
Investor Herd Dynamics - tlammens
http://paulgraham.com/herd.html
======
jacquesm
This is spot on. When I found out that a fellow entrepreneur had been pushed
and pulled around trying to get funding for months without any solid
commitment I put two of the angels involved on the spot in a meeting and asked
them if I committed a certain sum of money for how much we could count on
them. The round closed with 5 investors within a few days.

All it takes is for someone to cross the bridge of commitment and others will
follow. The fact that I'm probably two orders of magnitude poorer than the
other investors probably helped in embarrassing them to make a move, it was
literally peanuts to them and the company went on to moderate success.

~~~
speeder
This is a problem when noone wants to lead though.

Here at my company we tried to make a pre-A round of sorts (mostly because we
are in Brazil, and investors here are unwilling to invest anything close to a
A round here).

We had several people commit saying that if other people go, they will go
too... But we found noone to commit as leader, and all the other commited
investors refused to go without a lead investor, kinda annoying situation.

Happily our seed investor liked our recent results and expanded his seed
investment instead.

------
rjvir
Seeing that YC's demo day is coming soon, it's awesome to be able to peer into
PG's mind - this essay along with "How to Convince Investors" must be the
exact advice relayed on to the current YC batch.

~~~
pg
That is exactly right. I'm trying to get a complete guide to fundraising done
in time for Demo Day, so I don't have to repeat all this stuff verbally (and
incompletely) yet again. There is at least one more coming on fundraising
tactics.

~~~
beat
Thanks for sharing this with all of us outside the YC world! I've really
appreciated the shower of wisdom in your recent burst of essays, and I'm sure
others appreciate it too.

------
jessaustin
I'd always wondered if anyone could upstage PG on HN. Apparently, Elon Musk
can.

~~~
anigbrowl
Heh, true. However, this short essay contains more useful actionable advice
for HN readers than is typical even for PG, so I hope it doesn't get
overlooked. Very very impressed, here.

------
cperciva
_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._

This seems a bit specious. Sure, the lower bound on the pre-money valuation
for investor #2 should be the post-money valuation for investor #1, not the
pre-money valuation for investor #1; but the valuation _per share_ won't
necessarily be any different.

~~~
johnrob
Startup valuations are not accurate. Your comment essentially proves the
point: If an investor is going to fund a company at valuation X, they prefer
that X is a combination of cash and stock and not purely stock. This implies
that a dollar of valued startup is not worth a dollar, which should be an
axiom.

A 3 MM dollar company comprised of 2 MM stock and 1 MM cash is more desirable
than one with just 3MM in stock.

------
oz
_" [2] Founders are often surprised by this, but investors can get very
emotional. Or rather indignant; that's the main emotion I've observed; but it
is very common, to the point where it sometimes causes investors to act
against their own interests. I know of one investor who invested in a startup
at a $15 million valuation cap. Earlier he'd had an opportunity to invest at a
$5 million cap, but he refused because a friend who invested earlier had been
able to invest at a $3 million cap."_

I'm not _surprised_ , per se, but rather always amazed whenever I hear stories
of rich people acting in ways inimical to their economic interests. One would
think that an experienced (I guess) businessman, such as a VC, would be
somewhat more rational than that. Then again, this _is_ an article about
'Investor Herd Dynamics', so I suppose that should inform my opinions about
human behaviour.

------
tkiley
It seems like the earliest investor in a multi-party round invariably gets
shortchanged in the literal dollar value of the deal. If committed investors
raise the valuation of a startup, would it make sense for a startup to offer a
slightly-sweetened valuation for the first investor to commit?

I understand that no one likes to have the price raised on them later, but
perhaps the underlying truth of increasing valuations could be restated in a
different way so it seems more like a discount to the first-in vs a price-hike
to the last in.

~~~
anigbrowl
What's lost in absolute $ terms is (IMHO) more than made up for by being known
as the early bird, which status will yield other opportunities. In game theory
terms being early is not optimal in a single round but close to optimal in the
iterated competition that more often prevails.

~~~
harryh
But it's very rarely known who is the early bird in investment rounds.

