Investor Herd Dynamics
paulgraham.com
paulgraham.com
All it takes is for someone to cross the bridge of commitment and others will follow. The fact that I'm probably two orders of magnitude poorer than the other investors probably helped in embarrassing them to make a move, it was literally peanuts to them and the company went on to moderate success.
Here at my company we tried to make a pre-A round of sorts (mostly because we are in Brazil, and investors here are unwilling to invest anything close to a A round here).
We had several people commit saying that if other people go, they will go too... But we found noone to commit as leader, and all the other commited investors refused to go without a lead investor, kinda annoying situation.
Happily our seed investor liked our recent results and expanded his seed investment instead.
This seems a bit specious. Sure, the lower bound on the pre-money valuation for investor #2 should be the post-money valuation for investor #1, not the pre-money valuation for investor #1; but the valuation per share won't necessarily be any different.
A 3 MM dollar company comprised of 2 MM stock and 1 MM cash is more desirable than one with just 3MM in stock.
I'm not surprised, per se, but rather always amazed whenever I hear stories of rich people acting in ways inimical to their economic interests. One would think that an experienced (I guess) businessman, such as a VC, would be somewhat more rational than that. Then again, this is an article about 'Investor Herd Dynamics', so I suppose that should inform my opinions about human behaviour.
I understand that no one likes to have the price raised on them later, but perhaps the underlying truth of increasing valuations could be restated in a different way so it seems more like a discount to the first-in vs a price-hike to the last in.
That is exactly what I did when raising seed money for dotCloud. It works great.
Our very first angel (Ash Patel from Morado Ventures) was not the first to express interest, but he was the first to actually sign a check. For that he got a better deal, as well as our lasting gratitude and permanent advertisement as "dotCloud's first angel". Everyone else in the round got identically unsweetened (but fair and attractive) terms. I was and continue to be very transparent about the arrangement, because it's very obviously fair, and doesn't make anyone feel like an idiot.
When we had the opportunity to further escalate the cost of the round, we didn't, because that didn't seem obviously fair and I didn't feel confident I could look an investor in the eye and tell him that it was. We may have left a little gravvy on the table, but in return we saved time, spared ourselves distracting drama, earned trust capital with our investors, and retained the ability to take the moral high ground in any future negotiations.
I don't claim that this is the best method. Certainly not every founder who successfully raised money did it this way. But it worked for me.
Good post by Mark Suster here: http://www.bothsidesofthetable.com/2012/09/08/should-investo...
Why not? (Unless I missed it, the article doesn't explicitly say.)
There is a lot more than gut judgement involved in deciding to give somebody I just recently met a large sum of my money. I don't let other VCs dilute my judgement but I certainly listen to them when they have more knowledge of the relevant facts about a company, its people, its product, or its market.
Note that I'm an angel investor, so I try to make sure the cost of due diligence is proportional to the amount I'm investing. If I were a fund and writing million dollar checks, I would spend the time to do all the due diligence myself.
There are a bunch of investors out there that I know, like, and trust.
Also slightly less importantly, there are investors I don't necessarily trust.
The composition of the syndicate is an important signal.
But I think the salient point is whether the investor is asking who the other investors are so they can cooperate with them, compete with them, or collude with them. And that depends on the investor, not whether they are an angel or a VC.
One thought that comes to mind is if you mention that you are also talking to "Sam " then "Bob" (who you are having a conversation with) can start to game Sam, or Sam can game Bob (when Bob mentions it to Sam later if they know each other).
So in terms of general business "loose lips sink ships" this is something to avoid.
So either party can play mind games with the other. And depending on the relationship of the two this could create a problem.
Other thing is that this gives the VC you are pitching a chance to drop things in your mind about the other VC that might affect your judgement. "Oh well he's a great guy but the one thing you need to consider is..."
My guess is PG might feel that the type of people in YC don't have enough experience to manage this situation properly so it's really similar to an attorney saying "don't say anything let me do the talking".
But if one VC knows who the other VC is, then collusion is simple and clearly in the VC's best interest.
The compromise position here is being honest but guarded - ie, especially if you are talking to one of those above - As a founder / CEO's, come back to the investor here and say we're talking to a couple of top-tier firms, which gives the signal effect to the investor that they need to sell / convince quickly while maintaining your leverage as an entrepreneur.
I don't know anything about startup investing. But I do know about machine learning. And you can often improve an ensemble predictor by adding (many) weaker features and averaging them with an already strong predictor.
One shouldn't confuse the prediction of an average predictor with the average of a bunch of predictions that come from a pool of on the whole mediocre predictors. Averaging is really a strong operation for prediction. Of course, it does help if the individual predictors are themselves independent or uncorrelated with each other, which I guess tends to be very untrue in a herd.
I assume the definition of raising money is that the original owner gives some percentage of the company to a new owner, and the new owner gives an amount of money to the company.
