August 2013The biggest component in most investors' opinion of you is theopinion of other investors. Which is of course a recipe forexponential growth. When one investor wants to invest in you, thatmakes other investors want to, which makes others want to, and soon.Sometimes inexperienced founders mistakenly conclude that manipulatingthese forces is the essence of fundraising. They hear stories aboutstampedes to invest in successful startups, and think it's thereforethe mark of a successful startup to have this happen. But actuallythe two are not that highly correlated. Lots of startups that causestampedes end up flaming out (in extreme cases, partly as a resultof the stampede), and lots of very successful startups were onlymoderately popular with investors the first time they raised money.So the point of this essay is not to explain how to create a stampede,but merely to explain the forces that generate them. These forcesare always at work to some degree in fundraising, and they can causesurprising situations. If you understand them, you can at leastavoid being surprised.One reason investors like you more when other investors like youis that you actually become a better investment. Raising moneydecreases the risk of failure. Indeed, although investors hate it,you are for this reason justified in raising your valuation forlater investors. The investors who invested when you had no moneywere taking more risk, and are entitled to higher returns. Plus acompany that has raised money is literally more valuable. Afteryou raise the first million dollars, the company is at least amillion dollars more valuable, because it's the same company asbefore, plus it has a million dollars in the bank.[1]Beware, though, because later investors so hate to have the priceraised on them that they resist even this self-evident reasoning.Only raise the price on an investor you're comfortable with losing,because some will angrily refuse.[2]The second reason investors like you more when you've had somesuccess at fundraising is that it makes you more confident, and aninvestors' opinion of you is the foundationof their opinion of your company. Founders are often surprised howquickly investors seem to know when they start to succeed at raisingmoney. And while there are in fact lots of ways for such informationto spread among investors, the main vector is probably the foundersthemselves. Though they're often clueless about technology, mostinvestors are pretty good at reading people. When fundraising isgoing well, investors are quick to sense it in your increasedconfidence. (This is one case where the average founder's inabilityto remain poker-faced works to your advantage.)But frankly the most important reason investors like you more whenyou've started to raise money is that they're bad at judging startups.Judging startups is hard even for the best investors. The mediocreones might as well be flipping coins. So when mediocre investorssee that lots of other people want to invest in you, they assumethere must be a reason. This leads to the phenomenon known in theValley as the "hot deal," where you have more interest from investorsthan you can handle.The best investors aren't influenced much by the opinion of otherinvestors. It would only dilute their own judgment to average ittogether with other people's. But they are indirectly influencedin the practical sense that interest from other investors imposesa deadline. This is the fourth way in which offers beget offers.If you start to get far along the track toward an offer with onefirm, it will sometimes provoke other firms, even good ones, tomake up their minds, lest they lose the deal.Unless you're a wizard at negotiation (and if you're not sure,you're not) be very careful about exaggerating this to push a goodinvestor to decide. Founders try this sort of thing all the time,and investors are very sensitive to it. If anything oversensitive.But you're safe so long as you're telling the truth. If you'regetting far along with investor B, but you'd rather raise moneyfrom investor A, you can tell investor A that this is happening.There's no manipulation in that. You're genuinely in a bind, becauseyou really would rather raise money from A, but you can't safelyreject an offer from B when it's still uncertain what A will decide.Do not, however, tell A who B is. VCs will sometimes ask whichother VCs you're talking to, but you should never tell them. Angelsyou can sometimes tell about other angels, because angels cooperatemore with one another. But if VCs ask, just point out that theywouldn't want you telling other firms about your conversations, andyou feel obliged to do the same for any firm you talk to. If theypush you, point out that you're inexperienced at fundraising — whichis always a safe card to play — and you feel you have to beextra cautious. [3]While few startups will experience a stampede of interest, almostall will at least initially experience the other side of thisphenomenon, where the herd remains clumped together at a distance.The fact that investors are so much influenced by other investors'opinions means you always start out in something of a hole. Sodon't be demoralized by how hard it is to get the first commitment,because much of the difficulty comes from this external force. Thesecond will be easier.Notes[1]An accountant might say that a company that has raised a milliondollars is no richer if it's convertible debt, but in practice moneyraised as convertible debt is little different from money raisedin an equity round.[2]Founders are often surprised by this, but investors can getvery emotional. Or rather indignant; that's the main emotion I'veobserved; but it is very common, to the point where it sometimescauses investors to act against their own interests. I know of oneinvestor who invested in a startup at a $15 million valuation cap.Earlier he'd had an opportunity to invest at a $5 million cap, buthe refused because a friend who invested earlier had been able toinvest at a $3 million cap.[3]If an investor pushes you hard to tell them about your conversationswith other investors, is this someone you want as an investor?Thanks to Paul Buchheit, Jessica Livingston, Geoff Ralston, and Garry Tanfor reading drafts of this.