~~~
ganeumann
It is by the other investors. And the best investment opportunities come when
other investors ask you to be in a syndicate for a deal they're leading. They
may do this because they hope that next time you're the early-bird investor,
you will remember them when you are helping form the syndicate.

------
dfabulich
"VCs will sometimes ask which other VCs you're talking to, but you should
never tell them."

Why not? (Unless I missed it, the article doesn't explicitly say.)

~~~
ganeumann
Sigh. I do this all the time as an early-stage investor. But I don't do it to
game the valuation, I do it so we can share the task of due diligence. Maybe I
understand the market/customer and the other VC knows the founders, or vice-
versa. It's nothing sinister, it's just a more efficient way to get the
information I need quickly and cheaply.

There is a lot more than gut judgement involved in deciding to give somebody I
just recently met a large sum of my money. I don't let other VCs dilute my
judgement but I certainly listen to them when they have more knowledge of the
relevant facts about a company, its people, its product, or its market.

Note that I'm an angel investor, so I try to make sure the cost of due
diligence is proportional to the amount I'm investing. If I were a fund and
writing million dollar checks, I would spend the time to do all the due
diligence myself.

~~~
jacquesm
Big difference, angel and VC are not interchangeable in this discussion and
the article explicitly mentions VCs, not angels.

~~~
ganeumann
He does say that, that angels cooperate more with each other than VCs do. So
yes.

But I think the salient point is whether the investor is asking who the other
investors are so they can cooperate with them, compete with them, or collude
with them. And that depends on the investor, not whether they are an angel or
a VC.

------
robrenaud
> 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.

I don't know anything about startup investing. But I do know about machine
learning. And you can often improve an ensemble predictor by adding (many)
weaker features and averaging them with an already strong predictor.

One shouldn't confuse the prediction of an average predictor with the average
of a bunch of predictions that come from a pool of on the whole mediocre
predictors. Averaging is really a strong operation for prediction. Of course,
it does help if the individual predictors are themselves independent or
uncorrelated with each other, which I guess tends to be very untrue in a herd.

------
nadam
Can someone point to a link which explains the math of startup fund raising? I
was thinking about it, and what I get is a paradox:

I assume the definition of raising money is that the original owner gives some
percentage of the company to a new owner, and the new owner gives an amount of
money to the company.

Let's say the company's valuation is 1 million dollars. Let's say the owner
sells 10% for 0.1 million dollars.

In a perfect market the company's new valuation is obviously 1.1 million
dollars: the original value in the company's resources (people, etc...) plus
the 0.1 million in the bank.

On the other hand in a perfect market perfect owners made a deal in which the
original owner's wealth is the same before and after the deal.

Before the deal he was worth 1million. After the deal he is worth 0.9*x, where
x is the new valuation of the company.

So:

1million dollars = 0.9x

x = 1.1111' million dollars

So which is the correct new valuation: 1.1, or 1.1111'? Or something
different?

Maybe the deal have to be made in infinitely small pieces, so the result is
coming from some kind of differential equation?

~~~
ganeumann
The money buys new shares in the company. Think about it in per share terms.
In your example:

