Dumb Money Breeds Lazy Behavior

Below is the ‘Tip of the Week’ from Ep 99. Public Policy for Angel Investors, Part 2 (David Verrill)

In today’s interview, David warned about the potential hazards of crowdfunding.  His take is that startup investing is a very risky asset class.  One where experienced angels can still lose a lot of money.  It requires experience, sophistication, due diligence, an organized strategy to access and invest in the best entrepreneurs and it’s just a lot of hard work.  While he supports new money being invested in startups, his concern is that these investors may not know how to protect themselves in a specific investment and also from fraudelent actors selling the dream of the next tech unicorn.  And, when a class-action suit occurs related to crowdfuning, it will also disparage the angel investing asset class.
 
I share David’s concern but, for today’s tip, I want to consider the effect of “dumb money” on founders.  Examples like crowdfunding for equity don’t just adversely impact those deploying capital, but also those that are raising capital.
 
 As I see it, there are three types of “Dumb Money.  Money that’s too early, too much, or from bad sources
  
Too Early
 Often inexperienced investors are quick to pull the trigger on big ideas.  But therein lies the problem.  These are ideas, not viable businesses.  And when a first-time entrepreneur takes money at the idea stage, their risk is removed.  Many will find out that the idea is unrealistic.  The problem doesn’t exist.  The customers aren’t interested in their solution.  Or, worst yet, the founder-theirself isn’t passionate about the business.  Sometimes the best thing an investor can do for a founder, is just say no.  Founders can learn much about themselves and their business in the early days without external financing.
 
 
Too Much
In my first year of angel investing, I cut a check for $50k to an early-stage company that had just launched.  They closed a total of $300k from a small syndicate of angels and commenced an aggressive marketing campaign.  Four months later, the money was gone and their only major learning?  “These marketing channels aren’t going to work.”  They hadn’t tested a range of traction channels and found the avenues to double-down.  Rather they tripled down on a hypothesis and now had nothing to show for it.
 
Now, $300k doesn’t seem like a lot of money.  But, it was both too early and too much.  They didn’t need $300k to throw at marketing.  They didn’t even have a strategy with a set of KPIs to measure against.  Look, sometimes a big infusion of capital is just what a company needs to reach the next level.  But, in many cases, too much money drives lazy behavior.  Would this startup have blown $300k of their own money on ineffective marketing?  Likely not.  They would’ve found the channels that drive the most ROI for their time and money… which is ultimatley what they did, once their cash reserve was gone.
 
 
From Bad Sources 
This is the one that bothers me most. Founders want the quickest path to capital, and I can’t blame them for that.  But at times that results in raising from the wrong folks with the wrong set of terms.  Or, instead of raising the money themselves, they hire a broker dealer, known to take up to 10% of the total capital raised, to fundraise for them.  I understand that we all can’t be experts in the fundraise process, but finding an adviser is a much better path than outsourcing completley.  And does one really believe they are going to get smart capital, from top tier investors, when they use a broker dealer who’s shopping it to anyone and everyone?  These folks have their own best interst in mind, not the entrepreneus.  Be careful when incentives aren’t aligned.
 
And, of course, you have the party rounds.  Lots of checks, in small amounts from no strategic or professional leader.  This happens in the angel ranks and is certain to occur with equity crowdfunding. With no leadership representing the group… Who is responsible for protecting them?  Who will build a relationship with the entrepreneur and help them through the growth phase?  No one.  And if the entrepreneur achieves success, in spite of their suspect investors, then they may have to deal w/ messy cap tables and/or extraneous reporting requirements when speaking with Series A investors.  Not good.
 
While more money to more startups is a good thing; let’s not lose sight of what’s really important.  Real companies, building real value.  And sometimes money can get in the way of what’s really important.  All money is not smart money.  And dumb money breeds lazy behavior.

 

 
   

   

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Pete Maglio

The takeaways to end this episode are fantastic! Thanks @TheFullRatchet & @BenEinstein! pca.st/Fey4 #smartHardware #startups