nPost Blog

Capitalism just like Adam Smith pictured it


From far away, things that are very different look alike. I grew up in a family of musicians and English professors. To them, the entire financial industry seemed corrupt. When I worked in finance – first on Wall Street and then in venture capital – I saw that the reality was much more nuanced. Some finance is productive and useful and some is corrupt and parasitic.

Most financial markets start out with a productive purpose. Derivatives like futures and options started out as a way for companies to reduce risk in non-core areas, for example for airlines to hedge their exposure to oil prices and transnationals to hedge their exposure to currency fluctuations. The sellers of these derivatives were aggregators who pooled risk, much like insurance companies do. The overall effect was a net reduction in risk to our economy without hampering growth and returns.

Then speculators entered the market, creating more complicated derivative products and betting with borrowed money.  This was defended as a way to increase liquidity and efficiency. But it came at the cost of making the system more complicated and susceptible to abuse. Worst of all, these so-called innovations increased the overall risk to the system, something we saw quite vividly during the recent financial crisis.

Venture capital is a shining example of capitalism just like Adam Smith pictured it, where private vice really does lead to public virtue.  Consider, for example, two of the largest areas of venture investment: biotech and cleantech.  Here we see the best and brightest – top science graduates from places like MIT and Stanford – devoting their lives to curing cancer and developing new energy sources.  These students may be motivated by good will, but need not be, since they will also get rich if they succeed.

A strong case can be made that the financial industry needs significantly more regulation, particularly around big banks and derivatives markets. But it would be a tragic mistake to create regulations that hinder angel investing and venture capital.  From the outside, VC and Wall Street might appear similar, but the closer you get, the more you understand how different they really are.

Stickiness is bad for business


It is common to hear entrepreneurs and investors talk about the high level of engagement (what we used to call “stickiness”) of their website.  They quite rightly believe that it’s better to have a more engaging user experience, as that generally means happy users. Unfortunately, the dominant advertising model on the web – Cost per Click (CPC) – rewards un-sticky websites.  As Randall Lucas said in response to one of my earlier posts:

The paradox, it seems is this: in a pay-per-click driven world, site visitors who want to stay on your site — due to it having the once-much-lauded quality of “stickiness” — are worth much less than those who want to flee your site because it’s clearly not valuable, and hence will click through to somewhere else.

Facebook recently became the most visited site on the web. Yet their revenues are rumored to around $1B – about 1/30 of what Google’s revenues will be this year. Google has the perfect revenue-generating combination:  people come to the site often, leave quickly, and often have purchasing intent. Facebook has tons of visitors but they generally come to socialize, not to buy things, and they rarely click on ads that take them to other sites. Facebook is like a Starbucks where everyone hangs out for hours but almost never buys anything.

The revenue gap between sites like Facebook and Google should narrow over time.  Cost-per-click search ads are extremely good at harvesting intent, but bad at generating intent.  The vast majority of money spent on intent-generating advertising — brand advertising — still happens offline. Eventually this money will have to go where people spend time, which is increasingly online, at sites like Facebook. Somehow Coke, Tide, Nike, Budweiser etc. will have to convince the next generation to buy their mostly commodity products. Expect the online Starbucks of the future to have a lot more – and more effective – ads.

A butterfly flaps its wings and you make a sale

From A Smart Bear: Startups and Marketing for Geeks

butterfly effectIt’s easy to be taken in by the idea of the Butterfly Effect: That a butterfly gently flapping its wings in the jungles of Madagascar can indirectly cause a Typhoon off the coast of Jakarta.

Or, updating for modern-day relevancy, Naomi Dunford pounds a curse word into a WordPress and Brian Clark makes $172. Or Dave McClure releases a silent-but-deadly outside a Menlo Park Starbucks and a social media company gets funded in Boston.

It’s a great story: Little actions can have enormous influence. A small favor you do on Twitter results in a viral post seven months later. A small change to your download page results in 20% more trials. A subtle shift in background color increases average time-on-site by 27 seconds.

We’re willing to believe it because mathematicians have proven it’s true for complex, fluid systems like weather and economics.

