Let’s start with a little story

A while back, while I was working at a VC firm (Giza), I met a nice new analyst at Pitango, and we had a really good lunch at a steak place in the Ackerstein complex. She told me about a company that her team at Pitango passed on named XtremIO. The team was a good one, people we knew, yet we had never heard of their new startup. I followed up, got their investor deck and invited them in for a meeting with the two guys at our fund who knew this space. About 12 months later we completed our first investment in the company. A few years later we sold the company to EMC for $435M cash. I had left the fund by this time and had begun my consulting career, which continues today with my partner Yossi Konijn in our firm Investable Solutions.

Remember this story. I’ll come back to it.

The referral axiom

It is common wisdom in the VC industry that referrals are the preferred way of doing business. This is a golden rule, a truism, supported by statistics, born out of experience, and obviously logical. At Giza, we would position ourselves as having proprietary deal flow based on referrals from our network of close connections in the industry. The same goes for most VCs.

Investors want to meet with companies referred to them by someone they know and trust. Speak to VCs or read about VCs and you will hear this mantra religiously. It is used as a kind of litmus test to see if the entrepreneur resides within the social circle of the investors and if he can get someone to vouch for him. The VCs look at it as a small hurdle and figure if this is too much, then the entrepreneur does not have what it takes, and they pass.

This is the referral axiom. It is not usually questioned, but I feel it should be.

Are referrals really objectively better than non-referrals, are they enough, and are all referrals created equal?

Startups must choose the right person to make a referral
Investors like referrals because it makes life easier by reducing the noise so they can focus their time and energy on fewer, more promising opportunities. There are people out there, service providers, other entrepreneurs, and other investors, that have active ongoing relationships with potential investors. This is good news for startups. However, just asking someone for a referral to one of his/her contacts is never enough. In my experience the top three mistakes that entrepreneurs make are the following:

  1. Thinking that the referral is enough – no. Even if you get a meeting following a referral, you need to be prepared and investable. Investors have higher expectations from referrals based on their respect for the person making the recommendation. If you are not ready for the investor you are hurting yourself (there’s never a second chance for a first impression, right?) and you’re hurting the person that referred you. Their next referral will not be taken as seriously.

  2. Choosing the wrong person for a referral – not all people who can refer you have the same strength of the relationship with potential investors – choose one who has a real relationship. I am connected to hundreds of people on LinkedIn, many of them investors. Does this mean I have a relationship with all of them? No. I have close ties with a select few (30-40), whom I trust and who trust me. One of the ways I keep in touch with investors at our firm is by providing services to them (due diligence for potential investments), and to their portfolio companies (strategy, business development, market research). It is this relationship that enables me to get quick answers on investment opportunities and honest feedback.

  3. Choosing someone who doesn’t understand investors – not everyone understands investors. The fact that I grew up in the VC industry means that I talk their language and can give insights to our clients on the psychology of potential investors, the level of preparation required, and many other tips that startups find to be invaluable. A referral from someone who does not understand how to work with investors is no better than a cold call.

Bottom line for startups

Referrals are important, but they are a double-edged sword. Done improperly they can cause more damage than good. However, entrepreneurs who have succeeded in choosing the right person to make the introduction referral can get:

  • “Red carpet” treatment
  • A faster and clearer process
  • Better positioning
  • A better outcome

After working hard on a startup, it is worth going the extra mile, and working with someone who can guide and coach you through the investment raising process. My experience has been that most investors appreciate the steady flow of qualified investment opportunities that I provide.

For the last five years, Yossi and I have been working with hundreds of startup companies. We take apart and put back together usage cases and business cases. We analyze large amounts of data to understand what the market is saying today and what it’s hinting about tomorrow.  We create a story of uniqueness, validation, and promise for potential investors. After putting in many long hours with our clients, we reach out to our investor friends and make a warm referral.

Investors today are more active

While it may not seem this way to startups, investing is a very competitive industry. Today more than ever, investors are proactive in sourcing referrals. They know that to sit back and receive referrals is a very passive and limiting approach to locating hot opportunities, and many great companies will be missed this way. There are many investors out there, and as I illustrated with XtremIO, there is no guarantee that the best deals will come referred.

What does this mean? This means that you can sometimes reach good, active investors without a direct referral. At a meetup, at a conference or at a pitch-night. If your story is good, and you can supply quality materials about yourself (a one-pager, an executive summary, an investor presentation) you may have a chance for a follow-up meeting and ultimately an investment. This approach will work much better than spamming investors or asking the wrong person to refer you.

Ultimately, referrals may be the best way to go, but they do require thinking and planning, and most importantly, choosing the right person to make them.