\- Pre-money there are 1,000 shares, valued at $1,000 each

\- The company sells 100 new shares for $1,000 each

\- Post-money there are 1,100 shares

So after selling 100 shares, the original owner now owns 1,000/1,100 shares =
90.9%. The new valuation is 1,100 shares * $1,000/share = $1,100,000.

~~~
nadam
Now everything is clear, thanks!

------
pixelmonkey
I wrote about this issue a couple years ago, observing similar behavior. I
used a modified horse gambling game as a metaphor for the investor dynamic.

"It's easier to play the option than the bet."
[http://www.pixelmonkey.org/2010/12/13/its-easier-to-play-
the...](http://www.pixelmonkey.org/2010/12/13/its-easier-to-play-the-option-
than-the-bet)

    
    
        In this new race, small signals have a big impact. 
        Charge ahead suddenly and you might get your 3 spots
        filled. Convince a top-tier gambler to go to bat for 
        you, and you’re all set — your other two spots will
        fill up quickly. If you’ve been in the race before 
        and had your spots filled up quickly, you’ll likely 
        get them filled up quickly when you enter the race
        again.

------
buro9
We're in a strange place right now, sat in the middle of two pieces of startup
advice.

Piece of advice #1: "The time to raise money is not when you need it, or when
you reach some artificial deadline like a Demo Day. It's when you can convince
investors, and not before."

Piece of advice #2: The best time to raise VC money is when you have
product/market fit and need rocket fuel to grow.

We were having conversations with investors to suss out the London startup
scene (we feel like outsiders mostly having kept ourselves to ourselves) and
to make connections with industry leaders who might make great advisors.

2 Weeks ago these conversations suddenly turned into "Shut up and take my
money.". Once this started happening, it happened at every meeting, with
investors swiftly upping the amount they believe we should take... we have a
herd all telling us to take their money. We haven't done a proper pitch to
anyone.

We were aiming at #2 (product/market fit), and have stumbled upon #1
(convinced investors forming a herd).

The problem is expectations. We are at seed stage, and are developing the
product/market fit. We have customers lined up, but we're not yet seeing good
traction with the existing customers we're engaged with. We want to carry on
improving the product, testing as we go.

If we take VC money we very much believe we'd be under expectation to focus on
growth before the product is the right one for the market (it has a lot of
promise today, but it's not yet proving itself fully).

Our current view is to to explain to investors/VCs that we're still seed and
take the money only if it doesn't come with conditions and is understood we're
still seed.

Not a lot of wisdom out there on whether you should decline VC money. We're
not of the belief that all money is good, especially if it proves to be a
distraction from just making the a great product that customers really want.

~~~
shykes
If you have the luxury to choose from multiple committed investors (and I
recommend you triple-check your assumption that these people are indeed
committed), then I would use that leverage to set the bar for your ideal
terms. Importantly, terms can have many dimensions: in addition to the dollar
amount and dilution, you can set expectations in terms of your stage, your
focus, autonomy in changing direction etc. You can also filter by personal fit
with the investor, how soon they hope for liquidity, their personal track
record and reputation (not the firm's), etc. Just like a great hire, you
should be wow-ed and be excited to work with them.

The more explicit the expectations, the better! Get to know them, ask them
about their styles and priorities, check their track record with previous
entrepreneurs (not just active investments! their loyalties may be mixed and
they will lack the perspective).

It seems like you also have the luxury of not raising money at all for another
X months (another assumption I assume you've quantified and triple-checked),
so that makes it easy to walk away if the bar is not reached. Just like any
other deal, your leverage is only as strong as your plan B.

I may be stating the obvious. In any case, good luck! "Shut up and take my
money" is always a good problem to have.

------
stevenj
Does this mean that in most deals the investors involved don't know who else
is in the syndicate until after-the-fact, if there are others?

------
LekkoscPiwa
Company isn't necessarily worth $1m more because it has $1m in the bank. Think
of the dot-com bubble in 90s. All these companies with millions in their bank
accounts that never sold anything to anyone for even one cent. But were
burning through cash like crazy. Would you invest in them just because they
have millions on the bank account?

The market is washed with cheap money courtesy of the FED. According to one
study VCs in the US gave _worse_ return in the past decade than blue chip
stock. High risk, high return companies have had worse performance in the past
decade than low risk, low return. This is not good statistics at all.

[http://blogs.reuters.com/felix-salmon/2012/05/07/how-
venture...](http://blogs.reuters.com/felix-salmon/2012/05/07/how-venture-
capital-is-broken/) [http://www.verisi.com/resources/venture-capital-
performance....](http://www.verisi.com/resources/venture-capital-
performance.htm)

The market is drunk on the money provided by the FED. We'll all have horrible
hangover after all is said and done. (i.e. the FED eventually rises interest
rates).

