Why VCs don’t invest at idea stage

I get this question in every event, forum and any possible gathering of investors and entrepreneurs. Why don’t you guys invest at an idea stage.

Here is why :

Ideas do not signal anything about the entrepreneur. VC’s tend to rely on lot of signals (proxies for character, EQ, IQ attributes) which can’t be quantified but gives them a confidence on the team. When an entrepreneur just comes with a plan on paper – here are some signals which are missing

• Fickle Mindedness / Commitment to pursue – How would a VC know if you’ll continue to pursue it 24*7 for the next 5 years and not be distracted by something cooler next month. That is why lot of VCs stress on how you came up with the idea , if it’s a problem very personal to you ; chances are you’ll stick with it till you solve it
• Skin in the game – When an entrepreneur spends a couple of lakhs of his savings and couple of months of his time on an idea, it is a strong signal of commitment towards the purpose. The more skin in the game, the better it is for a VC.
• Execution Capabilities – An idea does not signal anything about the execution capabilities of a person. Even with couple of years of work experience, entrepreneurship is like the deep end of the pool. Unless you have jumped in it and spent some time, any other experience does not matter.
• Resourcefulness – An entrepreneur is supposed to be street smart to work with the minimum resources and create value out of it. Asking for investment with plan on paper does not signal anything positive

That is why friends and family are more comfortable putting money than an institution because they already have all these signals from their years of knowing you. Without anything concrete to see, a fund cannot gauge all these attributes from 1-2 meetings with the entrepreneur. Few exceptional cases where VCs put money in idea stage :

• Founders willing to drop out of Tier 1 college – Very strong signal of commitment to the purpose. If the team thinks something is worth pursuing now instead of waiting for a year and they are willing to risk a Tier 1 college degree for it. I am all ears
• VCs putting in money at idea stages with founders they have worked before – They are already aware of all the attributes of the team and confident of their execution abilities.
  From a fund’s perspective, putting in at Idea stage also brings in 2 primary risks
  • Conflict of Interest: If the fund backs a team at idea stage whose execution capabilities it was unaware of and now discovers a better team, It can’t invest in them purely because of conflict of interest.
  • Some ideas are not multimillion opportunities. If after few months of effort, a large VC thinks the opportunity is not big enough for the fund to pursue and decides not to participate in the next round whereas the entrepreneur thinks otherwise, it’s a bad signal in the market and spooks off the incoming investors.

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