We want to be believe it because it’s harmonious and comforting to think that everything is connected, and that the tiniest action has the potential for significant effect.

“Even the smallest person can change the course of the future.”
The Fellowship of the Ring, J.R.R. Tolkien

For me the most compelling evidence comes from cognitive psychology where studies abound with astounding tales of subtle environmental changes radically and systematically affecting people’s behavior.

It’s relevant for marketing and sales because it’s an inside scoop about how to manipulate strangers on the sly. It’s akin to subliminal messaging, but more pervasive, more powerful, and less susceptible to biting satire.

Eerie examples:

  • Touching merchandise while you’re shopping increases the chance that you’ll purchase it. (source)
  • Students performed word-searches from random words. Some of the puzzles were seeded with words associated with old age, e.g. gray, wrinkle, bingo, Florida. While traversing a hallway after solving the puzzle, those students given “old” words walked more slowly. (source)
  • Students took a survey about health risks; half walked down a hallway where someone was sneezing. Those who passed the “ill” confederate reported a more negative view of the American health system and believed the average American was more likely to die of heart attack. (source)
  • Students were asked to recount memories while moving marbles between two trays. When moving marbles from a lower tray to a higher one, the memories were more positive; when moving downward the memories were more negative. (source)

This news should be simultaneously titillating for marketers (“Ooo, puppet strings!”) and frightening for consumers (Are you ever in control of your own decisions?).

But actually, when taken to its logical conclusion, you have to ignore most of it.

After all, these studies must be just the tip of the iceberg. When I’m at the mall I’m passing people who are coughing just like the experimenter in the study… but also people who are angry, laughing, sitting, jogging, yelling, sleeping, shoplifting, and eating. Each storefront beckons me with colors, shapes, fonts, compositions, arrows, borders, lighting, and even sounds and smells.

double-doozieAll this is (apparently) tugging me in different directions, just below the veneer of consciousness where my impulsive, subconscious lizard brain is eagerly lapping up the stimuli and directing my attention and my wallet.

But then again, despite these impressive efforts, I’m distracted by the P.A. system blaring about a 6-year-old knee-deep in the fountain outside the Men’s Dillards. And then my cell phone goes off with a new tweet mentioning @asmartbear and my heart goes all aflutter (Ooo, attention! Please love me so I can love myself!). And then a butterfly flaps its wings (this time in Argentina) and suddenly and inexplicably I decide against the indulgence of a Double Doozie Cookie®.

It’s worse on the Internet. You’re competing not only with the real world but with the virtual world of tabbed browsing, Twitter alerts, back buttons, bouncing tray icons, and instant messaging.

It seems to me that instead of chasing subtle subliminal effects, most of which will be wiped away by the ambient noise of life, we could spend our time on the big-ass, in-yo-face, non-subliminal effects.

Like, if you get a popular blogger to mention you, that’s more influential than the color of your logo. (200 words from Seth Godin is good for 1000’s of unique visitors.)

Like, if you have a compelling story that people intrinsically want to spread, that’s more influential than building a snappy Flash animation for your home page. (Kiva and Zappos win not just because they are awesome, but because it’s awesome for you when you tell other people about their awesomeness.)

Like, if you thoroughly thrill one person in a product demo, that’s more money in the bank than 1,000 people hitting your website and getting “branded” that you’re “trustworthy” because of your steel-blue color palette and stoic font. (I’ll take one Tom over ten thousand StumbleUpon hits.)

I like the idea of subtle yet powerful influences as much as anyone else, and I’m not saying design and attention to detail isn’t important or valuable. I just think most of our efforts are drowned out by the seething distraction that is the Internet and life in general.

Take care of the big stuff first.