edit: I love it how people down vote just because I said something opposite to
what PG claims. And then no response neither ;-) Somehow this actually makes
me feel good! Because it looks like I'm right as nobody replied.

~~~
lsc
the business cycle goes up; the business cycle goes down. We all know this to
be the case, and the business cycle is obviously up, so quit whining and get
to work.

If you have no name, this is the time to make your name. If you have a name,
this is the time to make money with that name. These are the times in which
you have the most leverage.

Yes, of course, the business cycle will go down again. when will it change
direction? How sharp will that transition be? Nobody knows. Worrying about
that is... trying to know the mind of god. We all have a set of tools, a set
of resources and abilities. We need to use those resources and abilities to
make enough money (or enough notoriety) that we will be able to deal with the
thin times. Now is the time to run hard, not to wonder about macro. There will
be plenty of time for that during the next downturn.

Sitting here and complaining about the business cycle doesn't help you, it
doesn't help me, and who knows, maybe some people feel that it brings that day
of "the business cycle goes down" closer to now. That was the primary reason
why I'd guess you got down-voted.

The other thing? Do you remember the '90s? I worked through the crash. It was
not at all obvious ahead of time, which companies would come through, and
which companies would not. I mean, it seems obvious now, sure, but it was not
obvious then.

~~~
LekkoscPiwa
>the business cycle goes up; the business cycle goes down. We all know this to
be the case, and the business cycle is obviously up, so quit whining and get
to work.

I do work. Business cycle is up temporarily on cheap credit. There is no
substance to it. 70% of new hires since 2008 in the US are part time. The debt
to GDP ratio is higher than ever. Food stamps are on record high. Inflation if
used Ronald Reagan years formula and not today's hocus-pocus hedonistic
whatever is at 10%. The whole thing seems to work just because of the interest
rates at 0% since 2008. And you can't have them at zero forever.

> Sitting here and complaining about the business cycle doesn't help you, it
> doesn't help me, and who knows, maybe some people feel that it brings that
> day of "the business cycle goes down" closer to now. That was the primary
> reason why I'd guess you got down-voted.

Wow. If 50 million Americans on food stamps, 10% inflation rate, and average
real wage adjusted for inflation lower than in 1960s is up in the business
cycle, I'm afraid to ask what will be down. Greece?

> The other thing? Do you remember the '90s? I worked through the crash. It
> was not at all obvious ahead of time, which companies would come through,
> and which companies would not. I mean, it seems obvious now, sure, but it
> was not obvious then.

No, it wasn't. The same like right now it is not obvious to you that the "up"
you perceive is just a bubble in the US Treasuries. Don't worry, will be
obvious to you soon as well.

