c3258bc1b09c
======
projectramo
I would be curious to see more detail about these factors:

"...the attractiveness of the market, strategy, technology, product/service,
customer adoption, competition, deal terms and the quality and experience of
the management team."

I feel that there is another layer of analysis that is being missed which is
the interaction.

Q: Would you invest in AirBnb at 31B?

Hypothetical response: No, there is so much competition from the hotels, and
competing sites. I think they have liability risk.

Q: How about at $1B value?

Hypothetical: Are you kidding me? Of course!

The valuation interacts with the other criteria.

Q: Would you invest in my personal device company at $100 million?

Hypothetical answer: No way. I think the market is saturated.

Q: Will you do it now that Steve Jobs is back from the dead and has agreed to
be the CEO?

Hypothetical answer: duh! Of course!

Again, the "team" has now changed things around.

I can't think of any situation where these factors don't interact with each
other.

~~~
abuteau
Hey op here, good feedback,

Yes factors do interact. However it was not really part of the survey.

One thing they had was the difference between most important factors and
important factors

In the summary, I reported only the most important factors. If you look at the
important factors here are the results, which show a bit the factors
interacting:

Team 96% for early, 93% for late

Business model 84% for early, 86% for late

Product 81% for early, 60% for late

Market 74% for early, 69% for late

Industry 30% for early, 37% for late

Valuation 47% for early, 74% for late

Ability to add value 44% for early, 54% for late

Fit with the fund 48% for early, 54% for late

There are also other factors that will impact the companies valuation such as
anticipated exit, comparable companies, competitive pressure and desired
ownership.

For more a deeper analysis I think it would be interesting to see the survey
applied to a scenario planning model like the team at the OS Fund did [1].

[1] [http://osfund.co/the-osf-playbook/](http://osfund.co/the-osf-playbook/)
[EDIT]: Formatting

~~~
graycat
In the report, I didn't see much mention of _traction_ , revenue, _social
proof_ , etc.

For _technology_ , sure, bio-medical VCs can evaluate that, but I doubt that
information technology VCs can or will.

For deal flow, a common remark of VCs is that an entrepreneur who contacts a
VC direction is just "coming over the ransom" which means that they are to be
ignored. From that contempt, tough to believe that VCs care much about deal
flow.

A common remark is that VCs lose money on ~90 percent of their deals but that
last 10 percent, or even the one best deal, makes up for all the losses and
makes money besides. Okay, then, necessarily what the VCs are interested in
are exceptional deals. That is, they are looking for another Microsoft, Apple,
Cisco, Google, Facebook. Okay, then in their deal sourcing they have a
fundamental problem: They are getting too much of their deal flow from their
colleagues, and that's not promising for finding the needed exceptional deals.

~~~
abuteau
I'd say anticipated exit, comparable companies, competitive pressure and
desired ownership play the role of social proof. For revenue, most likely
related to the business model.

The interesting distinction in the report was between deal flow and deal
selection. VCs care more about deal selection. For deal flow most of it is in
their own network or through syndicates.

For the 90% fail 10% success you can look at exit multiples coupled with type
of exit (M&A, IPO, failure).

My hypothesis is that most of them dont really have a proprietary deal flow
and are unable to make great deal selection apart from the top VCs..

~~~
graycat
> For revenue, most likely related to the business model.

You totally lost me: In the report, I just didn't see any mention of traction
or revenue. I can't see that traction or revenue are part of the business
model, product, technology, or anything else that was mentioned.

Business model? Sure, for some early stage, can discuss that independent of
traction or revenue.

IMHO, from all I've seen, for information technology VCs and early stage, far
and away, far above anything else, what VCs want to see is traction
significantly high and growing rapidly. In comparison, everything else is
small potatoes. The form of traction they want to see most of all is revenue,
but they will also consider number of unique users per month, any COMSCORE
data, number of Web pages viewed per month, etc.

