Why Won’t VCs Here Invest in Napkins?

The Quiet Part Out Loud
Written By Chris Neumann

One of the most pervasive stereotypes in Startupland™ is that Silicon Valley VCs are more willing to take risks than VCs in other ecosystems.

It’s not true.

Over the years, I’ve tried my best to take a literary sledgehammer to this overly simplistic narrative. While it’s unequivocally true that investors in Silicon Valley behave differently from their peers in other countries, attributing that to a cultural propensity for risk isn’t the reason.

Why do I care about this so much? Repeating and amplifying this naive stereotype derails founders outside of Silicon Valley when it comes to fundraising. It holds back ecosystems when it comes to recognizing their strengths and weaknesses. It even clouds the ability of VCs to look in the mirror and understand why they are (or are not) winning deals.

 

“Show me the incentive and I’ll show you the outcome.”

 

In the past, I’ve unpacked a number of falsehoods about Silicon Valley VCs that flow from this simple stereotype, including:

In this post, I’m going to dive into another widely-held belief: that Silicon Valley VCs are more willing to invest in ideas than VCs in other ecosystems.

 

What is a Napkin?

Let’s start off by defining very specifically what we’re talking about with a simple hierarchy of early (pre-revenue) startup progress:

  • Team Only: The founding team is set. They don’t yet have a specific thesis beyond a vague idea of the market they’re going after and/or a concept for the product.

  • Team + Idea: The team has come up with a specific idea. That idea is represented using some combination of a simple business plan or pitch deck, technical papers, and possibly a proof-of-concept implementation (i.e. a technical prototype that can do one or two hard-coded things meant to demonstrate the technical potential of the idea).

  • Team + Prototype: The team has developed a working prototype of the idea. This is a rudimentary implementation focused on high-level design and functionality, but not sufficient to perform market testing (while it can be shown to potential users/customers to gather feedback, it’s not yet ready for actual user testing).

  • Team + MVP: The team has developed an MVP (“minimum viable product”) that can be used for alpha / beta testing with prospective users/customers/investors.

Now, let’s talk briefly about what it takes to get investment at each of these stages:

 

Team Only

Despite what you might think from reading TechCrunch, raising VC funding at the “Team Only” stage is exceedingly rare. Startups that do so generally fall into one of four categories:

  1. Celebrity Repeat Founders - These teams are comprised of well-known repeat founders who have demonstrated significant success in the past. Very few startups fall into this category, in part because such founders have both the financial means to bootstrap their company beyond this stage and they know the value of doing so.

  2. High-Profile Spinout Founders - These teams are comprised of founders who together spun out of a highly-regarded company. They typically signal a desire to focus on a problem immediately adjacent to the one they most recently worked on, leaving investors confident that they “know enough” about the market to hit the ground running.

  3. Buzzy First-Time Founders - These teams are comprised of founders who did something to generate disproportionate buzz prior to launching a company (think viral social media stunts). The bet here is that there’s enough of a halo around these founders that they’ll be able to create something of value, making it a not-unreasonable investment for a Pre-Seed VC to make.

  4. Friends-of-the-Family - This is the most common form of “team only” investment (but the type that rarely makes the news). Friends-of-the-family are individuals known to a VC firm, such as founders from a previously-exited portfolio company, who are are trying to figure out what to do next. These founders may or may not have a specific idea for a company. VCs will often employ them as EIRs (“entrepreneurs-in-residence”) in order to provide them with resources or they may invest a small amount of money directly if a company has already been formed.

 

Team + Idea

Raising VC funding at the “Team + Idea” stage most commonly occurs for startups building a product that involves meaningful technical innovation. For these companies, the time from idea to prototype is significant. Startups that choose to raise at this stage typically do so because they need money to cover the founders’ cost-of-living, are looking to hire additional engineers to help develop the prototype and/or because they require specialized hardware or other resources in order to develop the prototype. Most deep tech companies fall into this category, as do many enterprise software companies.

Aster Data, where I was the first employee, is a classic example of this. The three cofounders spent the summer after their graduation from Stanford building a simple proof-of-concept implementation for what would become the world’s first “big data” platform. The system with which they raised their first round of funding was nowhere close to a prototype — all it could do was run a small set of hardcoded SQL statements (known as the TPC-H benchmark). It had no ability to take user input, nor could it interpret any SQL other than the set of hardcoded statements that it was built for. What this rudimentary proof-of-concept could do was out-perform a $10M purpose-built Oracle data warehouse on that set of benchmarks using five cheap, off-the-shelf computers from Frys.

