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August 2013  
  
The biggest component in most investors' opinion of you is the opinion of
other investors. Which is of course a recipe for exponential growth. When one
investor wants to invest in you, that makes other investors want to, which
makes others want to, and so on.  
  
Sometimes inexperienced founders mistakenly conclude that manipulating these
forces is the essence of fundraising. They hear stories about stampedes to
invest in successful startups, and think it's therefore the mark of a
successful startup to have this happen. But actually the two are not that
highly correlated. Lots of startups that cause stampedes end up flaming out
(in extreme cases, partly as a result of the stampede), and lots of very
successful startups were only moderately 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 forces are always at
work to some degree in fundraising, and they can cause surprising situations.
If you understand them, you can at least avoid being surprised.  
  
One reason investors like you more when other investors like you is that you
actually become a better investment. Raising money decreases the risk of
failure. Indeed, although investors hate it, you are for this reason justified
in raising your valuation for later investors. The investors who invested when
you had no money were taking more risk, and are entitled to higher returns.
Plus a company that has raised money is literally more valuable. After you
raise the first million dollars, the company is at least a million dollars
more valuable, because it's the same company as before, plus it has a million
dollars in the bank.   
  
Beware, though, because later investors so hate to have the price raised 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.   
  
The second reason investors like you more when you've had some success at
fundraising is that it makes you more confident, and an investors' opinion of
you is the foundation of their opinion of your company. Founders are often
surprised how quickly investors seem to know when they start to succeed at
raising money. And while there are in fact lots of ways for such information
to spread among investors, the main vector is probably the founders
themselves. Though they're often clueless about technology, most investors are
pretty good at reading people. When fundraising is going well, investors are
quick to sense it in your increased confidence. (This is one case where the
average founder's inability to remain poker-faced works to your advantage.)  
  
But frankly the most important reason investors like you more when you've
started to raise money is that they're bad at judging startups. Judging
startups is hard even for the best investors. The mediocre ones might as well
be flipping coins. So when mediocre investors see that lots of other people
want to invest in you, they assume there must be a reason. This leads to the
phenomenon known in the Valley as the "hot deal," where you have more interest
from investors than you can handle.  
  
The best investors aren't influenced much by the opinion of other investors.
It would only dilute their own judgment to average it together with other
people's. But they are indirectly influenced in the practical sense that
interest from other investors imposes a deadline. This is the fourth way in
which offers beget offers. If you start to get far along the track toward an
offer with one firm, it will sometimes provoke other firms, even good ones, to
make 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 good investor 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're getting far along with investor B, but you'd rather raise
money from investor A, you can tell investor A that this is happening. There's
no manipulation in that. You're genuinely in a bind, because you really would
rather raise money from A, but you can't safely reject 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 which other VCs
you're talking to, but you should never tell them. Angels you can sometimes
tell about other angels, because angels cooperate more with one another. But
if VCs ask, just point out that they wouldn't want you telling other firms
about your conversations, and you feel obliged to do the same for any firm you
talk to. If they push you, point out that you're inexperienced at fundraising
— which is always a safe card to play — and you feel you have to be extra
cautious.   
  
While few startups will experience a stampede of interest, almost all will at
least initially experience the other side of this phenomenon, 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. So don't be demoralized by how hard it is to get the
first commitment, because much of the difficulty comes from this external
force. The second will be easier.  
  
  
  
  
  
  
  
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