Photo: Thomas Kelly By Noah Jessop One of the challenges of Venture Capital is the feedback cycle — it takes many years to know if an investment will be a good one or not. Sure, companies can quickly fail, and winners may seem to emerge in just a year or two — but “it ain’t over until it’s over.” When running a company, the feedback cycle is very rapid. Either customers buy your product or they don’t. Either you ship product or you fall behind. New hires either join or they take other offers. Sometimes the feedback is even faster: people (customers, potential investors, recruits) won’t even take your call. But on the investor’s side, it’s easy to go soft, lured into complacence by the endless stream of interesting and plausible companies to meet. Without any of this hard, affronting feedback available — many investors unconsciously take a shortcut and believe: The definition of a ‘good’ deal is who else is looking at it. In early stage technology business, most venture backed companies will, with near-certainty, require future equity financing. So oddly enough, this makes the value of a particular deal opportunity be who else might be interested. easily perceivable But here lies the challenge: if deal quality is measured by who is else is interested, than you, the investor, . will always be behind by definition Meet a new company no one has heard of? Hmm, seems early. Meet the hot deal that everyone is calling on — must be the hot thing, something special. Investors structurally cannot meet a deal everyone is talking about first. While it’s true that popular deals are more likely to get capital, this . is totally uncorrelated with actual return If the investor is actually a momentum investor (often in disguise, even to themselves), that’s OK. Just know who you are talking to (or better, who you are). As an exercise to the reader, take a small random sample from any truly great venture fund — in most draws, you’ll miss the companies that drive the economics for the fund. Just because they are looking — and went on to invest — means absolutely nothing in this hits-driven business. One of my investor friends quipped “I don’t ask who they are talking to…it’s like romantic partners, I don’t want to know who else they’ve been with already.” What entrepreneurs can do about this 1) Don’t let fundraising drag along. Just as investors like to know who else is looking as a shortcut, there is a dangerous cousin: how many people have not chosen to invest already. When I was a founder, I always urged my peers starting (or languishing) on their fundraising process to do something: Some of the best companies can do this somewhat organically — the phone is ringing off the hook with potential customers, the money is pouring in, and while having $4.50 coffees is nice, it’s a distraction. Wrap it up and get back to work. create a discrete moment of FOMO . The perfect specimen of this moment is the ultimate FOMO-Festivus: YCombinator’s demo day. All investors can be quite certain that hundreds of other vetted, liquid, and serious investors have seen the deal — managing to tip 1) who is looking at the deal and 2) create time pressure. While they’ve worked very hard to scale this model, this is hardly a solution for every great aspiring technology entrepreneur in the world. 2) Classify potential investors: independent thinker or momentum player? Sometimes momentum is structural rather than personal — when funds can only write a $100–200K check, they rely on the founder to be able to attract sufficient investment to be able to hit whatever the next milestones for the company. Sometimes nascent venture funds will prioritize companies that will seem promising to later investors — they’ve got their own milestones to hit to secure the next fund. The only catch with momentum investors is that not all of them realize they are in the momentum business. Independent thinkers will be willing to lead before others do. Sometimes investors have an easier time with independently leading when it’s a field they know well. Hopefully the proliferation of sector-specific seed funds will add to the ranks of truly independent investors. Having a strong contrarian view often takes a little time. If you identify investors you like, with a history of leading and independent thought, don’t be afraid if it takes a few months to fully get to know each other and understand the business. We often meet entrepreneurs with a common refrain: “we’ve got strong interest, just looking for a lead.” Leading is hard. Saying “we’re interested, pending who else is, price and everything else” is easy. 3) Run a tight process This doesn’t mean a fast process. Just a coordinated process. If your business is in a new area that’s hard for folks to wrap their head around, don’t be shy to connect a few months before a formal round. Test your materials on other entrepreneurs who have been through the process before. Have your materials ready to go. In many cases, you are signing up for a 5–10 year relationship with potential investors. So don’t rush things. Set the tone for how you will run your board and your company. Most of all, find the people you want to go build something great with. And get back to work.
