The toughest moment in a new angel’s investing career: a very large round has lots of momentum – it has been expanded and is still over-subscribed. And it is a classic case as these things go, driven by the usual factors: little bit later stage with some traction, so risk is perceived as lower, great pitch by an appealing CEO, backed by a seemingly good team, momentum in the round building quickly, a product people can understand that is already built and in the stream of commerce, and, perhaps most importantly, a perception of scarcity as the round filled up.
Image by Doug Wertman
It is that scarcity factor always gets people’s juices flowing. Psychologists say people overweigh the fear of loss or losing out more than they should relative to the fear of doing something that may turn out to be a mistake in the future. And momentum in a round can also cause tremendous peer pressure to join. Whether you call it the bandwagon effect or not, people get themselves into a twist about it.
And I would generally agree that the bandwagon effect can be a problem. But for a different set of reasons. It’s the flip side of the bandwagon coin I see as the real problem.
Here’s what I mean: the psychology of momentum plays a big role in how well early stage rounds do. As an investor, it is easy to allow yourself to be caught up in that psychology. However, the risk of piling into a bad deal because tons of people are piling in is not the real threat. Sure, you definitely can get swept into mediocre stuff that way, but usually not catastrophes. That’s because these deals usually have some safety features built in: it is harder (though admittedly not impossible) to pull the wool over the eyes of a large group of experienced investors than it is to fool just a few: with more eyes on a deal, important issues usually come to the surface. Plus those larger, broader-based deals have very strong foundations of investor support so if the company gets stuck, they often have sufficient financial and human capital at their disposal that they can get back on track.
So while there is surely some risk of what we will call positive bandwagoning, I think it is actually the risk of negative bandwagoning that is the bigger risk to your portfolio. Here’s why: because nearly all great ideas seem absolutely crazy early on. They just don’t seem like smart ideas. They are too out there. They will never work.
This article was written by Hambilton Lord, Manging Director of Launchpad Venture Group and was originally published by the Seraf team. Seraf provides portfolio management tools for angel investors. Seraf’s intuitive web dashboard gives angels the power to organize all of their investing activities in one online workspace and analyze performance for greater exit potential. Built by angels, exclusively for angels, Seraf puts investors in control of their portfolios and makes it easy to share with colleagues, advisors and family.