 

George Candea hard at work on the floor of his Stanford apartment

 

The “Team + Idea” stage is what we’re referring to when we talk about raising off a napkin. The idea is relatively fleshed out, but the company is still far from a functioning prototype or MVP.

In the case of Aster Data, it took nearly two more years to build the first MVP (it was 2.5 years later and another round of funding before the company came out of stealth mode, and even then the system we were selling could only process a fraction of the SQL that our customers used).

 

Team + Prototype

Similar to the “Team + Idea” stage, raising funding at the “Team + Prototype” stage is most common for startups that are building technically complex products. In particular, companies that raise at this stage generally foresee a meaningful amount of time between prototype and MVP and require additional resources to get there (such as for many hardware companies).

If the gap between prototype and MVP is perceived to be relatively small, most VCs will be unwilling to invest until the company has actual user feedback.

 

Team + MVP

At the “Team + MVP” stage, a startup has developed a representation of the product that is close enough to what it will ultimately bring to market that it can begin user/customer testing. Prospective investors are able to personally try the product out. Moreover, those investors can gather feedback from initial test users and/or pilot customers, thus allowing them to better predict how the company’s value proposition will be received by the market.

Notably, companies at this stage have mostly overcome technical risk. While there may still be some challenges in the future (such as in manufacturing or scaling), the existence of an MVP suggests that the key hurdles have been solved and the product is technically feasible.

 

It’s smooth sailing from here, folks.

 
 

How VCs Invest in Napkins

As I mentioned earlier, when we refer to founders “raising on a napkin” (or VCs “investing in a napkin”), we’re talking about the “Team + Idea” stage. At that point in a startup’s journey, the team is formed, they’ve landed on a specific idea, and they have put some amount of work towards fleshing it out.

Let’s look at what needs to be true for a VC to invest at this stage:

 

1. Time-to-Prototype

First and foremost, investors (in Silicon Valley and elsewhere) will almost universally refuse to invest at this stage if there is not a significant length of time from idea to prototype inherent in the concept.

Generally, if you can build a functioning prototype in 6 months or less, VCs will hesitate to invest until that is done. They might suggest that you bootstrap until you get there or raise a small amount of angel funding if necessary. While this might seem unfair, if you look at it from a VC’s perspective, waiting a few months for the founders to develop a prototype will alleviate considerable investment risk (both in terms of the the concept and the team).

With AI coding tools now widely available, time-to-prototype (and time-to-MVP) have been drastically reduced for many software startups. As such, this requirement has gained additional emphasis in the eyes of early-stage investors. If you’re building an app or vertical SaaS product, it’s difficult to credibly argue that you can’t leverage these tools to get to a reasonable prototype or MVP without outside funding.

 

2. Technical Complexity

Products that have a lengthy time-to-prototype almost always have significant innovation and/or technical complexity under-the-hood. That means genuine technical challenges that need to be overcome and, thus, genuine technical risk.

In other words, the idea might not actually work.

VCs who invest at this stage are ultimately underwriting the technical risk inherent in the idea and, thus, the ability of the team to solve the technical challenges that they will face in the months ahead. In the case of Aster Data, the early investors had to look at the proof-of-concept implementation and the backgrounds of the founders to answer key questions, including:

  • Were the performance improvements demonstrated in the hard-coded set of benchmark queries likely to be replicated across the broader SQL language?

  • Would the performance improvements remain as significant as the amount of data being processed increased?

  • Were the benchmarks likely to be representative of how real-world customers would use the system?

  • What additional technical challenges would need to be solved in order to evolve the simple prototype into a fully-functioning data warehouse?

  • Did the founding team seem capable of overcoming those challenges?

 

3. An Obvious Market

The third characteristic of startups that successfully raise funding on a napkin is that almost all of them are targeting an “obvious” market. Assuming that the technology works, VCs need to believe that there is a sizable, natural market (or markets) at the end of the proverbial tunnel.

