Vc Bias: Do Looks Matter?

Venture capitalists (VCs) are investors who provide capital to new businesses, typically startups, in exchange for an equity stake. VCs are known for making large bets on new startups, with the hope that they will eventually become the next big thing. However, the question arises: do VCs only invest in people who look like them?

While there is no definitive answer to this question, it is important to consider the factors that VCs take into account when making investment decisions. These include the management team, business concept and plan, market opportunity, and risk judgement. VCs invest in a management team and its ability to execute the business plan. They look for experienced and accomplished managers who have successfully built businesses and generated high returns for investors. Additionally, VCs seek to invest in businesses with a large market opportunity and a unique, innovative product or service.

It is worth noting that VCs have been criticised for bias in their investment decisions, with female founders receiving a disproportionately low amount of VC funding. This bias may be influenced by factors such as gender stereotypes and implicit biases, which can impact the evaluation of female entrepreneurs and their business ideas. However, it is important to recognise that VCs are also driven by financial incentives and the potential for high returns, rather than solely by personal biases.

In conclusion, while VCs may have certain preferences or biases that influence their investment decisions, it is unlikely that they only invest in people who look like them. Instead, their decisions are guided by a range of factors, including the quality of the management team, the market opportunity, and the potential for high returns.

VCs are motivated by FOMO and FOLS

Venture capitalists (VCs) are motivated by two key psychological drivers: the Fear Of Missing Out (FOMO) and the Fear Of Looking Stupid (FOLS). These fears play a significant role in shaping their investment decisions and strategies.

FOMO: Fear of Missing Out

VCs have a deep fear of missing out on potentially lucrative investment opportunities. They are constantly worried about passing on a company that could become a major success, or failing to get involved in a deal that their competitors are pursuing. This fear is driven by the high-risk, high-reward nature of the venture capital industry, where identifying and investing in the next big idea can lead to substantial financial gains. As a result, VCs are always on the lookout for promising startups with the potential to become the next Facebook or Tesla.

FOLS: Fear of Looking Stupid

VCs also have a strong fear of making investments that might be perceived as foolish or unwise by their peers. They are cautious about investing in companies that compete with established businesses, especially if those businesses have already received significant funding or are dominated by a successful competitor. VCs want to avoid being questioned about their investment choices and strive to maintain their reputation and credibility in the industry.

Balancing FOMO and FOLS

VCs are constantly balancing these two fears as they screen and evaluate potential investment opportunities. They seek to find safe deals at low prices while also aiming for high-risk, high-reward outcomes. VCs want to invest in companies with strong potential, but they also want to minimise the risk of looking foolish if the investment doesn't pay off. This dynamic can create challenges for startup founders seeking funding, as they must navigate the complex motivations and concerns of VCs.

Using FOMO and FOLS to Your Advantage

Understanding the psychology of VCs can be beneficial for startup founders when pitching their business ideas. By emphasising the low risk and high potential of their venture, founders can assuage the fears of VCs. Additionally, creating a sense of competition and urgency by mentioning interest from other investors can trigger FOMO and motivate VCs to act quickly. It is crucial for founders to learn the language of VCs and tailor their pitch to address their specific concerns and motivations.

VCs need large exits

VCs, or venture capitalists, need large exits because they are seeking high returns on their investments. VCs typically raise funds with a 10-year lifecycle, including five years of investing and five years of working with companies to create exits. The goal is to ""de-invest" at a higher price than the initial investment, maximising the value of their investments.

To achieve this, VCs need to hold a significant stake in the companies they invest in (typically 15-25%) and maintain good relationships with the founders and other investors. They look for startups with the potential to become billion-dollar companies and aim for huge outcomes. VCs seek to identify companies that can provide a meaningful exit, which is typically defined as a company able to return one-third of the fund.

The exit strategy for VCs can be through acquisitions or initial public offerings (IPOs). Acquisitions are the more common route, providing a faster and cheaper option for VCs to exit their investments. On the other hand, an IPO offers the largest return potential for startups that have the capability to become industry leaders with steady revenue growth.

Overall, VCs need large exits to generate substantial returns for their investors and compensate for the high risks associated with venture capital investments.

VCs need a big stake

Venture capitalists (VCs) need to secure a large stake in the companies they invest in. This is because they are seeking high returns on their investments, often aiming for a successful exit that can return the whole fund. To achieve this, VCs typically require a significant ownership percentage, usually in the range of 15-25%. This allows them to maximise their gains when the company is successful and helps them secure a seat on the company's board, giving them more influence over its direction.