Let's say the company's valuation is 1 million dollars. Let's say the owner sells 10% for 0.1 million dollars.
In a perfect market the company's new valuation is obviously 1.1 million dollars: the original value in the company's resources (people, etc...) plus the 0.1 million in the bank.
On the other hand in a perfect market perfect owners made a deal in which the original owner's wealth is the same before and after the deal.
Before the deal he was worth 1million. After the deal he is worth 0.9*x, where x is the new valuation of the company.
So:
1million dollars = 0.9x
x = 1.1111' million dollars
So which is the correct new valuation: 1.1, or 1.1111'? Or something different?
Maybe the deal have to be made in infinitely small pieces, so the result is coming from some kind of differential equation?
- Pre-money there are 1,000 shares, valued at $1,000 each
- The company sells 100 new shares for $1,000 each
- Post-money there are 1,100 shares
So after selling 100 shares, the original owner now owns 1,000/1,100 shares = 90.9%. The new valuation is 1,100 shares * $1,000/share = $1,100,000.
If company is worth 1m, and someone invests 100k, they get 0.1/(1+0.1) (current value of company + additional $100k after investment) worth of shares, what gives investor c. 9% of shares.
Founder now has 91% of shares, what still give him $1m. (91% x $1.1 = $1m)
It has a calculator that provides economic breakdowns and a supporting article defining the key terms of a term sheet.
Why? It is still 1 million dollars. The only difference is that the owner now owns 0.9M$ worth of company shares and 0.1M$ cash.
The rest of the company still has the same value, plus some (unclear) amount from having successfully raised money.
"It's easier to play the option than the bet." http://www.pixelmonkey.org/2010/12/13/its-easier-to-play-the...
In this new race, small signals have a big impact.
Charge ahead suddenly and you might get your 3 spots
filled. Convince a top-tier gambler to go to bat for
you, and you’re all set — your other two spots will
fill up quickly. If you’ve been in the race before
and had your spots filled up quickly, you’ll likely
get them filled up quickly when you enter the race
again.Piece of advice #1: "The time to raise money is not when you need it, or when you reach some artificial deadline like a Demo Day. It's when you can convince investors, and not before."
Piece of advice #2: The best time to raise VC money is when you have product/market fit and need rocket fuel to grow.
We were having conversations with investors to suss out the London startup scene (we feel like outsiders mostly having kept ourselves to ourselves) and to make connections with industry leaders who might make great advisors.
2 Weeks ago these conversations suddenly turned into "Shut up and take my money.". Once this started happening, it happened at every meeting, with investors swiftly upping the amount they believe we should take... we have a herd all telling us to take their money. We haven't done a proper pitch to anyone.
We were aiming at #2 (product/market fit), and have stumbled upon #1 (convinced investors forming a herd).
The problem is expectations. We are at seed stage, and are developing the product/market fit. We have customers lined up, but we're not yet seeing good traction with the existing customers we're engaged with. We want to carry on improving the product, testing as we go.
If we take VC money we very much believe we'd be under expectation to focus on growth before the product is the right one for the market (it has a lot of promise today, but it's not yet proving itself fully).
Our current view is to to explain to investors/VCs that we're still seed and take the money only if it doesn't come with conditions and is understood we're still seed.
Not a lot of wisdom out there on whether you should decline VC money. We're not of the belief that all money is good, especially if it proves to be a distraction from just making the a great product that customers really want.
The more explicit the expectations, the better! Get to know them, ask them about their styles and priorities, check their track record with previous entrepreneurs (not just active investments! their loyalties may be mixed and they will lack the perspective).
It seems like you also have the luxury of not raising money at all for another X months (another assumption I assume you've quantified and triple-checked), so that makes it easy to walk away if the bar is not reached. Just like any other deal, your leverage is only as strong as your plan B.
I may be stating the obvious. In any case, good luck! "Shut up and take my money" is always a good problem to have.
The market is washed with cheap money courtesy of the FED. According to one study VCs in the US gave worse return in the past decade than blue chip stock. High risk, high return companies have had worse performance in the past decade than low risk, low return. This is not good statistics at all.
http://blogs.reuters.com/felix-salmon/2012/05/07/how-venture... http://www.verisi.com/resources/venture-capital-performance....
The market is drunk on the money provided by the FED. We'll all have horrible hangover after all is said and done. (i.e. the FED eventually rises interest rates).
edit: I love it how people down vote just because I said something opposite to what PG claims. And then no response neither ;-) Somehow this actually makes me feel good! Because it looks like I'm right as nobody replied.
If you have no name, this is the time to make your name. If you have a name, this is the time to make money with that name. These are the times in which you have the most leverage.
