Hackers, Painters - and Investors

We originally did this a few days ago for our own purposes, a sort of "Investing 101", its a precis of the excellent larger piece Paul Graham did earlier this year - but as there was so much discussion on investing at NMK Forum 07 we thought it may be useful to share it because its quite a good summary and gets the points across fast. Go to the original article for depth:

1. The investors are what make a startup hub.

If I had to narrow that down, I'd say investors are the limiting factor. Not because they contribute more to the startup, but simply because they're least willing to move.

2. Angel investors are the most critical.

VCs invest other people's money, and angels invest their own. Though they're less well known, the angel investors are probably the more critical ingredient in creating a silicon valley. Most companies that VCs invest in would never have made it that far if angels hadn't invested first.

3. Angels don't like publicity.

If angels are so important, why do we hear more about VCs? Because VCs like publicity. They need to market themselves to the investors who are their "customers". Angels....don't want to market themselves to founders: they don't want random people pestering them with business plans.

4. Most investors, especially VCs, are not like founders.

Some angels are, or were, hackers. But most VCs are a different type of people: they're dealmakers. Hackers like to make things. This would be like being an administrator.

5. Most investors are momentum investors.

Because most investors are dealmakers rather than technology people, they generally don't understand what you're doing. They win by noticing that something is taking off a little sooner than everyone else.

Investors always say what they really care about is the team. Actually what they care most about is your traffic, then what other investors think, then the team.

6. Most investors are looking for big hits.

What this means is that most VCs will only invest in you if you're a potential Google. They don't care about companies that are a safe bet to be acquired for $20 million. Angels are....happy to invest in a company where the most likely outcome is a $20 million acquisition if they can do it at a low enough valuation.

7. VCs want to invest large amounts.

The fact that they're running investment funds makes VCs want to invest large amounts. VCs don't regard you as a bargain if you don't need a lot of money. That may even make you less attractive, because it means their investment creates less of a barrier to entry for competitors. So if you're doing something inexpensive, go to angels.

8. Valuations are fiction.

VCs admit that valuations are an artifact. They decide how much money you need and how much of the company they want, and those two constraints yield a valuation.

9. Investors look for founders like the current stars.

Now most VCs know they should be funding technical guys. This is more pronounced among the very top funds; the lamer ones still want to fund MBAs.

10. The contribution of investors tends to be underestimated.

Investors do more for startups than give them money. They're helpful in doing deals and arranging introductions, and some of the smarter ones, particularly angels, can give good advice about the product.

11. VCs are afraid of looking bad.

As a friend of mine said, "Most VCs can't do anything that would sound bad to the kind of doofuses who run pension funds." Angels can take greater risks because they don't have to answer to anyone.

12. Being turned down by investors doesn't mean much.

Investors would be the first to admit they're often wrong. So when you get rejected by investors, don't think "we suck," but instead ask "do we suck?" Rejection is a question, not an answer.

13. Investors are emotional.

I'm not sure if it's their position of power that makes them this way, or the large sums of money involved, but investment negotiations can easily turn personal. If you offend investors, they'll leave in a huff.

14. The negotiation never stops till the closing.

Inexperience and wishful thinking combine to make founders feel that when they have a termsheet, they have a deal. It's not uncommon for investors and acquirers to get buyer's remorse. So you have to keep pushing, keep selling, all the way to the close.

15. Investors like to co-invest.

...I think the main reason VCs like splitting deals is the fear of looking bad. If another firm shares the deal, then in the event of failure it will seem to have been a prudent choice—a consensus decision, rather than just the whim of an individual partner.

16. Investors collude.

Though a professional investor may have a closer relationship with a founder he invests in than with other investors, his relationship with the founder is only going to last a couple years, whereas his relationship with other firms will last his whole career.

17. Large-scale investors care about their portfolio, not any individual company.

They don't need any given startup to succeed, like founders do, just their portfolio as a whole to. So in borderline cases the rational thing for them to do is to sacrifice unpromising startups.

18. Investors have different risk profiles from founders.

Most people would rather a 100% chance of $1 million than a 20% chance of $10 million. Investors are rich enough to be rational and prefer the latter. So they'll always tend to encourage founders to keep rolling the dice.

19. Investors vary greatly.

It's particularly important to raise money from a top firm if you're a hacker, because they're more confident. That means they're less likely to stick you with a business guy as CEO, like VCs used to do in the 90s. If you seem smart and want to do it, they'll let you run the company.

20. Investors don't realize how much it costs to raise money from them.

Investors have no idea how much they damage the companies they invest in by taking so long to do it. But companies do. So there is a big opportunity here for a new kind of venture fund that invests smaller amounts at lower valuations, but promises to either close or say no very quickly.

21. Investors don't like to say no.

Because they're investing in things that (a) change fast and (b) they don't understand, a lot of investors will reject you in a way that can later be claimed not to have been a rejection. Unless you know this world, you may not even realize you've been rejected. Here's a test for deciding whether a VC's response was yes or no. Look down at your hands. Are you holding a termsheet?

22. You need investors.

Why? What the people who think they don't need investors forget is that they will have competitors. The question is not whether you need outside investment, but whether it could help you at all. If the answer is yes, and you don't take investment, then competitors who do will have an advantage over you. And in the startup world a little advantage can expand into a lot.

23. Investors like it when you don't need them.

So you shouldn't start a startup that's expensive to start, because then you'll be at the mercy of investors. If you ultimately want to do something that will cost a lot, start by doing a cheaper subset of it, and expand your ambitions when and if you raise more money.

Its not totally our experience, nor yours I suspect, but Paul has seen a lot more than we have I'm sure so its well worth going through this.