Does Your Startup Have Founder-Fund Fit?
By: Akash Bhat
Tags: Venture Capital, VC, Startup, Value Driven Approach, Fundraising

Founders drive the culture and values within the company. You can’t dissociate that. The alignment between founder and fund is essential. Without that “fit” you’re unlikely to get the funding you need.

The other day I was catching up with an investor friend of mine over a cup of chai over Zoom, when I asked her if there’s anything noteworthy happening within her portfolio. She nodded her head, but in disappointment, so I asked her about it. She told me that one of the companies in her portfolio was raising a later-stage round, but the firm wasn’t investing in them. I immediately knew something was wrong because this was a startup that had done well, and nine out of ten times you follow-on as an investor if the ‘growth’ is significant. This is the ‘one’ other time, and she continued to tell me that they had had a terrible experience with the CEO / founder and they no longer felt comfortable being in business with him. You can see why she was disappointed. An investment in a company that’s growing in this economy would put the fund in a better position to yield good returns, but at what cost?

This led me to think about portfolio construction and development in the context of today’s world. How important is ‘value’ fit and do VCs care about it? Notice how I didn’t bring up culture here; because cultural fit could often come down to rapport, and that’s completely different. You may not have a great rapport with your investor(s), but continue to be in business with them. The concept of ‘value’ fit can also be extended to M&A (startup-startup, corporate-startup or PE).

Bad behavior doesn’t go unnoticed, we all know that, and when a pattern begins to emerge, people usually distance themselves. In the context of venture capital, bad behavior/culture also reflects poorly on investors sitting on the board as it shows what little control they have over the company/CEO. This is one of the top reasons why CEOs lose their jobs (e.g.: Travis Kalanick). This intrigued me, and I wanted to do some more research on this subject.

Those who know me, know that I host a podcast series called ‘The Desi VC’, where I speak with angel investors and venture capitalists investing in tech startups in India. Over the course of my interviews, I began quizzing my guests on what was the most important thing they looked for while investing in early-stage startups. “It’s the team” –– was the unanimous response.

More often than not, investors back founders and not the product as not many early stage startups have found product-market fit (PMF) and in some case, even traction. Let me elaborate further.

Investing in the jockey rather than the horse

You might often hear this being said –– “Great founders will find ways to make a product work”. I took a step back when I first heard it and wanted to see if there’s truth to that statement. And there was! You may Google the rest, but here are three that surprised me. I’m not sure how many of you know this but YouTube began as a video-dating site where people could upload videos to introduce themselves and discover others. The founders of Slack, first started out by developing an online-video game called Glitch, in which strangers spoke to one another in a quest to acquire loot. The financial failure of their game led them to spin off the most essential aspect of their business –– messaging. Lastly, Shopify was a result of a failed online e-commerce business called Snowdevil.

Great founders team can pivot if there are signs of misalignment with respect to market, customer behavior, competition, timing etc., and for these reasons and others alike, investors are comfortable backing great founders than the idea itself. But why?

What is founder-fund-fit

I do a lot of reading and reflecting in my spare time, and I was wondering why investors are comfortable investing in founders at the early-stage, when the product at its infancy or the market is sometimes volatile. Venture is a high risk, high reward game if done correctly. 38 of the top 100 venture capital firms today (see the graph below) were founded by entrepreneurs themselves, who started disruptive businesses in their fields. It of course makes sense to have empathy towards founders who might be have similar personality traits. It’s a virtuous cycle in some sense.

Founder-fund-fit (FFF) is an interesting concept because, in my opinion, it sits exactly between ‘founder-product-fit’ (which basically means the founder is building a product in a market he/she understands really well –– this is usually the precursor to FFF) and ‘product-market-fit’. In founder-product-fit (FPF) investors are typically looking for passion, experience or unique insights/experience that founders might have which gives them the edge to build competitive products (some times even in a crowded market). In product-market-fit (PMF) the startup begins to see less churn and more retention, organic growth and rise in demand of the product/service, which is a good benchmark to attract Series A and beyond investors. What’s missing here and something that is often overlooked, is founder-fund-fit. Between FPF and PMF, a lot could go wrong. Some times, a startup might not even achieve PMF, in spite of the startup having FPF, and this could be attributed to FFF.

FFF can take shapes in many forms, for instance, being of the same wavelength matters as managing expectation is key to future success of the business and founder-investor relationship. During an investment, investors/VCs would like to gauge whether the founders will be on board with the direction they would need to take to make the deal work for them. We’ve seen many companies fail because of the misalignment with investors. A good example of this is when a startup raises ‘way more capital’ than required, which then forces them to swing for the fences in trying to hit investor benchmarks, often leading to failure.

Founder-fund-fit is all about the future and how good both the investors as well as the founders feel about their targets to achieve future benchmarks, while keeping in mind the uncertainties involved in the market.

In the tenth episode of my podcast, I had a very interesting conversation with Abhishek Prasad, Managing Partner and Co-founder of Cornerstone Venture Partners (CSPV), where he mentioned that often there’s a mismatch between investors and founders, he called this –– ‘founder-vision vs ‘investor imagination’. What he means here is that founders must balance their need for capital against unrealistic or ambitious investor benchmarks. It’s very easy for both investors and founders to fall into the trap where one party dominates the other post-investment, leading to a soured relationship where the investor feels uncomfortable coming back for the subsequent round of investment in the company. Keep in mind that most startups continue to raise capital from previous investors and absence in a round will be viewed as a red flag by other potential investors. Now, this really could affect both the startup and the existing VC as it would certainly impact fund-raising (which the startups badly need!), in turn hurting the investor chance of gaining a good return on their investment.

S ometimes, the follow-on investment decision can be driven more by looking back than looking forwards — Collin West and Nihar Neelakanti

Therefore, it becomes critical for both parties to manage expectations at the outset and maintain a cordial relationship throughout the life of the startup.

The best founders and investors take their time getting to know each other. Mark Suster, Managing Partner at Upfront Ventures has a great philosophy on this where he says –– invest in lines, not dots. He believes that one meeting is simply a dot on the X-Y axis and there’s literally nothing else to contrast and compare, and you’re often at the mercy of someone else’s judgement to base your decisions. Instead, build a relationship over time and have multiple data points (a line) to support you. Similarly, as a founder, I’d try to spend time with investors and getting to know them long before I plan on raising money.

Remember you cannot fire your investors, on the contrary, they can fire you.