Case in point: when investors were evaluating Aster Data for its initial investment, not a single VC asked “what is the market for this?” or “what will your initial market be?” It was obvious. In 2005, the database market was already $15B and was growing at a blistering pace (it’s now more than $150B). It was crystal clear that if the technology worked, there was a huge potential market.

Put another way, in order for VCs to commit at the “Team + Idea” stage, there must be relatively little market risk. That’s not to say that there won’t be go-to-market risk (the startup will still need to figure out how to sell, how to market, and everything else involved in generating revenue), but investors need to feel confident that there’s a compelling set of initial customers for the first version of the product.

A counter point to this is what happened to me when I subsequently co-founded DataHero. We had hoped to similarly raise our initial round of funding with a proof-of-concept (as we knew it would take at least 6 more months to get to a prototype/MVP), but VCs weren’t convinced that there was a market for cloud BI. And they were unwilling to invest until we could show evidence to the contrary.

 

Are Silicon Valley VCs More Willing to Invest in Napkins?

All of this brings us to the core question of this post: are Silicon Valley VCs more willing to invest in napkins (“Team + Idea” startups) than VCs in other ecosystems?

I’ve met countless founders around the world building technically complex products with lengthy times-to-prototype who have struggled to raise funding at the “Team + Idea” stage. The vast majority of them relay an experience wherein one of two things consistently occurred:

  1. The VCs they spoke with, despite understanding that the product they’re building is technically complex and that they needed funding in order to build the initial prototype, responded with some version of “come back when you’ve built the prototype”.

  2. The VCs they spoke with, despite the existence of a fairly obvious, large market, got lost in market analysis and questions about their initial market, ICP, etc.

What’s going on?

 
 

There’s no way to get accurate data on the exact stage of pre-revenue development a startup was at when it raised funding, so I decided to focus on the characteristics of early-stage VCs themselves. Can we infer an answer to this question by studying the investors in various ecosystems?

Given that investing at the “Team + Idea” stage requires a VC to underwrite technical risk, it’s reasonable to presume that most VCs will hesitate to do so unless they themselves have some form of technical background. (While many VCs consult with external experts during diligence, my personal observation is that most aren’t willing to fully outsource the decision on what they perceive to be the most significant risk in a company.)

 

How Many VCs Have Technical Backgrounds?

By leveraging AI deep-research tools, I was able to build a dataset of investing partners (individuals with the title “Partner”, “General Partner”, “Managing Partner” or “Founding Partner”) at Pre-Seed and Seed stage VC funds in various ecosystems, along with their university degree(s) and operating backgrounds. Here’s what I found:

 

How Many Silicon Valley VCs Have Technical Backgrounds?

As a baseline, let’s look at VCs based in Silicon Valley. Here is a breakdown of the degrees held by investing partners at 100 Pre-Seed and Seed stage VC firms in San Francisco, Palo Alto and Menlo Park:

 
 

According to this sample data:

  • 1/3 of investing partners at Silicon Valley VCs have either computer science, computer engineering or electrical engineering degrees

  • 42.5% of investing partners at Silicon Valley VCs have some form of engineering degree (CS/CE, electrical engineering, mechanical engineering, etc.)

  • If we expand our definition of “technical degree” to include pure math and science (e.g. physics or biology, both of which are heavily represented in deep tech), the number grows to 48.4%

In other words, nearly half of all investing partners at Silicon Valley VCs have some form of technical degree. Put differently, nearly half of all investing partners at Silicon Valley VCs have the background required to underwrite technical risk in some subset of companies.

 

How Many VCs in Canada Have Technical Backgrounds?

Next, let’s take a look at Canada. Here is a breakdown of the degrees held by investing partners at 75 Pre-Seed and Seed stage VC firms located in the Great White North:

 
 

According to this sample data:

  • Only 15% of investing partners at Canadian VCs have either computer science, computer engineering or electrical engineering degrees (for those of you about to object that CS falls under the Faculty of Math at Waterloo…that’s taken into account here :) )

  • 29.6% of investing partners at Canadian VCs have some form of engineering degree (CS/CE, electrical engineering, mechanical engineering, etc.)

  • If we expand our definition of “technical degree” to include pure math and science, the number is 35.9%

In other words, slightly more than 1/3 of investing partners at Canadian VCs have some form of technical degree.

 

How Many VCs in the UK Have Technical Backgrounds?

