
A VC: Why Seed Investing Is Less Risky Than Later Stage Investing - far33d
http://avc.blogs.com/a_vc/2007/03/why_seed_invest.html
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Alex3917
When investing in early stage companies, you put in less money and the upside
is much greater. If this were the full picture then obviously early stage
ventures would be a better deal. Of course, many more early stage companies go
under than late stage companies. This extra risk is supposed to balance out
the greater reward. But does it?

To borrow Kedrosky's terminology, VC investing is really a combination of two
separate skills: picking and poking. Picking is choosing which startups to
invest in, and poking is helping the startup along to further its chances of
success.

The vast majority of people investing in early stage ventures are friends,
family, and fools. Because these people aren't very good at either picking or
poking, their risk level is very high. This in turn drives up the cost of
capital.

You can reduce your risk by becoming better at picking. You can also reduce
your risk by becoming better at poking. And if you can become better at both,
you can reduce your risk a huge amount. Because there are so few investors who
are good at both, these people are barely even taken into account when
determining the cost of capital. Which is why if you are good at both, it's an
arbitrage opportunity for the investor.

For late stage ventures, there is much more money on the table which means
much less amateur investment. Because you don't have as many dumb people
pumping up the cost of capital, there isn't really any arbitrage opportunity.

Incidentally, PG has reduced his risk even further by creating news.YC so he
can get to know the founders a little bit before investing. Theoretically, if
a founder knows that PG has less risk because of this, the founder should be
able to use this as leverage to get a better valuation. However, this doesn't
work in reality because the shortage of PGs creates a market inefficiency (in
favor of PG). However, I suspect that anyone who can successfully clone him
will have a good arbitrage opportunity.

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pg
Jeez, Fred, don't _tell_ everyone.

~~~
johnm
:-)

Actually, I don't think that's much of a problem -- it's the same underlying
issues as to why there aren't more people starting startups.

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Constantine
Well Alex makes an interesting point, that you would need more skill to get a
big return on the little hands, but I still think that if you had a large sum
of capital and you were especially good at the poking, that small investments
would pay off exceptionally well.