Four Steps to Take Before Creating Your Marketing Dashboard

Many companies are attempting or are building marketing dashboard in order to communicate marketing’s value. The explosion of dashboard tools and technologies has sometimes made designing an effective dashboard even more challenging. Metrics and KPIs are the building blocks for your dashboard. The dashboard is the visualization of the data these represent. It is a visual collection of the data that provide the means to quickly get an overview of how your organization is performing and the reasons behind its performance. Therefore those metrics and KPIs that are the most effective at communicating your contribution to the business, alerting you to performance issues, and enabling you to make fact-based strategic decisions are the ones you should include on your executive and operational level dashboards. The goal of the dashboard is to provide actionable information based on past data which predicts future performance, allowing for effective decision-making. Before you develop your dashboard decide who is the target user. A dashboard aimed at the C-Suite and one that is intended to be used by the managers of the various marketing functions are going to be very different. They will need to be related and one may actually be a subset of the other. We recommend you start by thinking about the C-Suite at your user and then peeling the onion so to speak as you move further down the organization structure.

To create a dashboard you will need to understand, clarify and define the role of marketing, so that what you report represents what marketing is and/or is expected to do. Once this is completed these four steps will help you get started: (this sentence was written twice on the item you sent me, please check the original and fix)

1. Identify Business Outcomes. Start by identifying the things that your company must achieve in order to be successful. These are the needles your organization must move.

2. Map the Role of Marketing: Identify the linkages between these outcomes and marketing performance.

3. Select the Metrics and KPIs: Determine what metrics best demonstrate how marketing is impacting the outcomes. Use the metrics and KPIs that illustrate how marketing is making a contribution and the return on this contribution for your dashboard.

4. Establish the context. Context defines the interrelated conditions in which something exists or occurs. Context help you know what data is “good” vs. what is “bad” data and will ensure you dashboard avoids end users from drawing false conclusions. It is important to consider how the design and placement of controls within a dashboard. The layout of the data should be in a logical and fluent order.

The dashboard should also conform to the 3 and 10 second rules; within 3 seconds the user should have an idea as to the overall performance of the subject, and within 10 seconds the user should have a general idea as to why this performance is being achieved. Before starting on a dashboard consider the platform you are going to use because this will impact your functionality. Also consider the format of your data and how the data is going to be stored. (there was a typo here I fixed, please check the original)

By developing the metrics and communicating these in a dashboard, the learning organization will have the data they need to make fact-based decisions. It will also elevate the confidence of the CEO, CFO (this was CDO and should be CFO, please fix on the original) and other members of the leadership team in the marketing organization.

VisionEdge Marketing, Inc, is a leading data-driven metrics-based strategic and product marketing firm located in Austin, Texas. The company specializes in consulting and learning services that help organizations use data to make fact based decisions to address market, customer, and product opportunities and to improve and measure marketing performance. For more information, go to

Killer March Madness Challenge – Vittana Student Loans

From Inspired Startup


I was turned on to this innovative Seattle startup that focuses on improving the lives of extremely poor through the use of educational loans.  It is self-sustainable as 97% of the loans are paid back and can be used again to loan to more people in need.  Ideas like this can change the world.  I love it and that’s why I just placed my first loan in the program and started a group to compete in their March Madness Challenge – anything that ties in the sports world is very cool.  Having been to Central America several times, I chose to loan to Evalesthy Mercado in Nicaragua.  You can read about her story here.  It is refreshing to see entrepreneurs tackle the issue of extreme global poverty and we need to support them.  Whether it is Vitanna or another great Seattle-based organization like One Day’s Wages – if you have the means to give, please do.  Each dollar is directly given to those who need it most, meaning 100% of your donations go to those in need.  This is the new breed of non-profits and transparency at its best.  If you don’t have the means to give, talk about the issues and raise awareness amongst your peers – it’s what I call “social giving”.

Who are some of your favorite non-profits or for-profits that are doing innovative work in solving global poverty?  I’d love to hear about them!  Perhaps, you are ready to embark on a new journey starting your own?

How to Ask for an Introduction

From Tony Wright dot com

I don’t know a ton of important people. But as a founder of a venture-backed startup with some amazing investors and advisors, I do know a few.

With Nivi and Naval preaching the gospel of social proof (can I get an “amen”?!) and with fundraising posts and articles espousing the importance of introductions, it’s no surprise that about once a week someone asks me to introduce them to someone else. It’s especially common around Y Combinator Demo Day, where YC groups shift from pure product mania to fundraising mode. I’m pretty sure that YC tells new crops of startups to ask for introductions from the funded companies from previous sessions.

