Momentum InvestorsBy The Pakistani Spectator • Jul 8th, 2007 • Category: Uncategorized • One Response
Because most investors are dealmakers rather than technology people, they generally don’t understand what you’re doing. I knew as a founder that most VCs didn’t get technology. I also knew some made a lot of money. And yet it never occurred to me till recently to put those two ideas together and ask “How can VCs make money by investing in stuff they don’t understand?”
The answer is that they’re like momentum investors. You can (or could once) make a lot of money by noticing sudden changes in stock prices. When a stock jumps upward, you buy, and when it suddenly drops, you sell. In effect you’re insider trading, without knowing what you know. You just know someone knows something, and that’s making the stock move.
This is how most venture investors operate. They don’t try to look at something and predict whether it will take off. They win by noticing that something is taking off a little sooner than everyone else. That generates almost as good returns as actually being able to pick winners. They may have to pay a little more than they would if they got in at the very beginning, but only a little.
Investors always say what they really care about is the team. Actually what they care most about is your traffic, then what other investors think, then the team. If you don’t yet have any traffic, they fall back on number 2, what other investors think. And this, as you can imagine, produces wild oscillations in the “stock price” of a startup. One week everyone wants you, and they’re begging not to be cut out of the deal. But all it takes is for one big investor to cool on you, and the next week no one will return your phone calls. We regularly have startups go from hot to cold or cold to hot in a matter of days, and literally nothing has changed.
There are two ways to deal with this phenomenon. If you’re feeling really confident, you can try to ride it. You can start by asking a comparatively lowly VC for a small amount of money, and then after generating interest there, ask more prestigious VCs for larger amounts, stirring up a crescendo of buzz, and then “sell” at the top. This is extremely risky, and takes months even if you succeed. I wouldn’t try it myself. My advice is to err on the side of safety: when someone offers you a decent deal, just take it and get on with building the company. Startups win or lose based on the quality of their product, not the quality of their funding deals.