The desire for large stakes is driven by two main factors:

• Return on Investment: VCs aim for high returns, often targeting a 100% return on their investment or even expecting each investment to have the potential to return the entire VC fund. To achieve this, they need to secure a large enough stake in the company so that their share of the profits is substantial.
• Board Influence: VCs want to have a meaningful say in the companies they invest in, and owning a significant percentage of the company gives them more power to influence its decisions and strategy. However, this also means that VCs need to be selective about which companies they invest in, as they can only effectively serve on a limited number of boards.

The specific ownership percentage sought by VCs can vary depending on the stage of investment and their overall strategy. For example, a VC leading a Series A investment may seek to own at least 20% of the company, while for a Series B or C round, they might aim for a smaller percentage (around 10-15%). In recent times, it has become more common for one major VC to take the lead with a large stake, while a number of other VCs invest smaller percentages.

The need for a big stake also stems from the high-risk nature of venture capital investments. VCs know that many of their investments will fail, so they aim for large stakes in the successful companies to make up for these losses. This is often referred to as the "Babe Ruth effect", where VCs swing hard and occasionally hit a home run, making up for all the losses and then some.

It's important to note that VCs' desire for large stakes is not just about financial gain but also about maintaining influence and control over the companies they invest in. This can sometimes lead to unnatural behaviour, such as walking away from a deal if they cannot secure their target ownership percentage.

VCs need to maintain good relationships

Maintaining good relationships with VCs is crucial for long-term success and can be even more valuable than the funding received. Here are some strategies to build and maintain positive relationships with VCs:

Regular Updates

Providing regular updates is an effective way to show progress and build enthusiasm for your startup. VCs appreciate receiving consistent and personalised updates, whether it's through a monthly or quarterly newsletter, email communication, or other formats. Highlight key metrics, achievements, challenges, and goals. Include personal touches, such as photos and testimonials, to make your updates more engaging and memorable. Remember, VCs want to see momentum and progress, even without their financial support.

Transparency and Honesty

Building trust with VCs is essential, and being transparent and honest about your startup's performance is crucial. Don't exaggerate numbers or hide problems. Be upfront about challenges, risks, and uncertainties, and show that you are proactive in addressing them. VCs can easily spot red flags and inconsistencies, and valuing honesty helps maintain their interest and confidence in your venture.

Seek Advice and Feedback

VCs have extensive experience and expertise in the startup ecosystem. By seeking their advice and feedback, you demonstrate respect for their opinion and a willingness to learn and improve. This approach refines your business model and fosters a collaborative and respectful partnership, which is essential for future growth and potential funding opportunities.

Face-to-Face Meetings

Building strong relationships with VCs is similar to building friendships. J.J. Kasper, the founder of Blue Collective, recommends scheduling regular face-to-face meetings with VCs. While email updates and gifts are common, nothing replaces the rapport built through in-person interactions. Treat VCs as you would a friend, and they will be more inclined to support and invest in your venture.

Gratitude and Value Addition

Expressing gratitude and adding value to the relationship are important. VCs appreciate it when you make their lives easier and more enjoyable. Share relevant information, insights, or opportunities, such as market trends or industry news. Show that you value their expertise, network connections, and funding support. Building a respectful and mutually beneficial partnership increases the likelihood of long-term success.

VCs invest in people, not just businesses

While a "good idea" is essential for venture capitalists (VCs) considering an investment opportunity, it is not the only factor. VCs invest in people, not just businesses. The team behind a business idea is a top factor that VCs consider when deciding where to place their money.

VCs are selective about where they invest because they take on serious financial risk. Around 65% of VC-backed businesses fail to return their capital. When evaluating a potential investment, VCs consider the management team, business concept and plan, market opportunity, and risk judgement.

The management team is the most important factor. VCs are not looking for "green" managers; they seek experienced executives who have successfully built businesses that have generated high returns for investors. VCs want to see a team that is passionate about their product or service and has the skills to overcome future challenges.

In addition to the team, VCs also consider the proof of concept, the size of the market, and the terms of the investment. They want to see a compelling and unique product with strong differentiators and a large market of people spending money. VCs also want to know how their capital will be put to work, with a detailed financial forecast and a clear path to a reasonable return on investment.

VCs are looking for huge outcomes and low risk. They want to find very safe deals at the low price of a very risky deal. To convince a VC to invest, entrepreneurs should showcase their low risk, high potential, and momentum in the form of interest from other investors.

Frequently asked questions