What does surprise me is how people ask for these introductions. Here’s pretty much how they usually read:

“Hey Tony. I’m [insert name] from [company name]. We’re starting our fundraising effort and I was wondering if you’d introduce me to [insert RescueTime investor/advisor].”

I usually will make the introduction, but the person asking for it is certainly not making the most of the opportunity (and asking me to spend my social capital by doing so). So after making a mess of these introductions in varied ways, here is my suggested checklist for making an introduction (it’s pretty much my reply when I get a request like the one above):

  • Write the introduction for me. Seriously. You know more about your story than I do. You know the things to say that will make someone light up. I don’t. I might flub it. I can personalize it (“Hey [insert investor name]- hope your trip to [offensively exotic location] was fun. Welcome back! Listen, I wanted to introduce you to…”), but you should make the pitch. Bonus: this saves me a few minutes of writing, which is kind and thoughtful of you!
  • Don’t bury the lede. What’s the thing that will get an investor excited? Be concise, but talk about social proof, traction, growth, size of the market, how badass your team is, mainstream press coverage, other investors who are on board, and user passion/joy. Choose whatever distinguishes your startup from the sea of startups that investors read about every single day. Unless your product is revolutionary, spend more time talking about your market (“we’re helping companies in the billion dollar widget maker market sell doodads”) and your team than your product (“we’ve got an ajaxy shopping cart!”). If they investor blogs or has EVER talked about their investment strategy, hopefully you’ve read how they think and tune your pitch to match that.
  • Heap on the social proof, man! Getting an email intro from a near-stranger (me) is about the weakest social proof you can get (but it’s better than nothing). Tell us how many other investors you have soft-circled. Give us a link to a list of all of the blog posts praising you. Or all of the users tweeting about you. We’re herd animals. If the investor feels like the herd is leaving him behind, that’s a good thing.
  • Think about why it’s an opportunity for investors. If I’m writing to an investor about a company that looks like a credible opportunity, that’s me doing them a favor. If you don’t have any bullet points that many you look like a great opportunity, that’s me doing you a favor and adding noise to their already overflowing inbox.
  • Keep it short. All of the above stuff could mean a lot of content. You’ve got to pick and choose what to send and hope it’s enough bait for the investor to dig in and learn more.
  • Bonus points: track it. When we were talking to investors, we created custom (private) pages for each investor we were courting giving them a ton more to dig through and get excited about if they wanted. The emails were short and sweet with a “want to learn more” link at the end. We used Google analytics to track which people clicked through and which individual pages they clicked on so we could know what to focus our discussions on when we met them.

All that said, if you’ve got a great investment opportunity (with a launched product and some happy users), don’t be shy about dropping me a line if I can help (with introductions or advice).

(post scriptum: If you are in the market for introductions, you should check out VentureHacks’ StartupList!)

Employed with a side of startup

From A Smart Bear: Startups and Marketing for Geeks

Most people start their first company while they still have a day job.

It makes sense: You don’t need loans, and you don’t need funding. If you “fail” all you’ve lost is time, but considering the fun, the stories, and everything you’ll have learned, that’s hardly a failure.

You just need to give up all your free time which, if you’ve caught the “founders” bug, is A-OK with you.

Work hard play hard

But you’ve also placed yourself in a hazardous, potentially legally ambiguous situation. If managed improperly, you’re unnecessarily risking lawsuits and worse.

I’ve been on both sides of the table: I’ve done a startup while working and I’ve employed people who either were or are very capable of having their own startup on the side. And I’ve known people who were sued because of it, and not all of them won.

Here are my tips for how to pull this off.


Ho hum, hedging is so tedious. But I have to say it: I Am Not A Lawyer. None of this is legal advice. If you do or don’t do anything listed here and anything bad happens, it’s not my fault.

If anything good happens, I’m thrilled and honored to accept your munificent cash donation.

