Investing in tech startups an act of trust for VC firms

When investing in tech startups, including BI vendors trying to get started, venture capital firms want to see more than just a good idea.

They want to see a real need for a particular product when they consider investing in tech startups, and they want to see founders who have enough management experience that they won't ruin a company with poor decisions even if what they're bringing to market could stand out.

There is also a litany of things they don't want to see when they're investing in tech startups, warnings that tell investors a particular company is a bad bet.

Vanessa Larco is a partner at New Enterprise Associates, a venture capital firm with over $20 billion in assets under management. From Salesforce and Tableau years ago to Sisu just recently, NEA has a history of investing in tech startups, and betting on BI vendors in particular. Larco, meanwhile, has a background in computer science that includes time as director of product management at Box and leading the speech recognition experience team at Xbox Kinect v1, and she leads some of NEA's investments in tech startups and participates on deal teams led by colleagues.

Vanessa Larco

Larco recently answered a series of questions about investing in tech startups. In Part I of a two-part Q&A, she discussed what she looks for in BI startups and what stood out about Sisu. In Part II, she went into detail about what might prevent an investor from working with a company, and her process for investing in tech startups.

In a given year, how many tech startups -- not only BI vendors -- might NEA invest in?

Vanessa Larco: It's anywhere from 15 to 30 new investments per year where we take a board seat -- this excludes seed deals.

Meanwhile, when looking at investing in tech startups -- those 15 to 30 in a given year -- how many pitches do you go through before choosing who to work with?

Larco: For me individually, I invest in one or two companies a year -- period. I spend 12 months just finding those one or two companies a year. But I talk to at least one or two companies a day, so I'm seeing between 600 and 1,000 companies a year and I invest in one.

So of those other 599 to 999 companies, what is it about them that eliminates them? What are some obvious warning signs and some more subtle things that stop you from investing in a tech startup?

I can think of hundreds of reasons why you shouldn't invest, but what you're actually thinking about is what's that thing, what's the spark that makes you suspend disbelief and take that leap of faith.

Larco: By default, it's more about what is that special thing that makes me say, 'Yes.' When you're investing in a company in their early startup phase, there are a billion reasons why you shouldn't invest. I can give you a thousand red flags -- the capital-to-revenue ratio doesn't make sense, the team isn't experienced in the space, it's too early for us because they're pre-product, or it's too late for us because they're pre-IPO, the work that they're going after isn't big enough, the economics don't really make sense, and I don't understand how they're going to make sense in the future. I can think of hundreds of reasons why you shouldn't invest, but what you're actually thinking about is what's that thing, what's the spark that makes you suspend disbelief and take that leap of faith, because they're all leaps of faith.

So what gives you that faith when investing in tech startups?

Larco: On every deal, at least a dozen people are like, 'That's the dumbest stuff that I've ever seen; how did that person ever think that was a good idea?' You have way more naysayers than you have people who think something is brilliant. That's just the nature of investing in startups.

You're looking for that spark when something just clicks for you about the founding team, whether it's that they're incredibly accomplished, or have some unique insights, or there's something incredibly special that even if something doesn't make sense you feel like the team will figure it out and you just really want to work with them. There's enough stuff there that's interesting that you believe they'll make something work and their initial hypothesis is something I can get behind. Or it's, 'Holy cow, I've never seen such an innovative product. It meets a need that no one is paying attention to, and it leads to their vision of how they'll become an independent company… that expand its vision.' Or it can be that you don't really get it, but holy smokes, look at the customers they have attracted in a short amount of time -- these are hard customers and we know they don't just buy anything, so we know something is there, and if these people see it a bunch of other people will see it and they'll be successful.

And what's the process – how does the relationship start and progress to the point where NEA commits capital?

Larco: It's different for everybody. Some people are super data driven, some people are very relationship driven. I'm personally a hybrid of being space driven and relationship driven. There are some spaces I really like, data being one of them, HR tech being another. And then I want to get to know the people and find out if they're people I'll click with, so then we'll just spend time together over months, and then when they're ready I'm just like, 'I'm here.' We've done all the work, I know I want to invest. And from there you talk to your partnership and do a financial analysis and a returns analysis, and do the actual quantitative work. That's the easier part. The harder part is to get the conviction to take a leap of faith. For me that's about the relationship, and I really believe in the founders -- I see the need.

How long might it take from the point when you first meet with someone to the point when you close the deal?

Larco: For me it's longer than most. I like to get to know someone because ideally we're going to spend the next 10 years of our lives working together, through the ups and the downs, so I want to get to know the founders a year before they actually want to take funding from us. And once they say they're ready to go, it can take us two to four weeks to make the investment as a partnership.