In the game of venture-backed startups, if you’re focused on downside protection, you’ve already lost…
A founder told me he ran into a situation where potential investors pressed him about the risks of his startup failing. He was confused about how to fully address concerns of risk and wanted to know “What can I provide them upfront that will make them more comfortable about the chances of losing their money?”
My overall feedback to him was this: If you’re focused on answering questions about managing risk and minimizing downside, you’ve already lost. If you’re not focused on the reasons you will be a MASSIVE business, you’re playing the wrong game and setting yourself up for failure. And if the investor you’re talking to isn’t focused on the moonshot potential of the opportunity, they’re not the right partner and shouldn’t be talking to you (and vice versa).
In order to understand this feedback, you first need to understand the basics of investing overall and specifically the VC investing business model.
Just because the term “VC investing” has the word “investing” in it, doesn’t mean you can take your knowledge of “real estate investing,” “stock market investing,” or “NFT investing🤪” and copy paste it. In all cases, investors put money in (invest) and hope to be able to take out more money than they put in (profit). Investing 101. Duh.
How they do that and the expectations around how their investments will generate profit is the subtlety that will help you understand my feedback.
For many types of investing, the risk of the underlying asset (the actual thing you invest in) like real estate or a public market stock is such that the price can fluctuate up and down but don’t realistically have a chance of going to zero. A house that can provide shelter and a public company that is generating scaled revenue both have intrinsic value that won’t ever completely evaporate.
Because of this dynamic, investors in those asset classes will put money in knowing there is some risk of their investment going down slightly but they’re betting on the overall portfolio of bets to go up on average. Making sure their investments don’t go down dramatically is an important part of making the portfolio strategy work.
Side note: what’s portfolio strategy? It is making a basket of bets, not just 1 bet, with the expectation that the average of the outcomes will generate the outcome you want.
A VC’s business model is different. They play a high risk, high reward game. In this case, the underlying asset (a brand new startup) has very little intrinsic value. With no revenue and no hard assets, the possibility of an investment going to zero is incredibly high. In fact, even investments that return some money but don’t go to zero, are essentially counted as zeros within their portfolio strategy. That’s because the only investments that matter in a VC’s portfolio are the grand slams. Their portfolio strategy is keyed off of very few winners covering the zeros from the rest of the portfolio.
Let’s go back to where I started.
If you go into a VC pitch focused on minimizing downside, you’ve already lost.
*caveat - notice the qualifier “VC” in front of “pitch.” We are talking about raising money for a venture-scale business, not smaller lifestyle businesses. And in case you needed to hear me say it… (I feel like Andrew Gazdecki is waiting to jump in to eviscerate me if I don’t…) I LOVE lifestyle businesses. Bootstrappers are amazing. That said, I am specifically talking about venture-backed businesses. Ok, continuing on.
Minimizing downside is just the wrong mindset to have when pitching investors. No startup founder in this game goes into a pitch saying “By the way, if we fail it will be because of these three reasons: the market might turn against us, we might have co-founder conflict, and we might not find PMF… but we are trying our hardest to avoid these. For those defensive reasons, you should invest in us!”
Instead there should be a deep confidence in your understanding of the space you’re in and a belief that you’re pointed in the direction of a possible moonshot.
Have you thought about how this could become a massive company? How it could be a moonshot? It might be a slightly scary thought exercise but you need to stretch your mind there and truly think about it.
You’ve already thought about it, you say?
Most of you haven’t. I don’t count your hand-wavy “There’s a $1T TAM and if we just take 1% of that market it’s going to be a multi-billion dollar company” as really going through the thought exercise.
Go bottom-up and piece together how what you’re doing now evolves into that moonshot winner that everyone talks about when it IPOs.
Side note: Do you understand “bottom-up”? I mean take what you do today at a granular level (“I sell t-shirts”) and imagine how you’ll have to grow what you do to become a company that’s worth over a billion dollars. Download this bottom-up guide / worksheet to determining how you fit into a VC portfolio strategy.
That’s the scary large vision you need to have at least entertained before you go raising for your company. If you’re talking to the right investors who bet on the potential for large outcomes (not downside protection), they will be focused on that vision and deeply understand / accept ALL the risks that come with betting on such an audacious goal at the early stage.