Architecting an Investor

Aug 2013

(Follow up Essay to Venture MicroFinance)

 

“She was struck by the simple truth that sometimes the most ordinary things could be made extraordinary, simply by doing them with the right people.”

– Nicholas Sparks, The Lucky One

 

“Those who are enjoying something, or suffering something, together, are companions. Those who enjoy or suffer one another, are not.”

– C.S. Lewis, That Hideous Strength

 

In designing how you would be an investor you also can’t help but architect how you imagine an ideal investor works and how you could be like that. So you would probably start by designing the schema for this hypothetical ideal investor. Then that schematic would be something to aspire to.

Little things I don’t like that I’ve noticed investors do is be uncontactable. It’s really frustrating to send someone an email and never get a response. It’s understandable because they’re likely busy but that one improvement would make dealing with one so much easier. So an investor who returned emails quickly is like a web app with an intuitive user interface. It makes them pleasant to deal with.

Moving to what they actually do is provide money, give useful advice and know lots of people who would be able to help a company. I think one thing that would be useful to add is patience.

Usually companies don’t just happen, they take a long time for the value to materialise. The best ones can take decades and an investor hoping for a quick exit is probably doing a disservice to the company they are a part of.

An investor who is patient is probably also a nice person. Patience is one of those characteristics that is a prerequisite of niceness. I don’t think I’ve ever met a nice person who wasn’t also very patient. Because patience is the umbrella under which a person is also forgiving.

It’s why I think frequently the relationships between the best investors and the best entrepreneurs is a lifelong one. Because they forgive the entrepreneurs mistakes and back them regardless, even over long time horizons. And the entrepreneur learns from mistakes and gets better as a result. It is also a form of hedging. If you meet someone really interesting and decide to back all of their future projects. Eventually that person will probably succeed, returning whatever was lost on the failed ones. In a field fraught with so much risk, it is a way of creating a safety net.

So much of the industry is dominated by opportunists who will try to take advantage of entrepreneurs, that a nice person who is also capable is probably miles ahead without even realising it.

 

Probably the most useful thing at the early stage is advice and motivation. Someone to be a sounding board for decisions who is decentralised from the day to day operations. Like a birds eye view to give brutally honest advice.

Advice is something really hard to measure. You can’t see the end result because advice usually triggers something in the person who hears it. So if you were to isolate the output it is the relative success of whatever the person they are advising is doing.

So if you advise someone to do something and it fails, the advice must have been terrible by default. But if they do it and it succeeds then the advice must have been really good. And the entrepreneur is the filtering mechanism by which good advice is sorted from bad.

How do you get good at giving advice? One way is to probably give lots of it and measure the success of the people you give it to. I know plenty of people who think they give good advice but if you measured the things they were advising, they usually ended up failing. So advice is one of those things easily susceptible to the Dunning-Kruger effect.

Probably the best way to learn how to give good advice is to give lots of it for free and see what happens. Eventually you’ll start to see trends in what works and what doesn’t.

The most interesting realisation is how dangerous bad advice can be. When Tom told me about Tramsurance I actually tried to talk him out of it because I thought it was silly, but had he listened to me it would have never happened. So immediately I know sometimes I give bad advice. But it’s improving.

I figured I should try to learn how to give good advice before starting to put money in things. It would almost be a disservice to the startup if I didn’t. But there’s no comprehensive course or literature that can really teach you this because every situation is different. Most of the time knowing what to say just comes from experience and practice.

So to learn, I tried giving free advice to anyone who would ask me for it. The results were surprising. (Updated 2015) Of what you might consider 11 startups, 5 failed outright with one being a spectacular failure. 2 sold for small amounts and 4 raised over a million dollars, one of which is now regarded as a Silicon Valley “hot startup” and another dangerously close to dying before fixing the business. Almost all of them I discovered because of this blog or right at their founding or first year of operation, which is a very positive sign.

The most important realisation was learning the characteristics of hype. There were 3 startups a lot of very wise people thought would be successful that I thought secretly weren’t very good. And 2 startups lots of people thought really sucked and payed little attention to that I thought were secretly great. The first 3 ended up doing quite badly but the latter 2 now look like they’ll be really huge.

