Among the many reasons why it is challenging to be a founder, there is this quirk of the venture business — there are a lot of investors, and it is tough to figure out who is the right one.
One axis of the decision-making model is what I think of as Momentum vs. Conviction.
One way you can identify the momentum species is if they ask the magic question: “Who else is in the deal/round?”
Momentum investors are driven by the trend du jour. They often show up when:
- The round is oversubscribed and the company operates in a “hot” space
- Participating in the round will allow the investor to be part of an “in group” of “top tier” VCs
- The investor missed the last hot company in this space and is prepared to do anything to get into the next one (this is one sad reason VC bubbles form)
- There’s a great/famous VC leading the round
- A great/famous VC led the last round
It seems obvious that this isn’t the kind of investor a founder wants. But in the moment, it is really difficult to say no to someone who is persistent, especially when you’ve been laboring away at your product on starvation wages for years. The attention can also be fun. For the moment, everything’s great, you’re hot, and dollars are flying at you.
The question in your mind may be: So what? What if they’re in the company for the wrong reasons?
The answers unfortunately only emerge over time:
- In future rounds, they will be unable to come to a decision on whether or not to fund you based on how you’re actually doing. They seek external validation from the market and cannot think through the nuances to figure out where the market is going and how you can play a role in the market
- Their term sheets can often cause trouble. If the deal is hot, they may overprice it (and then later yank or revise it if the deal cools). High prices driven by the perception of being “hot” can often lead to downstream issues in future rounds (but that’s a whole different post).
Momentum isn’t the only way to make investing decisions. Someone could also invest in your startup based on the conviction that your company represents the best approach in a space they understand and care about. Here are some of the signals of conviction investing:
- They want to learn about the company and the space
- They admit when they are learning and how much time they need
- Rounds can move fast, but these investors will want to do the work to get to comfort regarding the industry, the company, the founder, and all open issues
- They almost never ask the dreaded question “who else is in the round”, because they’re basing their decision on their work.
It’s fantastic to be a hot company, but if the music stops, and if you cease being the next hot thing — you want a conviction investor at the table with you.