Pick a business that can thrive within your constraints

Your side venture has constraints a “normal” business doesn’t have:

  1. You can’t answer the phone during normal business hours.
  2. You can’t answer emails during normal business hours.
  3. You can’t afford to hire three developers to add features and bugs.
  4. You have to work in fits and spurts.

Your natural tendency is to fight these constraints, but that’s the wrong approach. For example, you know that to avoid social media shitstorms you’re supposed to have stupendous customer service, so you claim as much on your website. But then you don’t have a phone number and emails sent to you at 10:00am don’t get answered until that night (which means they’re not viewed until the following day).

That’s called a “missed expectation.” It’s also called pissing in the wind — it’s just going to come right back at you.

The right attitude is not only to work inside your constraints, but to turn them into competitive advantages!

For example, your regular income affords you the luxury of underpricing your service. So if anyone complains that there’s no phone number, you can just point out that for $5/mo you can’t afford a phone staff.

As another example, pick a product in which simplicity and having very few features is an advantage. “We do only one thing and we do it better than anyone” is a great marketing slogan. You don’t have the time to make a Microsoft Excel knock-off, so don’t!

Embrace slow growth

We all have dreams of stratospheric growth, whether it’s hoping the next blog post will get 267 votes on Hacker News and double your RSS subscribers, or hoping that the advent of release v1.1 will set the blogosphere ablaze.

Good work if you can get it, but it’s not a “plan,” especially not for a business you’re running in your spare time. In fact, any bootstrapped company should be aiming for slow, consistent growth rather than explosive growth.

This is not a bad thing! Slow growth maximizes your chance for success. Slow means your success is not dependent on some unlikely, massive event that’s totally outside your control. Slow means you can change drastically during the early days without sinking the company. You have a job, so you don’t require explosive growth to be successful anyway.

Remember, your immediate goal isn’t to make millions of dollars, it’s to build a business just solid enough to quit your day job. That might mean enough profits that you can already live (frugally) off the company. Or it might mean you have enough customers to have “proved” you have a viable business model, so now you can raise money with sensible terms.

Don’t lie at work

The best way to avoid a lawsuit is to prove that your employer knows you have a side project.

I know, you really really want to ignore me and operate in secret. You’re afraid to tell them because they’re might do something — fire you, distrust you, or look at you funny at lunch.

Yes, that might happen. But what’s worse — one of those things or a lawsuit? If you don’t think they’ll sue you, then you shouldn’t be afraid of telling them! They are going to find out anyway. You need to tell them on your own terms.

I’ve always told my employer, and it always worked out for the best.
Here are those stories.

How do you tell them? Write a simple document explaining what you’re doing. Here’s my template:

To Whom it may Concern:

I have a hobby which does not in any way conflict with work. I’m writing this letter to make sure you’re aware of it so there’s no misunderstanding.

My hobby is ….

I work on my hobby only at home and on my own time; it is not in conflict with my employee agreement. I own it; [Company] has no ownership or rights to it. Like any hobby, it could generate a small amount of income.

Although I don’t anticipate it, I understand that if my hobby ever became in conflict with my job that it’s my responsibility to notify you immediately.

Thank you.

Then you get this letter signed by someone with authority. “Authority” means someone who can legally represent the company. This will of course depend on the company, but typically C*Os or the company’s legal council is a good bet.

Getting a supportive boss to sign it isn’t good enough. He can’t speak for the company.

Check your employment agreement

There’s a phrase in the template letter about your side business not conflicting with your employment agreement. Is that true? It’d better be.

Employment agreements are typically biased in favor of the employer, sometimes with outrageous clauses saying that anything you do, even at home and on your own time and unrelated to anything at work, is automatically owned by the company, and that furthermore you’re responsible for identifying and reporting on those things, and if you don’t do all of the above there’s no limit to the damage you could have caused.

Courts have thrown out some of these egregious contracts, but that’s unusual, and you can’t depend on that. You don’t want to go to court at all. Besides, you signed it.

Read over your agreement and make sure it’s legal to have the side business. If it isn’t, you must write a letter like the one above specifically stating that this is a valid exception to your employment agreement.