This is too small a sample size to draw any real conclusions but it was reassuring for the same reason when getting a math question wrong, you learn the process to get it right the next time. Not that the reasoning was flawed but that the wrong formula was being applied. It isn’t just about being right. It’s about being right when everybody else is wrong.

Since there is no algorithmic approach to this, it’s all intuition – so honing intuition proves to be one of the best approaches at how to pick winners and losers. Intuition is the layman definition of pattern recognition. It forms the underlying decision making which manifests as intuition. But how do you practice this?

I once knew a professional poker player who would say if you want to get good at poker, just go to tables and watch. Pretend you’re nobody, sit on the edge and observe. Watch for the tells and the giveaways and the patterns. First learn how to read the people, then learn to read the table and only then learn to read the cards.

 

The first thing I noticed is how similar advice starts to resemble guidance. The person for the most part already knows the answer they just need someone else to confirm it. The other is how infrequent it is, the time input is only like a few hours per month. And often the only times you even get contacted is during pivotal butterfly effect type moments, where the company would look very differently depending on the choice made at this point in time.

The other is how much genuine interest can affect the composition of the startup. It’s very hard to get excited about things that aren’t interesting. So when you do get excited it’s like an adrenaline boost to the company. An investor who sounds genuinely excited by what you’re working on is one of the most reassuring things you can get and will likely cause you to work harder on it. So this becomes a reinforcing cycle.

When you start to seem like a person who gives good advice, that balloons. What happens is more and more people start asking for advice and this is what I imagine people are referring to when they talk about dealflow. If the people who ask for advice are good entrepreneurs then that would be good dealflow.

But quickly it starts to become unscalable. Whenever there is a free commodity it ends up being oversaturated. Because there is only a finite amount of time and a person probably doesn’t want to spend all their time advising people they end up needing to say no a lot.

But the investor doesn’t know which of the people is going to succeed. So they draw out the process of saying no longer than it needs to be, wasting everyone’s time. So our hypothetical ideal investor is also probably someone who says no quickly. Another way of saying that is they are someone who makes decisions quickly.

 

I think lots of people complain about their investors being unhelpful. So I also imagine they would want to help the company by being in many ways a surrogate founder. I think if I invested in a startup, I’d like to also write code for it or help with sales. Or to try and get people I know to try their best to help the company when it needed it, like to be their early users or provide feedback.

The best investor I’ve ever met was actually a private equity firm. In their office they had a big room which they called the war room. It was just a plain conference room but inside it the walls were plastered with business cards. I asked what they were for and he said each card was a person in the network that could be called upon to help the company.

Looking at the cards closer, there were designers, developers, lawyers, accountants. There were even obscure people like a consultant who specialised in getting new pharma products through FDA approval, a party planner who specialised in Gala events, video producers and even an intern matching agency.

Anything you might need for a growing company was there on the wall already pre-vetted. It seemed like the most genius thing I’d ever seen. As you run into any problems or whenever the company needed anything they could ask their investors who would refer them to one of these service companies or people they knew were excellent at their job. It also ferments a poorly measurable concept like how strong a network is. If someone wants to see how strong their investors network is they can just see it.

Notice I haven’t actually talked about the composition of the startup yet. That’s because I don’t really know what it would look like. What would the best investors look for? There are probably big broadstrokes like a big market and a unique insight about that market but I don’t know how you would measure that in any meaningful way. I think sometimes the most innovative things don’t really look like they’ll work at first so a better method would be to focus on the person doing it instead. But that can be very hard since it comes down to evaluating whether or not you think someone is capable or not.

Usually, after you break through the surface you start to realise an investor is looking for a certain type of founder or company. And often what they are looking for comes from some model of success they’ve seen or experienced in their own lives. If I had to break it down into one sentence that I’ve seen. It would be:

Tenacious determined founders with a company that uses software to solve real problems for a lot of people, in a big market, is quick to be profitable then reinvests profits for growth and wants to be in business and grow forever.

That’s what I’d be looking for.

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