I was describing to a first-time entrepreneur the other day why we don’t do ad-supported deals at Founders Co-op, and she wondered out loud why so many first-tier VC firms are willing to make these kinds of bets. My answer at the time was that they have (much) more capital to work with and can afford to make much riskier bets. But even as I was saying it I realized that I didn’t really believe my answer. I think the real reason is that many firms have made a lot of money on “Greater Fool” deals and don’t see any reason to stop now.
Greater Fool investing (more politely known as “momentum” investing) is the practice of buying assets for more than you know them to be worth in hopes of pawning them off on an even bigger sucker before the music stops and the real value of the asset becomes clear. The first Web bubble was built on these kinds of deals, but it applies equally to all asset classes and can be spotted at almost any time (even during market downturns). Tech stocks are particularly susceptible, because technology so often trades in dreams about the future, but even traditional industries like chain restaurants display the pattern (think Krispy Kreme or Boston Chicken).
Don’t get me wrong: most bigco’s can’t innovate their way out of a paper bag, and buying startups can probably be defended as a rational way for them to outsource their R&D. But investing in a startup that aims to get bought by Google is like buying the swimsuit issue in hopes of getting a date with Marisa Miller. Not only are the odds of you achieving your planned outcome vanishingly small, you’re also missing (IMO) the entire point of building a company.
Call it a lack of imagination, but because we have both the luxury of choice and the constraint of limited resources, we only invest in companies that plan to derive their revenue and profits directly from the customers they serve. We’re guaranteed to pass up some big wins this way, but I expect we’ll dodge our share of bullets, too.