BTW, you haven't addressed anything that has to do with extremely poor VCs
performance in the past decade from my post. And that $1m on the company's
bank account usually doesn't translate into the company being worth $1m more.
Which was my main point. Care to talk about this?

~~~
lsc
>Business cycle is up temporarily on cheap credit. There is no substance to
it.

The money will pay your bills as well as any other money.

My point here is that you can't do anything about this ebb and flow of money,
'fake' or not. Point is, you need some. I need some. Not a whole hell of a
lot, really, on a global scale, but you need some money very badly. Even if
it's "fake" money that isn't being managed in the way you like.

>70% of new hires since 2008 in the US are part time. The debt to GDP ratio is
higher than ever. Food stamps are on record high.

The market for labor is intensely local, but local in a different way from the
market for real-estate. Yeah, most folks are still getting shit upon. The
business cycle isn't 'up' for them at all.

But it's 'up' for the sort who read hacker news. Engineer salaries are through
the roof. I can't keep a PFY. Used to be that I'd keep someone for years if I
hired them full-time; tens of months if I hired them part-time. The last few
PFYs got yanked out from under me within the first month or two. [1]

The bubble is localized to our industry (and to a lesser extent, to my
physical area.)

You.. sound foreign, so I'm guessing you don't remember what it was like in
silicon valley and outlying areas in the early to mid-aughts? [2] It was
/really bad/ for computer folks, and really not all that bad for everyone
else. I had many, many friends who were of my technical level working retail.
It was really bad for us. (but the retail jobs were still there; everyone else
was largely fine.)

Right now? it's our turn for the good times, while everyone else suffers. I'm
not saying it's fair or good... just that it is, and shouting that money is a
government construct, and that they are trying their damnedest to generate
some inflation (no shit.) changes nothing.

>Inflation if used Ronald Reagan years formula and not today's hocus-pocus
hedonistic whatever is at 10%. The whole thing seems to work just because of
the interest rates at 0% since 2008. And you can't have them at zero forever.

I don't understand why people seem to think inflation is some kind of crazy
boogyman. Think about it. Everyone is in debt. Much of that is fixed-rate
debt. Real inflation (including wage inflation) would be good for all of those
people.

In fact, I personally believe inflation, nationwide, really is close to as low
as they say. It's hard to have real inflation without wage inflation, and
we're only seeing that here in silicon valley. From what I understand, this is
a problem. We need inflation (especially wage inflation) to deal with our
consumer debt problem.

Now, what we've been seeing is inflation in commodities, which is about the
worst-case all around. We need inflation in wages (which will result in
general price inflation, but so long as wages inflate, too, I think that's
just fine.)

Of course, all that macro bullshit is just that; it's bullshit. I'm no expert,
and I'm not convinced at all that the experts know anything themselves.

I do have some experiences with this industry, though, and the bit about
making hay while the sun is shining? it's real. It's way easier to make career
progress while the (local) economy is up.

[1]I don't begrudge them that; that's the whole deal with hiring apprentices.
They take the job for low pay so they can get the job for high pay after they
have built some experience with you. If one of your employees gets hired away
for 2x or 3x the maximum amount you could pay them, there's really nothing to
do but congratulate them and ask if they know anyone who might want their old
job. (That's how I get my best recruiting leads.) But it does mean that the
job market for smart young programmers/sysadmins is hotter than it was.

[2]I mean no insult; Your English is not terrible for a native speaker, and
English is a tough language. I'm a monoglot, myself.

I guess the corollary here is that if you still aren't in the US or in silicon
valley, well, you probably see things rather differently than I do.

~~~
LekkoscPiwa
thanks for the reply. The thing with inflation: true, it helps those in debt.
But is destroys savers. Inflation is a simple mechanism of wealth transfer
from savers to debtors. You described who the debtors are. I agree. Let me
tell you who the savers are: mostly retirees (401k), elderly people who use
their life savings to pay the bills, etc, and others like successful
businessmen who just want to save. I just don't think that it is morally ok
and I know that it is not economically ok (due to moral hazard) to just move
wealth from people who worked and saved to ones who were irresponsible with
their debt, took risks, and now want someone else to be responsible for that.
Because there are more debtors than savers then simple political calculation
says screw savers, let's rescue debtors as they are the majority of voters.
And here we go:

Insurance premium for me is up 20% year to year. Food is up. Medication is up.
Gas is up. All kinds of insurances are up. And all of these hurt common folk
the most too. Guys living paycheck to paycheck. But those don't even get what
the inflation is and how it translates to their daily lives. So the Government
just continues printing.

Now talking about good times we have now in the IT. My answer to this consists
of 2 points: (1) It's not only IT. Just read somewhere that some parameters of
the housing market are as "hot" now as they were in 2007 in some areas (Las
Vegas); cars are also selling as well as in 2007; etc. Which takes me to (2)
The FED by keeping interest rates at 0 since 2008 was able not only to
reinflate housing and IT bubbles but probably to create even more bubbles all
over the place. So what I think and of course I may be wrong -- what you are
experiencing with your new hires now is just another bubble built on cheap
credit. Since 2008 the whole world has been buying US Treasuries like never
before, funding US Government, financial sector and big businesses on
unprecedented scale. The VCs I mentioned - how in the world can you be a VC
and have worse return than S&P500 for the past decade? And still get funding!
Why? Because with interest rates at 0% nobody wants to keep cash or money on
deposits - everybody has to "invest" (or rather speculate). So that's what
happening. If you do nothing with that cash you loose 10% year to year. So you
invest no matter what. In IT, real estate, startups, whatever. Once the world
stops buying US Treasuries on such a scale and actually starts selling them,
the interest rates will go up. So then the question is why to invest in all
these crazy startups, equities, bonds, real estate, etc. When just keeping
cash at the bank deposit returns 5% a year? Or maybe even better at 18% (as it
used to be the case in 1981). That's when you will see - sorry for putting it
so bluntly - how much all these VCs, IT sector, real estate, etc. are really
worth. Without cheap credit doing the work of life support.