My guess is that the LPs enforce the high interest in traction. Or, the LPs
very much like traditional accounting, even the traditional approach of a
commercial banker where a loan is against assets as counted by usual
accounting. Well, for startups, the commercial banker approach won't work, so
the VCs talk the LPs into accepting a substitute, a surrogate, _traction_. So,
the _asset_ they are investing in is the _traction_. For team, determination,
technology, business model, etc. accountants and commercial bankers don't care
about those, so LPs don't either, so VCs don't either.

Or the VCs believe in a Markov assumption: The past and future of the company
are conditionally independent given the current traction and its rate of
growth. Or, if the traction is good, then everything must be good. If the
traction is not good, then nothing else matters.

The report mentioned that VCs can invest in ideas. My guesses are that
information technology VCs regard an idea and a dime as not quite enough to
cover half of a 10 cent cup of coffee. The standard remark is that "ideas are
easy, plentiful, and worthless. Execution is hard, rare, and everything." Of
course, by an _idea_ what VCs have in mind is just some fast, over the back
fence to a neighbor description of the project, say, as a user or customer
would see it. For people in technology, an _idea_ is something that might get
a patent, be protected as a trade secret, is the crucial, core, enabling
_secret sauce_ and the main asset of the whole project. Information technology
VCs won't evaluate such ideas. I can think of no sense in which a VC will
invest in an idea. Moreover, I have to suspect that VCs really hate ideas that
would be secret sauce from research. Why? Because the VCs know that that then
would be part of the business they would not understand, and that scares them.
For _technology_ , what information technology VCs want is just some routine
software that, if necessary, they could turn over to any of 20 programmers
they could recruit in less than a week.

My guess about VCs is that they are looking for some special situations. So,
there are, say, four co-founders. The company has traction significant and
growing rapidly. But so far the company is still losing money and, really, is
about to go out of business. All the credit cards are maxed out. All four co-
founders are married, and all the wives are pregnant. Then, sure, a VC might
give enough money for a little more runway and take a lot of control. The
company is so desperate that they are ready to sign a bad business deal. The
VC sees that even if the company totally flops, given the four co-founders, he
could likely get his investment back from just an acqui-hire.

------
forgottenacc57
Is it a perfect team, with a complete working product, massive user base and
sales and no risk and lots of other investors wanting in? We're in!

Else, "Your company is not a fit for us right now but keep us in the loop."

~~~
abuteau
Mostly ;)

Marc Andreessen wrote a good article on the layers of risks that VCs are
looking into [1]. Most of them want to maximize the upside while minimizing
the downside..

[1]
[http://pmarchive.com/guide_to_startups_part2.html](http://pmarchive.com/guide_to_startups_part2.html)

------
jkarneges
As a founder, my observation of seed stage fundraising is that there's a high
degree of randomness, or at least most of the factors involved are outside of
your immediate or near-term control. Decisions are mostly based on the
excitement investors have for the team and idea. Since excitement is
emotional, this can really vary. Decisions can be made based on how the
investor's day has gone so far.

You would think that success is mostly about your pitch, and if you have great
slides, meaningful graphs, and nail the delivery then you get money. It's not
like this at all. VC fundraising is not Shark Tank. It's market timing, it's
people, it's emotions.

There's a saying that seed funding is easy and the money grows on trees, and
things don't get hard until the Series A. I think the more nuanced explanation
is that when seed funding is successful it is usually easy (the stars
aligned!), otherwise it's impossible. This leads to successful founders
telling stories about easy seed rounds, but there are probably fifty times as
many founders who have failed to raise that just don't talk about it.

Here's what Aaron Harris of YC said this year:

"Unfortunately, fundraising takes up a lot more time and thought than it
should, because it seems like something that should be systematic but is
actually chaos, which really confuses people, especially people who are
logically brained." (source:
[https://www.youtube.com/watch?v=5ZXU84_sGXo](https://www.youtube.com/watch?v=5ZXU84_sGXo)
)

Not terribly actionable information, but good for founders to know.

------
zzalpha
So they report the factors they weigh, then self-report the factors they think
contributed to success?

That feels like fertile ground for confirmation bias.

~~~
avs733
I have a foot in the engineering research, the educational research, and the
business research camps.