Finally, let’s look at the UK. Here is a breakdown of the degrees held by investing partners at 75 Pre-Seed and Seed stage VC firms located in the United Kingdom:

 
 

According to this sample data:

  • Only 15% of investing partners at UK VCs have either computer science, computer engineering or electrical engineering degrees (the exact same percentage as in Canada!)

  • 28.0% of investing partners at UK VCs have some form of engineering degree (CS/CE, electrical engineering, mechanical engineering, etc.)

  • If we expand our definition of “technical degree” to include pure math and science, the number is 36% (again, almost the exact same number as in Canada).

In other words, slightly more than 1/3 of investing partners at UK VCs have some form of technical degree.

 

Let’s put all of these results on a single chart in order to see the comparison more easily:

 
 

At this point, the key difference should be obvious — the percentage of Silicon Valley VCs that have a computer science, computer engineering or electrical engineering degree — the three most relevant degrees when it comes to underwriting technical risk in the vast majority of VC-backed companies — is more than double that of VCs in other countries (33% in Silicon Valley vs. 15% in both Canada and the UK).

 

So…VCs in My Ecosystem are More Risk Averse!

No, they’re not.

The role of a VC is to generate returns. And they do so by underwriting risk. When a VC makes an investment, they’re doing so based on a risk-reward calculation that reflects their belief that a given company will be able to overcome all of the obstacles it will face in order to become successful.

Good VCs only underwrite risks that they understand. Investing without fully understanding the risks that a company faces is little more than gambling (which, despite what many pundits might believe, is not what VCs do). What the data above shows is that a significantly higher percentage of early-stage VCs in Silicon Valley are qualified to underwrite technical risk — particularly the type of technical risk inherent in software and hardware startups.

The implication of this is an (uncomfortable) confirmation that when the vast majority of early-stage VCs outside of Silicon Valley pass on opportunities to invest in “Team + Idea” startups, they’re making the correct decision based on rational economic theory.

Not because they’re risk averse, but because they do not have the technical background necessary to judge if the idea is a reasonable one or not.

 

What Does This Mean for Founders?

First off, this data suggests that what founders outside of Silicon Valley often perceive — that VCs in Silicon Valley are more willing to invest in napkins than VCs in other ecosystems — is, in fact, accurate. But it’s not because Silicon Valley VCs more willing to take risks than VCs in other ecosystems. It’s because they’re more qualified to underwrite the technical risks required to invest in “Team + Idea” stage companies.

If you’re a founder outside of Silicon Valley attempting to raise at the “Team + Idea” stage, tailoring your investor outreach to take the background of VCs into account can have a massive impact on your success. Here are some suggestions on ways to do that when filling your fundraising funnel:

  • Prioritize investors with the type of educational background and/or work experience necessary to understand what your building (though don’t do this exclusively, as resumes don’t tell you everything about a VC or what they’re willing to invest in)

  • Search for firms that have specifically invested in companies in your space pre-revenue (you generally can’t tell the exact stage that a company was in when they raised pre-revenue funding, so look for the investors listed when a company came out of stealth and, in particular, those listed as “prior investors” at the Seed round)

  • Ask other founders in your space who the VCs and angel investors are that they had positive pre-revenue interactions with

  • Expand your search beyond your local ecosystem to include other investors with a track record of investing in your space pre-revenue

 

Some Final Thoughts

The post above makes a number of assumptions, so I want to be clear on a few things:

  1. Educational background is definitely not the sole determinant when it comes to what investors will or will not invest in. There are certainly VCs without technical backgrounds who are willing to invest in “Team + Idea” stage companies. But in my experience, it’s a lot easier for founders to raise at that stage when the person or people sitting across the table from them inherently “get” what they’re trying to do.

  2. The datasets used for this post contain reasonably representative samples of early-stage VCs in each ecosystem, but I will not claim that they are statistically representative. That said, I do believe the analysis to be directionally correct and, thus, insightful.

As a final thought, at a time when many ecosystems around the world are trying to catalyze innovation in more technically complex fields (deep tech / hard tech / AI / defense / etc.), many would benefit from encouraging more technical expertise within their early-stage investor ranks.

The next generation of foundational companies will not emerge if the founders are unable to raise pre-prototype funding. And that’s exceedingly hard to do in ecosystems where the majority of the investor class is unable to confidently evaluate and underwrite technical risk.

Chris Neumann
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