Don’t use company property or Internet, for reals

Another clause in most employment agreements is that anything you do physically at work, or on software and equipment owned by the company (e.g. laptop, customer lists, Photoshop) is automatically the property of the company.

This clause is fair. If your project is really on the side, you have no business doing business at work. If your project is really yours alone, it cannot be assisted by a company laptop, company software, or company Internet connection.

When it comes to company property, be paranoid. Assume Big Brother is watching. Assume every laptop has a secret program that records all keystrokes, mouse clicks, screen shots, web sites, and emails you read or write. Assume everything you do on the Internet is recorded, cataloged, tagged, and monitored continuously by a methamphetamine-powered slave-army.

Now I realize you’re super clever. You want to sneak in some tech support emails during the day, so you use a cocktail of  Anonymizer plus GMail-over-SSL to confound the network admin. Because of course covering up your activity is a sure sign you’re doing something legal…

Even that is not enough. If they decide to sue, they get to look through your email records (it’s called “discovery”). Then they have 100 emails you sent during work hours. You lose.

Get the picture? Just don’t do it.

Time management is critical

I’m naturally awful at personal time management. I procrastinate, I’m disorganized, and if I’m not careful I’ll burn two hours ROTFL at FailBlog with nothing to show for it but tears of laughter puddled under my keyboard.

A startup already generates an infinite amount of work. It takes all your time, which for you is 40 hours/week less than it ought to be. You can’t afford to waste time, whether that means bad habits or working on the wrong tasks.

There’s no silver bullet — workflow is a personal matter — but here are some techniques to get you started:

  • Check email infrequently.
  • Inbox Zero — Processing email until nothing remains has both psychological and practical advantages.
  • GTD (Getting Things Done) — This technique literally changed my life. Few people implement 100% of this system, but everyone can take away a trick or two that makes them more productive.
  • Work in sprints — Short, focussed bursts of activity eliminate the surprisingly large waste that comes from context-switching and interrupt-driven behavior.
  • If you don’t sleep enough, your productivity plummets. Trading an hour of sleep for an hour of coding is never efficient.
  • Use a tool like RescueTime (free!) to empirically discover where you’re spending time; the waste becomes clear. P.S. Tony Wright, founder of RescueTime, started that company while employed and wrote about what he learned.
  • Optimize slowest tasks first — Identifying and optimizing the slowest tasks increases your overall productivity more than you think.

The true meaning of common idioms

From A Smart Bear: Startups and Marketing for Geeks

Non-native speakers of English tell me that the basic rules of grammar aren’t too hard to learn, but the idioms are murder.

(Ok, not literally “murder,” that’s just an expression…. nevermind.)

Idioms are used by many of God’s great creatures, not just humanoids, as I learned from The Oatmeal:


So to help all of us understand better understand American business vernacular or, as our UK brethren like to say, the American bastardization of the rich, beautiful language you so unashamedly defiled, I’ve prepared the following chart.

Leave a comment if you have more!

“To be perfectly honest with you, …”
– Everything I said before this moment was bullshit.

“Just kidding!”
– No I’m not.

“The deal is in the bag.”
– I’m lighting a votive candle and sacrificing a goat. It couldn’t hurt.

“In the fullness of time.”
– Maybe later, but probably never.

“It is and it isn’t.”
– It isn’t.

“Our company allows businesses to integrate, assemble and optimize available IT assets to drive business process productivity, delivering an innovative, enterprise-class business integration platform that incorporates proven integration technology with next generation capabilities into one interoperable set of tools that deliver a unique combination of efficiency, agility and control, combining industry leadership with a zealous commitment to customers to deliver tangible business value. “
– I have no idea what we do. Please give me money.

“It goes without saying that …”
– I’m about to say it.

“May be hazardous to your health.”
– Is unquestionably hazardous to your health.

“It’s not over ’till it’s over.”
– It’s over.

“It’s so hard finding good help.”
– I am a pompous ass.

“Less is more.”
– This is a steaming pile of excrement. Less of a negative is a positive.

“We’re a leading provider of …”
– I can’t think of anything else to say, and the lawyers tell me I can’t say “the” leading provider.

