How Do Venture Capitalists Make Decisions?

Based on booty, both kinds.

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..

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 )

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

> 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.

Haha