BTW, I'm an (proud) US citizen, originally from Poland. As crazy as it may
sound to you, after almost 10 years in the US (9 years IT experience) I
decided to move back to Poland because I'm really worried that the US economy
may face extremely serious crisis. Comparable to hyperinflation in Germany in
1920s. Think of me as of one of these tin hat guys or gold bugs ;-) My English
sucks at times. I try to reread whatever I write, but sometimes I just write
stuff and don't really care and well, it shows. My apologies, I tried to be
better this time, lol. Nice talking to you btw.

I get you. You are a business guy doing his thing and you could care less
about all the economics and politics BS. Honestly, I think that's great. I
don't want to waste your time, so just saying hello and take care.

~~~
lsc
>Let me tell you who the savers are: mostly retirees (401k), elderly people
who use their life savings to pay the bills, etc, and others like successful
businessmen who just want to save. I just don't think that it is morally ok
and I know that it is not economically ok (due to moral hazard)

and don't forget bondholders. But yes, inflation (I mean, flat, across the
board inflation, and it never actually happens that way) tends to hurt the
rich and tends to benefit the poor. The view that the rich are rich because
they are morally superior is pretty common, as far as I can tell; more common
here than abroad. It's a view that I disagree with.

~~~
LekkoscPiwa
How the QE works is that these trillions and trillions are pumped from the FED
directly to big zombie banks to help them stay afloat. As big banks spend
these money by investing in bonds, equities, VCs, whatever, the economy as a
whole starts feeling better, I agree. And the prices rise too. The problem is
that the last ones to receive it still have to pay harsh inflation tax even
though they didn't get much out of the benefit. It works like this (money
creation): FED --> banks --> whoever banks loan money to or invest in
(investment banks) --> VCs, real estate, homeowners (from your example), etc.
--> whoever these folks spend money to. The poor gets poorer in that scenario,
while rich get richer (and I'm a republican here, mind you)

So, to answer what you said -- newly created money benefits those who are
first to receive it. If the owner of the printing press (the Government) makes
it such that group A receives the money first and then decides how to spend
it, then the group A will benefit at the expense of everybody else. If group A
decides to spend it on people in group B then these folks will mainly benefit
as well. And then group B spends on others, so on. The last one to receive it
is the big looser. If the Government policy is to hand over the newly printed
money to the healthcare companies - healthcare wins at the expense of
everybody else. If the Government decides to spend it on the Travel industry -
these folks win while we all get hit with the inflation. Etc, etc. It's not
really rich vs poor debate, it is who gets the freshly printed money from the
FED first is the one who benefits at the expense of everybody else.

That's why inflation is bad. Inflation is the reason why you see the gap
between rich and poor - worlwide, not only in the US - getting bigger. Because
somehow the FED _always_ hands over newly created money to the banks. And I'm
not a socialist saying it's bad on moral grounds - far from it. I'm saying
that's a sick economy. The FED should be abolished and money should go there
where the markets want the money to go. Without being influenced by
politicians and their agenda. That's what - to me - true republicans hail -
free economy. The FED needs to be abolished. And as can be easily shown this
money creation process will create bubbles. If newly created money goes to IT,
IT has a bubble. That's what happened when the FED printed in 1990s to go over
Savings and Loan Crisis -- all the newly created money created IT bubble. To
fight off the results of that bubble bursting they printed even more -- that's
what caused to Housing Bubble. And when this one bursted (they always burst) -
they created the US Treasuries bubble. The Ultimate Bubble. The Wholy Grail of
Bubbles. Bubble in the reserve currency of the world. Bubble in everything
across the spectrum. I'm not going to sit around in the US and wait for that
one to burst as well.

Bauer Mayer Rothschild, 1838: "Let me issue and control a Nation's money and I
care not who makes its laws"