“Well bless your sweet little heart!”
– You’re a stupid bitch.

“It’s not personal, it’s just business.”
– I hate you.  Personally.

“It’s not you, it’s me.”
– …but you’re not helping.

“Congratulations again on being pregnant, what a wonderful journey you’re about to embark on!”
– I don’t have kids.

“Life starts at 40!”
– I am at least 39 years old.

Killer March Madness Challenge – Vittana Student Loans


I was turned on to this innovative Seattle startup that focuses on improving the lives of extremely poor through the use of educational loans.  It is self-sustainable as 97% of the loans are paid back and can be used again to loan to more people in need.  Ideas like this can change the world.  I love it and that’s why I just placed my first loan in the program and started a group to compete in their March Madness Challenge – anything that ties in the sports world is very cool.  Having been to Central America several times, I chose to loan to Evalesthy Mercado in Nicaragua.  You can read about her story here.  It is refreshing to see entrepreneurs tackle the issue of extreme global poverty and we need to support them.  Whether it is Vitanna or another great Seattle-based organization like One Day’s Wages – if you have the means to give, please do.  Each dollar is directly given to those who need it most, meaning 100% of your donations go to those in need.  This is the new breed of non-profits and transparency at its best.  If you don’t have the means to give, talk about the issues and raise awareness amongst your peers – it’s what I call “social giving”.

Who are some of your favorite non-profits or for-profits that are doing innovative work in solving global poverty?  I’d love to hear about them!  Perhaps, you are ready to embark on a new journey starting your own?

The importance of investor signaling in venture pricing


Suppose there is a pre-profitable company that is raising venture financing. Simple, classical economic models would predict that although there might be multiple VCs interested in investing, at the end of the financing process the valuation will rise to the clearing price where the demand for the company’s stock equals the supply (amount being issued).

Actual venture financings work nothing like this simple model would predict.  In practice, the equilibrium states for venture financings are: 1) significantly oversubscribed at too low a valuation, or 2) significantly undersubscribed at too high a valuation.

Why do venture markets function this way?  Pricing in any market is a function of the information available to investors. In the public stock markets, for example, the primary information inputs are “hard metrics” like company financials, industry dynamics, and general economic conditions. What makes venture pricing special is that there are so few hard metrics to rely on, hence one of the primary valuation inputs is what other investors think about the company.

This investor signaling has a huge effect on venture financing dynamics. If Sequoia wants to invest, so will every other investor.  If Sequoia gave you seed money before but now doesn’t want to follow on, you’re probably dead.

Part of this is the so-called herd mentality for which VC’s often get ridiculed. But a lot of it is very rational. When you invest in early-stage companies you are forced to rely on very little information. Maybe you’ve used the product and spent a dozen hours with management, but that’s often about it. The signals from other investors who have access to information you don’t is an extremely valuable input.

Smart entrepreneurs manage the investor signaling effect by following rules like:

Don’t take seed money from big VCs – It doesn’t matter if the big VC invests under a different name or merely provides space and mentoring.  If a big VC has any involvement with your company at the seed stage, their posture toward the next round has such strong signaling power that they can kill you and/or control the pricing of the round.

– Don’t try to be clever and get an auction going (and don’t shop your term sheet). If you do, once the price gets to the point where only one investor remains, that investor will look left and right and see no one there and might get cold feet and leave you with no deal at all. Save the auction for when you get acquired or IPO.

– Don’t be perceived as being “on the market” too long.  Once you’ve pitched your first investor, the clock starts ticking. Word gets around quickly that you are out raising money. After a month or two, if you don’t have strong interest, you risk being perceived as damaged goods.

– If you get a great investor to lead a follow-on round, expect your existing investors to want to invest pro-rata or more, even if they previously indicated otherwise.  This often creates complicated situations because the new investor usually has minimum ownership thresholds (15-20%) and combining this with pro-rata for existing investors usually means raising far more money than the company needs.

Lastly, be very careful not to try to stimulate investor interest by overstating the interest of other investors. It’s a very small community and seed investors talk to each other all the time. If you are perceived to be overstating interest, you can lose credibility very quickly.