During conversations with VCs, entrepreneurs will often encounter a few sneaky questions that have nothing to do with their actual businesses today. Many of these are attempts by investors to learn something specific that they don’t want to ask directly, and there’s usually some kind of hidden meaning behind a given question. Some VCs may just be fishing for more information, but many are looking for specific “right” answers.
It’s a funny dance, and while experienced entrepreneurs know what’s going on and how to respond, these questions can easily trip up a founder going through the fundraise process for the first time.
Below are some examples and suggested responses. Of course, it’s always best to be honest and authentic, so this is not a proposed script so much as additional context to incorporate into your own thinking.
Sneaky Question No. 1
“Where do you see this company going in 5+ years?”
What they’re really asking: “Is there a really big business here and is this founder going to grind it out to get there?” Another sneaky way to ask this question is something like, “Why would you even raise money for this business?”
This is often a way to understand potential founder-investor alignment. As a founder, it’s important to remember that you should really only talk to VCs if you believe you’re working on a venture-scale business that can produce hundreds of millions of dollars or more in revenue or value. In these cases, the goal should be an outsized exit to another company or an IPO.
Obviously, not every company a VC backs accomplishes this (most don’t). And of course, thousands of great businesses are built every year without any need for venture capital. But for most VCs to get a return, they need to make sure that every company in which they invest at least has a shot at larger outcomes.
They also need to believe that the founders they back are in it to build a great business in the long haul and won’t be tempted by smaller-scale exits along the way. These exits might enrich the founding team but leave the VC with a mediocre outcome. And while there are ways to deal with this along the way (e.g. founder liquidity), you shouldn’t mention it during an early-stage fundraising process.
Answer: “I think about this all the time, and I can’t seem to find any compelling evidence that suggests that this can not be a large, independent, public company.” This was one of the best answers I’ve ever heard, which came from Fred Shilmover, the CEO of one of our portfolio companies, InsightSquared.
Sneaky Question No. 2
“Where are you in your fundraise process?”
What they’re really asking: “How fast do I need to move here as an investor? How much heat is there around this deal? Is this a ‘shopped’ deal?”
In this case, the VC is definitely fishing for information. You may not give them any, but it doesn’t hurt for them to ask. As a founder, your best bet is to convey real momentum if you can. Just know that the VC will remember what you said if things unfold differently.
For example, if you say, “I have a couple partner meetings next week and think I’ll have a term sheet pretty soon,” then you’d better have some sort of deal in hand by the end of next week. Otherwise, investors will think that you lied, you misread the situation, and/or those other firms passed. Regardless, you’ll be on your heels.
Answer: “We are just starting our process but have had a few meetings and are getting great feedback. Things are moving really fast, so I’d like to get some indication of interest within three to four weeks, and then choose the right partner shortly after that.”
The general advice here is to tell the truth and convey that you have momentum and are confident that some sort of a deal will come together soon. I wouldn’t overplay your hand around timing or investor interest, however, until you’re very sure that you’re getting a term sheet. But after that, use that term sheet as leverage for other conversations. Even if it’s not from the world’s greatest firm, you can use it as a forcing function to get other VCs to move. But if you don’t have at least 90 percent certainty that a term sheet is coming, then I wouldn’t be as specific.
The suggested answer above is similar to the common response I’ve heard from Y Combinator companies. It’s a good response because it communicates a few things:
- There are other interested VCs in the mix.
- But this deal hasn’t been overly shopped to investors.
- And there is a loosely established, reasonable timeline that requires a given investor to move with conviction.
Investors will make up their own minds about whether they believe your reply here, but it’s still a reasonably solid “baseline” response.
As an aside: Never name potential investors unless you’re completely convinced they’ll give you a ringing endorsement should a given VC call them. If you find yourself being pressed for names, you can just say something noncommittal like, “There are only so many investors that are great at X (e.g. early-stage e-commerce), and we are speaking to some of the usual suspects.”
If the investor really presses with no good reason, then they are just being sad and you should move on immediately. The best investors make up their own minds.
Sneaky Question No. 3
“What are your valuation expectations?”
What they’re really asking: “Is this deal realistically in a range that makes sense for me such that I should invest time to learn more after this meeting?”
VCs use this question and others like it to determine whether the parameters of your round are likely to be something satisfactory to them. Some may have certain biases, while others like my firm NextView have very focused, thesis-based strategies.
For instance, an investor could think a pitch is interesting, but upon learning that the round is likely to happen at a $75 million pre-money valuation or higher, they’d rather just walk away. As a VC, time is your main resource aside from capital, so you don’t want to burn a bunch of cycles on evaluating an investment if there is realistically no way a deal could get done that would be good for both parties.
Answer: “I am running a process and want to make sure that whatever valuation we get is fair and consistent with the market. That said, I want this company to be as successful as possible, so I care more about finding the right partner than the highest valuation. I realize that any good investor will have some ownership goals at this stage, and I think there will be a way to make it work for everyone.”
The real answer is that, regardless of what kind of a deal you want, the market will determine the valuation. As a founder, it’s more advantageous to you to get people interested and then walk the price or round size up than it is to go out with a huge ask and try to back up if you get pushback.
How much you raise is sort of code for your valuation expectations. If you’re raising $10 million in your Series A, for instance, then it’s safe to assume you’re not going to expect a price of $12 million pre-money. On the other extreme, it’s also unlikely that an investor would do it at $112 million pre, unless you’ve totally crushed it. (Almost all VCs want to own close to 20 percent after a Series A.)
When I see a $7 million ask, I think to myself, “Okay, if existing investors do $2 million, then that’s $5 million that the Series A investor would put in. That would mean that the valuation needs to be $25 million post-money at most, so $15-$18 million pre is somewhere in the ballpark of this founder’s expectations.”
Find Your North Star
There are certainly other tricky questions that entrepreneurs will face, but hopefully this list can help start a healthy dialogue around this idea. Ultimately, the North Star to guide you through most VC conversations is your need to find the best long-term partner for your business, period.
Especially during the seed stage, the goal is to find the true believers. You can optimize your outcome a bit by having the right answers to the questions above, but if you truly prioritize finding the right fit above all else, you won’t need to game the system.
In the end, you want to find someone who will be aligned with your goals for your company and isn’t just investing because of heat, as well as someone who would be willing to pay a price that’s fair.