Funding Markets Develop in Reverse

I co-founded AngelList because I was tired of saying no to entrepreneurs. I wanted to say instead, “yes, we can help you get funded.”

So, it’s especially disappointing when we get promising startups pitching on AngelList from remote locations. Some we’ve managed to get funded – including ones in Canada and Europe. Others are harder – especially in Russia, Latin America, and Asia.

The problem, as I’ve come to realize, is that funding markets develop in reverse.

In any given geographic region, the first companies that get funded are the ones that least need funding. They have strong operating histories, auditable financials, predictable cash flows, etc.. Funding these companies is less risky, and so a secondary, and then a primary, market forms around them. Call these the public markets.

After the public markets come the mezzanine investors, investing just before a company goes public. And because the mezzanines now exist to pick up risk, late stage private investors start forming behind them. And so on and so forth until you end up with Seed incubators and Angel investors.

Essentially, the single biggest risk that you have as an investor is “downstream financing risk.” The risk that the company won’t be able to raise more money once it has spent all of your cash.

This explains the apparent paradox that in less mature innovation cities, you’ll have an easier time finding VCs who will invest $10M in a mature business, than Angels who’ll invest $100K in a raw startup.

It’s a measure of the incredible strength of the Silicon Valley ecosystem that Y Combinator has chosen it as its hometown. YC and its brethren can only exist because of the rich Angel ecosystem. Paul Graham was smart enough to realize that his graduates couldn’t function without a rich Angel ecosystem, and went to great pains (such as AngelConf) to foster it.

Similarly, the true evidence that the NY Angel market has finally blossomed is that TechStars and a number of other seed combinators are choosing to do business there.

As an entrepreneur choosing your base of operations, take a careful look around. If you don’t see many VCs, you’re not likely to find many Angels either. Even though the VCs invest more money, they actually take less risk.

Similarly, Angels should realize how this whole pyramid functions. Investing in companies that won’t have access to Venture is incredibly risky. Investing at Venture valuations in Angel-stage companies means that your portfolio will likely generate negative returns.

Finally, if you are one of these talented entrepreneurs in a “frontier” location where there aren’t enough angels around, you have two choices. You’re either going to have to bootstrap to the point that you can show real financial returns, which will attract local and foreign investors. Or, you should consider relocating your headquarters (although not necessarily the whole company) to a funding hub.

Privacy Violations

All sorts of businesses are being built by violating assumptions about the privacy of data.

Flickr violated the assumption that you wanted your photos private by default. Before Flickr came along, the default photo sharing model, espoused by Shutterfly, Snapfish etc., was that of private photo sharing.

LinkedIn violates the assumption that your resumé is private.

FourSquare violates the assumption that your location is private.

Twitter violates the assumption that some of your thoughts are private.

Instagr.am violates the assumption that your mobile photos are private.

Blippy is testing the assumption that some of your financial transactions are private.

All of these services take your original notion and need for privacy, and trade them off against your need for fame and recognition.

What’s next?

Why (Private) Investors are Herd Animals

It’s a common complaint – venture investors are driven by what other investors think, and therefore lack imagination and spine.

There’s some truth to it – it is human nature, after all, to look for social proof and authority when making decisions. However, that’s not the whole story.

In public markets, Investors make their decisions to invest in parallel, and in theory, most of the relevant information about a company is publicly disclosed, by law. Businesses are also much more mature, and therefore easier to value. Finally, the market is very liquid and very deep, so there isn’t much uncertainty about the supply of money available and availability of money in the future.

In a public market, it’s unlikely that I have access to private data about a company’s prospects, and if I do, I buy or sell the stock and move the price. Your ability to act on my knowledge is zero – by the time you learn about it, it will already be built into the price.

By contrast, in private markets, there is a lot more non-public information scattered across many individuals, and they have the luxury of deciding in series. Businesses are brand new and immature, and very difficult to value. The market is shallow and illiquid, and a “Keynesian Beauty Contest” means that you want to finance a company now just because it is likely to be financed in the future.

Therefore, when you see other investors piling into a company, you can infer: – They probably know something about the company or the market that you don’t, given that a lot of the information (quality of founders, state of competition, true size of market, etc.) is private and scattered across many minds
– This company is more likely to get financed in the future, since it seems able to attract many, high quality investors (the aforementioned Keynesian Beauty Contest)
– And you *still have time to act at the same price* on this new information

That last fact more than any other causes Investors to move in herds.

