Are you Chasing the Rocket or Building it?
Picture this: You discover that a syndicate of tier 1 funds is investing in a startup that you not only don’t have allocation in, but haven’t even heard about! You are devastated - and frantically start working your contacts at other funds for more information. Suddenly, an email appears in your inbox with the words you’ve been praying to see - they can get you in on the deal! You have the last golden ticket - the last seat on the rocket!
As investors, our job is to explore all compelling deals that come across our desks, which of course, includes hot deals other top firms have deemed destined for success. Tier 1 firms backing startups can also lead to certain market reactions like rushed reactive capital, strong customer introductions, etc. which can in turn change their trajectory. It is valid to interpret another fund’s investment as a signal, but it is imperative that this is not the only signal we take into consideration.
Based on the power law phenomenon of venture capital, we know that only a few investments will generate the majority of a fund’s returns. There is little evidence to show that reactive investing leads to an increased likelihood of identifying these breakout successes. In fact, there is significant data that demonstrates how initially unpopular bets have led to some of the biggest returns. The more time spent investing reactively and ascribing value based on another firm’s perspective means less time investing based on a unique market view.
Many of the biggest wins in venture capital have come from truly novel views on a market, geography, or product category. When ex-Sequoia partners Chris Olsen and Mark Kvamme started Drive Capital in 2012, their mission was to build a world-class VC firm in the "other 95%" of the U.S (aka not NYC and Silicon Valley). Their goal was to back founders in cities often overlooked by traditional venture capital. By 2022, Drive had $2B in AUM with 3 IPOs.
When AirBnB first launched, they were rejected by nearly every VC. In other words, the company was not a rocket destined for success. It was easy to say why the business model and value proposition would not work. The common belief was that people do not want strangers staying in their homes, and vice versa. Brian Chesky, Joe Gebbia, and Nathan Blecharczyh were notoriously rejected by Fred Wilson of Union Square Ventures, and sold election branded cereal as an alternative way to raise some capital and keep the company afloat. Despite initial hesitations, Paul Graham from YCombinator took an early, and unpopular, bet on AirBnB.
A company’s path is rarely written in the stars. An opportunity every other firm believes is destined for success could very well be the next Theranos. Another way to think about destiny, or lack thereof, in startup investing is the opportunities you had to invest but passed on. When a company you chose not to invest in ultimately winds down, the easy thing to say is “we made the right decision”. But what if that capital injection would have been exactly what the company needed to unlock their go-to-market? What if that in turn had completely changed the trajectory of the business and the company returned your fund? The decision to invest or not could very well be the catalyst to a businesses success.
You can be a good investor by following strong signals and investing alongside great investors. That said, by fighting for the last seat on a rocket someone else has deemed destined for success, you lose out on the opportunity to take the first seat. The motivation to pursue a deal should come from more than the knowledge that others are jumping on it. Conversely, the fact of others passing on an opportunity should not be the only signal to determine your own opinion on its potential. When everyone is saying yes, ask yourself if the opportunity is really so obvious. More importantly, when everyone is saying no, ask yourself ‘how might this work’? Why might you say yes?
