Tag Archives: Investors

The hype around initial coin offerings

There’s a new hype in cryptocurrency land these days. They’re called initial coin offerings (ICO’s) and they’re basically a way for aspiring services to raise money by issuing new digital tokens on the blockchain. If the services are successfully built and widely used, these tokens appreciate in value, thereby rewarding early investors.

People much more knowledgeable than I am on the topic have written about ICO’s at length elsewhere. I’m not going to repeat what they’ve said, but will point out one flaw in the arguments that ICO advocates are making.

In particular, advocates of ICO’s state that ICO’s are a great way to solve the chicken and egg problem when attempting to attract users to a new service with network effects.

A service with network effects is one which becomes more valuable for users as more other users use the service. This makes it difficult to attract users at the beginning, when there are few other users using the service. As a result, centralized service providers resort to offering incentives (financial and non-financial) for users to participate in the network. The discounts that car-hailing companies offer passengers and the bonuses that they offer drivers are great examples of this.

Since ICO’s offer investors the potential for appreciation in the value of the service’s underlying token, the argument is that they help solve the chicken and egg problem. They do this by giving early investors tokens which, since they will increase in value if the service is widely used, the investors are incentivized to use.

The problem with this argument is that, while centralized service providers traditionally give money to their users to use the service, services that perform ICO’s are requesting money from their users. In other words, the direction of money transfer is reversed. You will get a lot more people to use a service by giving away money than by requesting it. As a result, services built upon ICO’s appeal to a much smaller pool of potential initial users than services built by centralized providers. The solution which ICO’s offer to the chicken and egg problem is therefore not nearly as big as ICO advocates make it out to be.

In addition, if we think of the people which a service gives money to as its users, and the people which a service takes money from as its investors, services built upon ICO’s are currently claiming to create a new class of investor users. The problem with this is that the level of diligence required to be a user of a service is different than the level of diligence required to be an investor in the service. In the former, you’re consuming, and consuming is easy. In the latter, you’re producing or at least understanding how something is being produced, and that’s hard.

ICO’s are currently making people believe that it’s easy to do what’s hard.

This is an attractive value proposition. It explains why there’s so much interest in ICO’s, to the point where services are raising millions of dollars in minutes for a service which they often have yet to build.

The problem is that, in reality, doing what’s hard isn’t easy. As the services built upon ICO’s are built, or are not built, and are used, or are not used, reality will emerge.

Always be recruiting

I was recently speaking with the co-founder of a successful regional tech business. We’re not investors in the company, and the co-founder was looking for insights into the Turkish market.

In the middle of the discussion, I was caught by surprise when the co-founder asked whether I’d like to join the company. This is the first time that I’ve been on the receiving end of a startup co-founder offering an investor a job.

I like investing too much to make the shift, so I politely declined.

However, the anecdote is a great reminder that great founders are always recruiting.

Getting investors to act fast

When fundraising, the best way for an entrepreneur to get investors to act fast to complete an investment (and to get a healthy valuation) is to create demand for the company from competing investors.

However, this isn’t always possible. Especially in markets where capital is scarce, even very promising companies might not have many investors at the table.

When this is the case, some entrepreneurs resort to fabricating demand that doesn’t exist. They claim that investors who aren’t interested actually are, or they exaggerate the interest level of investors who have expressed initial interest. This often backfires because investors talk to each other.

Another approach is to set an arbitrary deadline. This doesn’t work because it doesn’t tell the investor what they have to gain from investing early and the investor knows that they’re the only party at the table. If the deadline were to pass it would simply be extended. In other words the deadline isn’t credible.

Rather than fabricate demand that doesn’t exist or set an arbitrary deadline, a better approach to get investors to cross the finish line is to show them the growth opportunities that the company will miss out on or have to delay due to the lack of funding. This also means that the investor who’s evaluating an investment in the company will miss out on them.

This includes highlighting the great team members that the company isn’t able to hire, demonstrating the foregone revenue or cost savings potential from not making a particular capex investment, and quantifying the opportunity cost of not conducting a specific marketing campaign, all due to delayed funding.

The reason why this works is two-fold. First off, unlike fabricated demand that doesn’t actually exist, it’s truthful. And second, unlike an arbitrary and uncredible deadline, it shows the investor what they have to gain from investing early.

Don’t bring your existing investors or advisors to fundraising meetings

I recently met with an entrepreneur raising money for their startup. What was interesting about the meeting was that one of the startup’s investors also attended. This isn’t the first time that I’ve seen this happen, but it’s pretty rare.

When this happens, you naturally question why the investor is attending the meeting. And I can think of two possible reasons.

The first is that the entrepreneur and the investor agree that the investor will be able to better pitch, or at least add significant value to the pitch of the entrepreneur’s business. This isn’t a good sign. The startup’s success after the meeting will be determined by the entrepreneur who spends all their time working on the company, not the investor who sits in meetings and offers advice once every few weeks. So the entrepreneur needs to know their business and be able to communicate and motivate others to want to be part of it as employees, partners, or investors.

The second is that the existing investor has concerns about the intent of the potential new investor (for example, are they simply fishing for market knowledge?) and wants to be there to evaluate that intent and protect the entrepreneur as necessary. This is like having your dad walk you to school each day because you fear that other kids might bully you along the way. It doesn’t work because there will come a day when your dad isn’t able to walk you to school and even on the days that he does he’s going to have to leave you once you get to school. In other words, your investor won’t be there to participate in every fundraising meeting you have and fundraising meetings are just one example of the tens of contexts where you’re going to need to protect yourself. The only solution is to learn to protect yourself on your own.

Using a similar logic, fundraising advisors also shouldn’t participate in your fundraising meetings.

If your initial fundraising meetings are successful, you receive a term sheet, and begin to negotiate it, then investors or fundraising advisors should get involved. Although they don’t know your business as well as you do, they’ve seen and negotiated many more term sheets than you have. So getting their input makes sense once you reach this stage.

Looking forward to seeing and hearing from you

Most investors agree that a startup’s founding team is the most important factor when making an investment decision. I think that the underlying attributes of a great founder include authenticity, caring a great deal about what you’re doing, and getting things done.

One way to evaluate founders is to evaluate each of these attributes one by one.

Another way is to think of another founder feature which is the direct result of having each of these underlying attributes. A great example of such a feature is whether you look forward to seeing or hearing from the founder. Independent of how a startup is performing at a specific moment in time, if the founder is authentic, cares about what they’re doing, and gets things done, chances are that you look forward to seeing and hearing from them. If they fall short on one or more of these attributes, chances are that you don’t look forward to seeing and hearing from them.

Startups take a lot of time and effort to build. So it makes sense for investors to work with founders who they look forward to seeing and hearing from.

Similarly, founders benefit from working with investors who, independent of the short-term pleasure or pain which their honest feedback may provide, they look forward to seeing and hearing from. If an investor isn’t authentic, doesn’t care about what you’re doing, or doesn’t get things done when they say they will, they’re unlikely to be the right partner for you.

In fact, it’s even more important for founders to work with investors who they look forward to seeing and hearing from than for investors to work with founders who fit this profile. The reason is that a founder has one business while an investor has many. If an investor doesn’t enjoy seeing and hearing from a founder, they can spend more time with other founders. If a founder doesn’t enjoy seeing and hearing from an investor, until they develop into a later stage company with a greater number of larger investors, they have to continue dealing with their current investor.