The level to which I trust the findings in business research is basically this
order:

1) Educational Research

2) Engineering Research

3) A guy on the corner saying 'trust me'

4) Business Research

The issue is simply down to the level of trust they seem to place in their
data. The data is treated as invariant and highly positivist, and their trust
in experts self-reports (because they are self-reports) is staggering. You
should be really cautious at an epistemic level of taking anything business
researchers tell you about how people make decisions.

~~~
abuteau
Agreed, I look at about 10 business paper a week and quality of statistical
analysis is frequently missing. What I liked about this one is that they are
pretty transparent on the methodology so you can see the surveyed VCs biases.
They also cross check the sources with other data..

------
princetontiger
Yikes. Look institutionalized. The big money is made during the troughs when
hand shacks work: 70s, early 90s, early 00s.

At the end of the day, most VC valuations are pulled out of a hat. There's a
reason why $1B has become a sexy handle: people ascribed some type of value to
this valuation.

------
comstock
The first table, which shows where deals are sourced from, was most
interesting. I was surprised that VCs reported that 22% of leads were
proactively sourced.

Beyond that, I don't think the trust VCs to self report. In particular all VCs
say "team" is really important. But in my experience they don't really probe
the team very much, or get to know them and their background well.

Possibly what they mean is "has previously been CEO of successful startup" or
something similar.

Overall, I think VCs build up a qualatitive feeling of how comfortable they
are with a play. And critically, how well it can be justified as being a
reasonable decision if things don't go well.

------
danielam
[http://www.kauffman.org/what-we-do/research/2012/05/we-
have-...](http://www.kauffman.org/what-we-do/research/2012/05/we-have-met-the-
enemy-and-he-is-us)

~~~
abuteau
Good research, thanks for sharing. Kauffman has interesting content.

------
logicallee
This write-up is wrong and incorrect.

At the seed stage, VC's actually do not make decisions this way.

I am going to give you a simple example: if a VC were presented with an
opportunity and they knew for a fact that this was proprietary dealflow and if
they did not invest, the company certainly would die, i.e. had precisely zero
viability _but for_ their (and only their) investment, are there conditions
under which they would invest?

The actual demonstrable answer at the seed stage is "no."

This proves that the write-up is incorrect. Not how VC's make decisions.

~~~
abuteau
Can I drop you a mail, I would be interested to explore where its incorrect.

Also please remember that the survey simplifies the reality by putting
everything in the same model of deal selection.

From a practical standpoint I have some VCs friends that use a model similar
to this and others dont.

~~~
logicallee
Your VC friends only _claim_ to use a similar model as this and it is not
true. It is also falsifiable empirically - you could verify it experimentally
if you really wanted.

You can email me at the email in my profile if you wanted. (I am not
affiliated with YC and I'm not a VC, though.)

However a good starting point for how investors actually make decisions is
here: [http://www.foundersatwork.com/1/post/2012/10/what-goes-
wrong...](http://www.foundersatwork.com/1/post/2012/10/what-goes-wrong.html)
under the "investors" section.

It is a much better summary of how they actually make decisions (as opposed to
what they report). I won't try to summarize it, just read those 11 paragraphs
- but I will quote "If you remember one piece of advice about investors, it's
that you've got to create some type of competitive situation."

This is entirely absent from the article (which is wrong.) "Table 2: Important
Factors for Investment Selection" is entirely, laughably wrong.

It is simply not the way VC's actually make their investment decisions. At
all. (Certainly at the seed stage.) Completely wrong. Sorry.

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rdlecler1
I was cofused. In the one chart, 0% of VCs reported that their own
controbution contributed to success, then father down 27% of VCs reported that
value add was an important factor in value creation. Anyone have additional
insight?

~~~
abuteau
The way the data was structured is they were asked what is the MOST important
factor (you can only chose one) whereas other parts of the survey were what
are the important factorS.. Might create the confusion.

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scott_booth
Based on booty, both kinds.

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nunez
this was an awesome read. archived for future ref:
[http://archive.is/XM2BO](http://archive.is/XM2BO)

