I wrote another post about what entrepreneurs should do to help their venture-backed companies succeed. Here’s what entrepreneurs should know about the psyche of the people they’re taking money from.
Again, this is not something I knew or appreciated until I was very late in the game. It’s been said before, but maybe by writing my own version of I’ll help emphasize this truth:
Investors are driven by fear and greed.
That’s all you need to know, but I’ll elaborate a bit more on both of these.
Fear — of missing out
Investors hate being the guy who turned down Pinterest, or Snapchat, or Uber. They’re out there. Some even make fun of themselves for it. (Missed on Facebook and Google, Bessemer? OUCH.)
So savvy entrepreneurs manufacture the fear of missing out (FOMO). They get buzz on TechCrunch and ProductHunt by winning awards or announcing crazy growth stats. Then they take a whole bunch of meetings at all the VC firms and make it sound like everybody is after them. Once the first angel investor buys in, the snowball hits.
Then you start throwing out the magic word: “oversubscribed.” That means demand for shares of your company has outstripped supply. You have no more stock to sell, and now you’re the King of the (Sand) Hill.
That best of all possible conversations goes something like this:
“How much are you raising, Ryan?”
“Well, actually, we’re oversubscribed. How much did you want to invest?”
“We write minimum $2 million checks.”
“Hmm… Okay. I’d love to work with you, so let me see what we can do.”
The FOMO winds are blowing your sails. Sit back and let the term sheets come.
Greed — is good
Partners at VC companies, the guys who will wind up on your board if you win the fundraising game, inevitably are greedy bastards. They want the biggest stake in the hottest company for the longest time. This way they can keep putting more money in as the other guys come in at higher and higher valuations. They get to look like oracles while the rest of the valley jumps aboard their train.
Greed is also at the heart of the unfavorable terms you’ll inevitably agree to even if you’re oversubscribed.
See, you’re selling “preferred” stock in your company. Preferred is above common, meaning when the liquidity comes, your investors get theirs before you get yours. Why? Because greed.
But, like I said, it’s good. At some level, I want my board members to be greedy. Our incentives are aligned. The bigger the company, the faster the growth, the sooner the exit and my yacht (By the way, I always thought a great name for a post-exit yacht is “Liquidity.” Get it?)
Just be careful what you wish for, because if the tables turn, and you need financial support for whatever reason, you won’t get it. Resources must be allocated to the clear winners, not the possible losers.
But why? Guess.