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Investor Herd Dynamics

by tlammens on 8/12/13, 8:18 PM with 52 comments

• by jacquesm on 8/12/13, 11:39 PM

  This is spot on. When I found out that a fellow entrepreneur had been pushed and pulled around trying to get funding for months without any solid commitment I put two of the angels involved on the spot in a meeting and asked them if I committed a certain sum of money for how much we could count on them. The round closed with 5 investors within a few days.

  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.

• by rjvir on 8/12/13, 8:39 PM

  Seeing that YC's demo day is coming soon, it's awesome to be able to peer into PG's mind - this essay along with "How to Convince Investors" must be the exact advice relayed on to the current YC batch.

• by jessaustin on 8/12/13, 9:06 PM

  I'd always wondered if anyone could upstage PG on HN. Apparently, Elon Musk can.

• by cperciva on 8/12/13, 8:54 PM

  After you raise the first million dollars, the company is at least a million dollars more valuable, because it's the same company as before, plus it has a million dollars in the bank.

  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.

• by oz on 8/13/13, 2:16 AM

  "[2] Founders are often surprised by this, but investors can get very emotional. Or rather indignant; that's the main emotion I've observed; but it is very common, to the point where it sometimes causes investors to act against their own interests. I know of one investor who invested in a startup at a $15 million valuation cap. Earlier he'd had an opportunity to invest at a $5 million cap, but he refused because a friend who invested earlier had been able to invest at a $3 million cap."

  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.

• by tkiley on 8/12/13, 8:59 PM

  It seems like the earliest investor in a multi-party round invariably gets shortchanged in the literal dollar value of the deal. If committed investors raise the valuation of a startup, would it make sense for a startup to offer a slightly-sweetened valuation for the first investor to commit?

  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.

• by dfabulich on 8/12/13, 8:56 PM

  "VCs will sometimes ask which other VCs you're talking to, but you should never tell them."

  Why not? (Unless I missed it, the article doesn't explicitly say.)

• by robrenaud on 8/12/13, 9:41 PM

  > The best investors aren't influenced much by the opinion of other investors. It would only dilute their own judgment to average it together with other people's.

  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.

• by nadam on 8/12/13, 10:02 PM

  Can someone point to a link which explains the math of startup fund raising? I was thinking about it, and what I get is a paradox:

  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?

• by pixelmonkey on 8/13/13, 1:04 AM

  I wrote about this issue a couple years ago, observing similar behavior. I used a modified horse gambling game as a metaphor for the investor dynamic.

  "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.

• by buro9 on 8/13/13, 10:25 AM

  We're in a strange place right now, sat in the middle of two pieces of startup advice.

  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.

• by stevenj on 8/13/13, 1:33 AM

  Does this mean that in most deals the investors involved don't know who else is in the syndicate until after-the-fact, if there are others?

• by LekkoscPiwa on 8/12/13, 11:12 PM

  Company isn't necessarily worth $1m more because it has $1m in the bank. Think of the dot-com bubble in 90s. All these companies with millions in their bank accounts that never sold anything to anyone for even one cent. But were burning through cash like crazy. Would you invest in them just because they have millions on the bank account?

  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.