Startup Fundraising

Why do investors pass on startups?

This lesson walks you through startup fundraising. It covers how investors think, how to pitch them, and where to find them.

In my opinion, most fundraising advice misses the mark. I run Julian Capital and Carveout, through which I've co-invested with 100+ investors, and I regularly ask why they pass on deals. I believe this has given me a clearer understanding of how investors think.

First, a disclaimer: I believe most founders would be happier pursuing a bootstrapped lifestyle business than one that requires venture capital (VC). Raising VC comes with the pressure of continually growing fast and large.

But if you’re passionate about building the biggest $1B+ company you can, then venture capital can be a fit. This is because VCs require big $1B+ exits to counterbalance the companies that die in their portfolio. That’s how venture math works—it's a numbers game with many deaths and a few wins.

As a founder, you benefit from VC dollars in a few ways: more cash means moving faster, hiring better talent earlier, reducing the stress of cash flow crunches, and optimizing more for the long-term. When you’re in a competitive market, you generally need these to not be leapfrogged by competition.

So this lesson will explain two things: (1) how to convince investors that you’re one in a million and (2) where to find investors that are most likely to invest in you.

What’s important to investors?

How you pitch your startup is not as important as you think. Investors mostly look beyond your presentation to index on five underlying factors:

  1. Market size
  2. Team quality
  3. Competitive landscape
  4. Market pull and market timing (see Lessons 1 and 2)
  5. Customer acquisition strategy (see Lesson 3)

These criteria reduce into four guidelines VCs generally abide by:

Let's deconstruct each.

1. Investors want to see market pull and timing that can create a $1B+ opportunity over time.

Most investors despise market risk. Market risk means there’s uncertainty about whether enough consumers will want to buy your product.

In contrast, investors are generally more tolerant of product risk (uncertainty about whether the product will work) or team risk (uncertainty about the team’s quality). Because these two risks can often be resolved over time through experience and iteration, whereas market risk is a brick wall: if no one wants your product, it doesn’t matter how well you deliver it.

Therefore, the first part of an investor pitch should show off your market pull. (I explain market pull in Lesson 1.) When investors believe market pull exists, it lessens their concerns over market risk.

As a reminder, here are the three factors that characterize market pull:

Further, recall from Lesson 2 that investors know that market pull arises due to market timing. Therefore, explain why your startup is only recently able to scale due to new changes in the market.

2. Investors must believe that competition won't prevent your rise to $1B+ over time.

The longer an investor has been investing, the more they’ve been burned by competitors who've stunted the growth of their most promising companies. This is why experienced investors research your competition to see who's motivated to line-extend into what you're doing and possibly crush you.

Note that investors are usually more tolerant of risk from old, lazy incumbents than they are from early-stage startups. They know that the old companies can’t compete with the speed, iteration, brand appeal, and adaptability of startups.

However, they often fear new venture-backed competition—especially if they have momentum and are targeting the same audience as you. Investors understandably find it hard to predict how the competitive landscape will evolve, so they often pass as a result. And if a competitor captures the whole market before you do, investors rarely want to bet on your ability to later steal customers away from them.

Here's how you can help investors overcome their concern for competition:

Let’s discuss that second point: If you're facing formidable competition, you should target a large audience segment before competitors can. You carve out your own market segment by pursuing what the competition can't without self-sabotaging their momentum or destroying what their customers love about them.

Here are two examples:

To recap, address the competition in your pitch. Explain who they are, how they all differ, and how you'll thrive in spite of their success.

3. Investors must believe the founders will be formidable over time.

Some investors index mostly on founder quality. Others index on market pull first then founder quality. In either case, here are the criteria I look for:

4. Investors must see that the founders deeply understand their market.

Are the founders impulsively pursuing their idea or have they studied the market's history first? If they've deeply analyzed the market, they'll know the obvious points of failure, the competitive dynamics, the realities of customer adoption, and the unexplored opportunities.

Investors want founders to sound like geniuses when describing their markets. This means mapping out all the players and knowing how they relate to each other.

The more direct experience founders have exploring how the market works, the better.

Where to find investors

Here’s where you can find VCs and angel investors:

Most investors really do want to see your deck. They’re desperate for deal flow and most of them don’t see as many good deals as they’d like. So, if they don’t respond within 7-10 days of each interaction, I’ve found it’s usually not because they're ignoring you but because they don't find you interesting.

Why investors pass

Investors often fail to provide authentic feedback on why they’re passing. They’re afraid to offend you or discourage you. In my experience, however, they’re usually passing due to a combination of the following:

  1. They like you but their conviction doesn't put you among the best deals they've seen that year, and they're patiently waiting for the very best.
  2. They don't know your space well enough and they're not interested in learning it. This means that even if you're an "obviously good" startup with all the right ingredients, many investors simply won't be emotionally excited by it.
  3. They don’t believe the market is big enough for you to become $1B+. Or they don’t believe you can survive the competition on the way to $1B+.
  4. They're not confident your customer acquisition strategy will scale to convince enough people to buy your product.
  5. They've been burned by investing in companies like yours before.
  6. They don’t believe the founders are formidable.

These factors mostly relate to market pull, market timing, and product-led acquisition, which is why this handbook spends half its length exploring those concepts—and why you should address them in your pitch.

If you speak to many investors and none get you, then maybe your idea isn't venture scale. Or maybe it's plain bad. Either way, I hope you learned a lot.

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