Yes, of course, the business cycle will go down again. when will it change direction? How sharp will that transition be? Nobody knows. Worrying about that is... trying to know the mind of god. We all have a set of tools, a set of resources and abilities. We need to use those resources and abilities to make enough money (or enough notoriety) that we will be able to deal with the thin times. Now is the time to run hard, not to wonder about macro. There will be plenty of time for that during the next downturn.
Sitting here and complaining about the business cycle doesn't help you, it doesn't help me, and who knows, maybe some people feel that it brings that day of "the business cycle goes down" closer to now. That was the primary reason why I'd guess you got down-voted.
The other thing? Do you remember the '90s? I worked through the crash. It was not at all obvious ahead of time, which companies would come through, and which companies would not. I mean, it seems obvious now, sure, but it was not obvious then.
I do work. Business cycle is up temporarily on cheap credit. There is no substance to it. 70% of new hires since 2008 in the US are part time. The debt to GDP ratio is higher than ever. Food stamps are on record high. Inflation if used Ronald Reagan years formula and not today's hocus-pocus hedonistic whatever is at 10%. The whole thing seems to work just because of the interest rates at 0% since 2008. And you can't have them at zero forever.
> Sitting here and complaining about the business cycle doesn't help you, it doesn't help me, and who knows, maybe some people feel that it brings that day of "the business cycle goes down" closer to now. That was the primary reason why I'd guess you got down-voted.
Wow. If 50 million Americans on food stamps, 10% inflation rate, and average real wage adjusted for inflation lower than in 1960s is up in the business cycle, I'm afraid to ask what will be down. Greece?
> The other thing? Do you remember the '90s? I worked through the crash. It was not at all obvious ahead of time, which companies would come through, and which companies would not. I mean, it seems obvious now, sure, but it was not obvious then.
No, it wasn't. The same like right now it is not obvious to you that the "up" you perceive is just a bubble in the US Treasuries. Don't worry, will be obvious to you soon as well.
BTW, you haven't addressed anything that has to do with extremely poor VCs performance in the past decade from my post. And that $1m on the company's bank account usually doesn't translate into the company being worth $1m more. Which was my main point. Care to talk about this?
The money will pay your bills as well as any other money.
My point here is that you can't do anything about this ebb and flow of money, 'fake' or not. Point is, you need some. I need some. Not a whole hell of a lot, really, on a global scale, but you need some money very badly. Even if it's "fake" money that isn't being managed in the way you like.
>70% of new hires since 2008 in the US are part time. The debt to GDP ratio is higher than ever. Food stamps are on record high.
The market for labor is intensely local, but local in a different way from the market for real-estate. Yeah, most folks are still getting shit upon. The business cycle isn't 'up' for them at all.
But it's 'up' for the sort who read hacker news. Engineer salaries are through the roof. I can't keep a PFY. Used to be that I'd keep someone for years if I hired them full-time; tens of months if I hired them part-time. The last few PFYs got yanked out from under me within the first month or two. [1]
The bubble is localized to our industry (and to a lesser extent, to my physical area.)
You.. sound foreign, so I'm guessing you don't remember what it was like in silicon valley and outlying areas in the early to mid-aughts? [2] It was /really bad/ for computer folks, and really not all that bad for everyone else. I had many, many friends who were of my technical level working retail. It was really bad for us. (but the retail jobs were still there; everyone else was largely fine.)
Right now? it's our turn for the good times, while everyone else suffers. I'm not saying it's fair or good... just that it is, and shouting that money is a government construct, and that they are trying their damnedest to generate some inflation (no shit.) changes nothing.
>Inflation if used Ronald Reagan years formula and not today's hocus-pocus hedonistic whatever is at 10%. The whole thing seems to work just because of the interest rates at 0% since 2008. And you can't have them at zero forever.
I don't understand why people seem to think inflation is some kind of crazy boogyman. Think about it. Everyone is in debt. Much of that is fixed-rate debt. Real inflation (including wage inflation) would be good for all of those people.
In fact, I personally believe inflation, nationwide, really is close to as low as they say. It's hard to have real inflation without wage inflation, and we're only seeing that here in silicon valley. From what I understand, this is a problem. We need inflation (especially wage inflation) to deal with our consumer debt problem.
Now, what we've been seeing is inflation in commodities, which is about the worst-case all around. We need inflation in wages (which will result in general price inflation, but so long as wages inflate, too, I think that's just fine.)
Of course, all that macro bullshit is just that; it's bullshit. I'm no expert, and I'm not convinced at all that the experts know anything themselves.
I do have some experiences with this industry, though, and the bit about making hay while the sun is shining? it's real. It's way easier to make career progress while the (local) economy is up.
[1]I don't begrudge them that; that's the whole deal with hiring apprentices. They take the job for low pay so they can get the job for high pay after they have built some experience with you. If one of your employees gets hired away for 2x or 3x the maximum amount you could pay them, there's really nothing to do but congratulate them and ask if they know anyone who might want their old job. (That's how I get my best recruiting leads.) But it does mean that the job market for smart young programmers/sysadmins is hotter than it was.
