I don’t want to get in the middle of all of this bubble talk. The fact of the matter is, great businesses can be built during any cycle. Put great entrepreneurs together with large, tough problems, fund the company appropriately and you can be successful. Is it appropriate to have pre-money valautions of 8 before you even have a product? Raising $100 million in a later round with lots of traction and no ostensible business model? Only time will tell—and smart people can reasonably disagree.
However, what I do see happening are instances of entrepreneurs ignoring what the market is telling them about their idea. The way the public markets work, when changes happen in the environment or the market doesn’t like your new strategy, you find out about it instantaneously via the price of your stock.
Private markets don’t work like that. In fact, they're are set up in such a way so that you can largely ignore the market as long as you can find one single investor willing to substantiate your story and plan—the “greater fool” theory, in a sense.
Here’s how it works: You go pitch your idea to nine smart, experienced investors with domain knowledge in your space. They all pass because you don’t have much traction, your business model is questionable, and 50 companies have tried and failed at doing the same thing as you. Plus, a market leader in your space is trying to do what you do, and your pitch is basically that they suck at it.
Rather than accept what the market is telling you about your idea, you go find the 10th investor—the investor with less experience in the sector, and less of a track record of finding success in your field. This investor usually don’t get included in highly competitive syndicates, so when someone smart like you comes along, they’re already excited about the possibility of getting in. They’re not seeing what other investors are seeing in the market—nor do they have a good sense of what makes success in this industry. It doesn’t matter, they’re excited about you and your team and they’re in for a check. They get all their friends to invest as well—other smart rich folks without much experience in investing in the top deals. Now, you’ve got yourself a round even though 90% of smart people in the space tell you that you should pick up your marbles and go home.
In fact, that’s what we tell entrepreneurs. We glorify the stories of entrepreneurs getting turned down by all the best investors only to somehow make it in the end.
Personally, I think that’s the exception. Most deals that get funded, in my opinion (not that of my firm’s) could have been oversubscribed by very experienced investors. Sure, some of them may disagree, but I find that it’s more binary than people think. Good deals appear more obvious in the beginning and get funded with reasonable haste. Some deals look great (many, in fact) and then fizzle out, but when a bunch of people in a row say that a deal has serious problems, I often find that they’re on to something.
Experienced investors have an information advantage that should be paid serious attention. They’ve seen this model play out time and time again. Entrepreneurs often dismiss the “haters”, but I think there’s really something to that. When I raised money from 21 angel investors, only one of them told me I wasn’t raising enough money. It didn’t matter—the round was getting done either way. However, I really wish I had paid more attention to the minority voice—because it was actually one of the most experienced people around the table.
I think it’s important to get at least a couple of really experienced folks invested in you—beacuse until you reach that level, I’m not sure I’d trust what the market says about your idea. If you have revenues or committed customers, that’s a different story—but too many people are raising money from new entrants into the investment world or from friends and family. This makes the bar too low for good ideas.
I know one company in particular, a tech team working on a very early idea in a tough space, that had the opportunity to join a top tier team with a Fortune 500 C-level leader, with a fantastic idea. They seemed ready to join until a random angel out of nowhere—someone undoubtedly without a history of successful consumer web investing—offered to lead a round for what they were working on. This is a team that knows a ton of other investors and often gets guidence from them—none of whom have jumped on board with their idea, because it’s really problematic. The team is super smart, but I fear that they’re going to spend the next 12 months spinning their wheels on an idea and approach that simply isn’t going to work. That’s a very expensive learning experience compared to the opportunity cost of joining a better idea with a more complete team.
Yet, what I’m saying now will come off as anti-entrepreneuer. The populists will chant from the sidelines, “Don’t let those big bad VCs tell you that your idea isn’t any good! You show them!” That seems like a more supportive position, but unless those people are writing checks to you, it actually does more harm than good.
I find this also works in friendships. Your best friend isn’t the one who supports you at every turn—it’s the one who smacks you on the back of the head when you’re doing something you shouldn’t. I’m sure you’ve figured this out, but I’m often that friend and it’s really hard to stand up in the face of unbridled support to tell someone, “Maybe this isn’t a good idea.” You can often seem unsupportive—and only until things blow up do people come back and say “I should have listened.”
I’m sure I turn out to be wrong half the time—maybe more. All I’m saying is, listen hard to the people who seem unsupportive—and be careful where you’re getting your support from. It might not be the best signal to direct your strategy.
And to all of you who go on to be successful despite the haters, more power to you. :)