It is rational for private investors to move in herds. They have the strong incentive – limited and diffuse knowledge. More importantly, they have the means – financings in which the price doesn’t change as the investors decide in series.

Who has time for meetings?

A lot of entrepreneurs assume that the initial way to engage with an investor is to *insist* on a meeting. It’s a relatively safe assumption that anyone on the buy side (an investor, an advertiser, an executive at a large company) receives far more requests for meetings than they can follow up on, and are constantly looking for excuses to say “no.”

Synchronous activities, such as phone calls, screencasts, videos, and webex conferences are almost as bad. If you’re trying to get the attention of an investor or exec at a major company, and don’t want to waste either your time or their time, pay very, very close attention to the cost of their time and you’ll fare better. In order of escalation, one should proceed as follows:

- Introduction – have your introducer send them an email *without putting you in the to or cc line.* That way, if the target does not wish to engage, you haven’t put them in the awkward position of having to supply an excuse or a turndown. The introducer protects their ability to be taken seriously this way.

- Once you have a response / interest, send something written for them to look over and offer a phone call, webex, or meeting as next steps. Written always beats a video or screencast, since most intelligent people can read a lot faster than they can listen. A webex demo is a crutch – if your product has to be explained, it probably isn’t ready for the average consumer. And if it’s in beta, you should at least know how to open up a password-protected demo version.

- If the target displays interest in learning more, then you can move to a call or in-person meeting.

People who insist on a webex demo or in-person meeting at the outset are forcing the target to make a high-cost decision, and are subtly signaling that they don’t value their own time, and certainly don’t value the targets’ time. They might think that they are demonstrating persistence, but one wants to see persistence in chasing the product, not in chasing dead-ends.

In short, your high-value targets don’t have time for meetings between un-screened parties, and since you’re busy building a company, you shouldn’t have time for them either.

Venture Hacks Meetup and Panel at SXSW

For those of you going to SXSW, I’ll be on the Seed Combinators Panel on Monday March 15 3:30pm. I’m joining Paul GrahamDavid CohenMarc Nathan, and Joshua Baer to talk about YStars, TechCombinators, SeedBoxes, and the like. Here’s the Plancast if you want me to “count you in.”

I’m also throwing a meetup on SundayMarch 14 5-7pm in the Four Seasons Lobby Lounge at 98 San Jacinto Blvd.

If you’re a Venture Hacker, please come talk to me about your startup and venture hacking at these two events. I’m looking forward to pressing the flesh and kissing some babies.

Please RSVP on Facebook xor Plancast so we can get a headcount. Gracias.

The iPad is imPortant

Perhaps not in this incarnation – remember the first iPod? But the concept is very, very important for two reasons:

- It’s the first computing device that’s social in the real world. The iPhone is something that one person uses at a time. The Laptop screen faces you – two people using it at one time is awkward. iPad style devices can be shared in the real world – imagine laying it flat and playing multiplayer games facing each other, or watching a movie together, or even showing someone a web page – far easier than on any other device.

- It runs the iPhone OS. Why do users need to know what a file system is? Or map the interactions of a moving block of plastic onto a screen (mice)? Or worry about memory management? Or multiple levels of trash-delete? Or the concept of multiple, mounted volumes? Or which network you’re connected to?

Basically, the iPad is (a) usable by the other 5.5 Billion humans, and (b) it can enhance real, physical human interactions. These two facts alone make it a worthy successor to the iPod and iPhone. Steve isn’t ready to start filling niche markets just yet. He’s still looking to rule the world.

Y Combinator vs. Graduate School

Y Combinator* is the new Graduate School.

In some ways, it’s better:

- You pay to go to graduate school. YC pays you.
– After school, you get a job. After YC, you create jobs.
– You repeat the works of the greats in school. YC expects you to do original work.
– In school, you are graded on an arbitrary scale by arbitrary people. After YC, you are graded by the real world.

Some day, most schools in most disciplines will be like this.

* – Of course, “Y Combinator” is a generic term for Techstars, I/O Ventures, SeedCamp, Capital Factory, Founders Institute, and all of the other similar pre-angel incubators.