[2]I mean no insult; Your English is not terrible for a native speaker, and English is a tough language. I'm a monoglot, myself.
I guess the corollary here is that if you still aren't in the US or in silicon valley, well, you probably see things rather differently than I do.
Insurance premium for me is up 20% year to year. Food is up. Medication is up. Gas is up. All kinds of insurances are up. And all of these hurt common folk the most too. Guys living paycheck to paycheck. But those don't even get what the inflation is and how it translates to their daily lives. So the Government just continues printing.
Now talking about good times we have now in the IT. My answer to this consists of 2 points: (1) It's not only IT. Just read somewhere that some parameters of the housing market are as "hot" now as they were in 2007 in some areas (Las Vegas); cars are also selling as well as in 2007; etc. Which takes me to (2) The FED by keeping interest rates at 0 since 2008 was able not only to reinflate housing and IT bubbles but probably to create even more bubbles all over the place. So what I think and of course I may be wrong -- what you are experiencing with your new hires now is just another bubble built on cheap credit. Since 2008 the whole world has been buying US Treasuries like never before, funding US Government, financial sector and big businesses on unprecedented scale. The VCs I mentioned - how in the world can you be a VC and have worse return than S&P500 for the past decade? And still get funding! Why? Because with interest rates at 0% nobody wants to keep cash or money on deposits - everybody has to "invest" (or rather speculate). So that's what happening. If you do nothing with that cash you loose 10% year to year. So you invest no matter what. In IT, real estate, startups, whatever. Once the world stops buying US Treasuries on such a scale and actually starts selling them, the interest rates will go up. So then the question is why to invest in all these crazy startups, equities, bonds, real estate, etc. When just keeping cash at the bank deposit returns 5% a year? Or maybe even better at 18% (as it used to be the case in 1981). That's when you will see - sorry for putting it so bluntly - how much all these VCs, IT sector, real estate, etc. are really worth. Without cheap credit doing the work of life support.
BTW, I'm an (proud) US citizen, originally from Poland. As crazy as it may sound to you, after almost 10 years in the US (9 years IT experience) I decided to move back to Poland because I'm really worried that the US economy may face extremely serious crisis. Comparable to hyperinflation in Germany in 1920s. Think of me as of one of these tin hat guys or gold bugs ;-) My English sucks at times. I try to reread whatever I write, but sometimes I just write stuff and don't really care and well, it shows. My apologies, I tried to be better this time, lol. Nice talking to you btw.
I get you. You are a business guy doing his thing and you could care less about all the economics and politics BS. Honestly, I think that's great. I don't want to waste your time, so just saying hello and take care.
and don't forget bondholders. But yes, inflation (I mean, flat, across the board inflation, and it never actually happens that way) tends to hurt the rich and tends to benefit the poor. The view that the rich are rich because they are morally superior is pretty common, as far as I can tell; more common here than abroad. It's a view that I disagree with.
So, to answer what you said -- newly created money benefits those who are first to receive it. If the owner of the printing press (the Government) makes it such that group A receives the money first and then decides how to spend it, then the group A will benefit at the expense of everybody else. If group A decides to spend it on people in group B then these folks will mainly benefit as well. And then group B spends on others, so on. The last one to receive it is the big looser. If the Government policy is to hand over the newly printed money to the healthcare companies - healthcare wins at the expense of everybody else. If the Government decides to spend it on the Travel industry - these folks win while we all get hit with the inflation. Etc, etc. It's not really rich vs poor debate, it is who gets the freshly printed money from the FED first is the one who benefits at the expense of everybody else.
That's why inflation is bad. Inflation is the reason why you see the gap between rich and poor - worlwide, not only in the US - getting bigger. Because somehow the FED always hands over newly created money to the banks. And I'm not a socialist saying it's bad on moral grounds - far from it. I'm saying that's a sick economy. The FED should be abolished and money should go there where the markets want the money to go. Without being influenced by politicians and their agenda. That's what - to me - true republicans hail - free economy. The FED needs to be abolished. And as can be easily shown this money creation process will create bubbles. If newly created money goes to IT, IT has a bubble. That's what happened when the FED printed in 1990s to go over Savings and Loan Crisis -- all the newly created money created IT bubble. To fight off the results of that bubble bursting they printed even more -- that's what caused to Housing Bubble. And when this one bursted (they always burst) - they created the US Treasuries bubble. The Ultimate Bubble. The Wholy Grail of Bubbles. Bubble in the reserve currency of the world. Bubble in everything across the spectrum. I'm not going to sit around in the US and wait for that one to burst as well.
Bauer Mayer Rothschild, 1838: "Let me issue and control a Nation's money and I care not who makes its laws"