083. Greater Fool Theory

VC Minute
In a world of information asymmetry, your current investors have the most information. And if they're not willing to step up, that is a very bad sign.

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Here’s where seed funding as a team sport turns against you. And it’s not with FOLS, fear of looking stupid. It’s something even worse: the “greater fool” theory. 

According to Investopedia, the greater fool theory argues that prices go up because people are able to sell overpriced securities to a greater fool. That is, of course, until there are no greater fools left. Nobody wants to be the last fool left holding the bag. 

If you don’t have other investors participating in your round, especially your current investors, that one investor you’re asking to be the only one in your round, that investor feels like the greater fool. 

Think about it from another angle. A venture investor is buying securities. In any securities market, in any investing market, decisions are made based off of information. Information in private markets is highly asymmetrical. 

Having investors in your round or not having any other investors in your round is an important piece of market information. It’s another piece of the due diligence puzzle that a fund is considering before they make an investment in you. 

Next, if you’re raising a bridge round, it implies that you have raised a prior round. Where are those current investors? How much are they putting in? Which one of those current investors is putting in the most money and stepping up to say, we believe so deeply in this company that we’re willing to double down on our investment? 

In a world of information asymmetry, your current investors have the most information. And if they’re not willing to step up, that is a very bad sign. 

For an investor to be the first one to jump in the pool, or for an investor to know that they’re going to be the only one in the pool, is a huge leap of faith. It takes a massive amount of conviction and confidence for a seed investor, for any investor really, to say, I’ll be the only one to put up money for this. 

 Most funds understand that they do not have all of the information that they don’t know everything that’s going on, and they can’t turn over every stone in the due diligence process. 

And so, there are approximations for this. One of those approximations is the number of investors, and the quality of those investors that are in the pool. If nobody else is in the pool, that is a piece of information. and it’s not a good one. 

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