How to Convince Investors

[How to Convince Investors]

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August 2013

When people hurt themselves lifting heavy things, it's usually
because they try to lift with their back. The right way to lift
heavy things is to let your legs do the work. Inexperienced founders
make the same mistake when trying to convince investors. They try
to convince with their pitch. Most would be better off if they let
their startup do the work — if they started by understanding why
their startup is worth investing in, then simply explained this
well to investors.

Investors are looking for startups that will be very successful.
But that test is not as simple as it sounds. In startups, as in a
lot of other domains, the distribution of outcomes follows a power
law, but in startups the curve is startlingly steep. The big
successes are so big they
dwarf the rest. And since there are only
a handful each year (the conventional wisdom is 15), investors treat
"big success" as if it were binary. Most are interested in you if
you seem like you have a chance, however small, of being one of the
15 big successes, and otherwise not.
[1]

(There are a handful of angels who'd be interested in a company
with a high probability of being moderately successful. But angel
investors like big successes too.)

How do you seem like you'll be one of the big successes? You need
three things: formidable founders, a promising market, and (usually)
some evidence of success so far.

Formidable

The most important ingredient is formidable founders. Most investors
decide in the first few minutes whether you seem like a winner or
a loser, and once their opinion is set it's hard to change. [2]
Every startup has reasons both to invest and not to invest. If
investors think you're a winner they focus on the former, and if
not they focus on the latter. For example, it might be a rich
market, but with a slow sales cycle. If investors are impressed
with you as founders, they say they want to invest because it's a
rich market, and if not, they say they can't invest because of the
slow sales cycle.

They're not necessarily trying to mislead you. Most investors are
genuinely unclear in their own minds why they like or dislike
startups. If you seem like a winner, they'll like your idea more.
But don't be too smug about this weakness of theirs, because you
have it too; almost everyone does.

There is a role for ideas of course. They're fuel for the fire
that starts with liking the founders. Once investors like you,
you'll see them reaching for ideas: they'll be saying "yes, and you
could also do x." (Whereas when they don't like you, they'll be
saying "but what about y?")

But the foundation of convincing investors is to seem formidable,
and since this isn't a word most people use in conversation much,
I should explain what it means. A formidable person is one who
seems like they'll get what they want, regardless of whatever
obstacles are in the way. Formidable is close to confident, except
that someone could be confident and mistaken. Formidable is roughly
justifiably confident.

There are a handful of people who are really good at seeming
formidable — some because they actually are very formidable and
just let it show, and others because they are more or less con
artists.
[3]
But most founders, including many who will go on
to start very successful companies, are not that good at seeming
formidable the first time they try fundraising. What should they
do?
[4]

What they should not do is try to imitate the swagger of more
experienced founders. Investors are not always that good at judging
technology, but they're good at judging confidence. If you try to
act like something you're not, you'll just end up in an uncanny
valley. You'll depart from sincere, but never arrive at convincing.

Truth

The way to seem most formidable as an inexperienced founder is to
stick to the truth. How formidable you seem isn't a constant. It
varies depending on what you're saying. Most people can seem
confident when they're saying "one plus one is two," because they
know it's true. The most diffident person would be puzzled and
even slightly contemptuous if they told a VC "one plus one is two"
and the VC reacted with skepticism. The magic ability of people
who are good at seeming formidable is that they can do this with
the sentence "we're going to make a billion dollars a year." But
you can do the same, if not with that sentence with some fairly
impressive ones, so long as you convince yourself first.

That's the secret. Convince yourself that your startup is worth
investing in, and then when you explain this to investors they'll
believe you. And by convince yourself, I don't mean play mind games
with yourself to boost your confidence. I mean truly evaluate
whether your startup is worth investing in. If it isn't, don't try
to raise money.
[5]
But if it is, you'll be telling the truth
when you tell investors it's worth investing in, and they'll sense
that. You don't have to be a smooth presenter if you understand
something well and tell the truth about it.

To evaluate whether your startup is worth investing in, you have
to be a domain expert. If you're not a domain expert, you can be
as convinced as you like about your idea, and it will seem to
investors no more than an instance of the Dunning-Kruger effect.
Which in fact it will usually be. And investors can tell fairly
quickly whether you're a domain expert by how well you answer their
questions. Know everything about your market.
[6]

Why do founders persist in trying to convince investors of things
they're not convinced of themselves? Partly because we've all been
trained to.

When my friends Robert Morris and Trevor Blackwell were in grad
school, one of their fellow students was on the receiving end of a
question from their faculty advisor that we still quote today. When
the unfortunate fellow got to his last slide, the professor burst
out:

Which one of these conclusions do you actually believe?

One of the artifacts of the way schools are organized is that we
all get trained to talk even when we have nothing to say. If you
have a ten page paper due, then ten pages you must write, even if
you only have one page of ideas. Even if you have no ideas. You
have to produce something. And all too many startups go into
fundraising in the same spirit. When they think it's time to raise
money, they try gamely to make the best case they can for their
startup. Most never think of pausing beforehand to ask whether
what they're saying is actually convincing, because they've all
been trained to treat the need to present as a given — as an area
of fixed size, over which however much truth they have must needs
be spread, however thinly.

The time to raise money is not when you need it, or when you reach
some artificial deadline like a Demo Day. It's when you can convince
investors, and not before.
[7]

And unless you're a good con artist, you'll never convince investors
if you're not convinced yourself. They're far better at detecting
bullshit than you are at producing it, even if you're producing it
unknowingly. If you try to convince investors before you've convinced
yourself, you'll be wasting both your time.

But pausing first to convince yourself will do more than save you
from wasting your time. It will force you to organize your thoughts.
To convince yourself that your startup is worth investing in, you'll
have to figure out why it's worth investing in. And if you can
do that you'll end up with more than added confidence. You'll also
have a provisional roadmap of how to succeed.

Market

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