The Greater Fool

Hello startup entrepreneur, let’s start off with flashy headlines like these which inspire and depress us both at the same time :

Ultra-Hot Secret Sharing App Whisper Raises $3 Million From Lightspeed, Trinity, And Others
http://www.businessinsider.com/secret-versus-whisper-2014-2

Secret Raises $10M At A $50M Valuation
http://techcrunch.com/2014/03/09/shh-secret-raises-10m-at-a-50m-valuation/

Our VC’s, advisors and “smart people with exits” always start their conversations with “this is a great app but….”

Where’s the revenue?

If there’s no revenue how are you going to make money?

What’s your differentiator and value proposition?

Next time I get asked these questions I plan to ask a follow up on if they invested in Whisper or Secret or 100’s of other products which have no revenue model, fairly similar to products already in market and only play is a buyout. Anyhow, I digress.

I totally respect this conversation with “smart people” because it grounds the entrepreneur to think about the key components of the business.  The investors are analyzing the business to see if there is value.  In particular they want to know if this product makes money and hence an easy metric to determine value (less risk), or does this business derive value from what other’s will be willing to pay for the whole business at someone point even if it doesn’t make money (high risk).

They want to be on the ground floor when this puppy goes to floor 101.  Ultimately, however far down the road, the entrepreneur needs a payout.  The team needs a payout.  The VC’s need a payout.  You must be asking if everyone needs a payout who is paying?

Ah yes, the greater fool theory (http://en.wikipedia.org/wiki/Greater_fool_theory).  Here’s the basic idea behind the theory (from Wikipedia)

The greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by the often irrational beliefs and expectations of market participants. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. Or one may rationally have the expectation that the item can be resold to a “greater fool” later.

In layman’s terms : Music is playing. Object is a hot potato. Everyone is standing in a line ready to take a piece of it and pass it down.  You don’t want to be at the end of the line when the music stops.

The greater fool theory in action : billion dollar journey

  1. An entrepreneur creates a product and needs capital to grow.
  2. $1 million seed round. Company is worth $4 million – Woohhooo from the entrepreneur and team. Gasp from the competitors.  Investor see’s value AKA investor see’s this as an opportunity where he bought something for cheaper than what it will be worth to someone else (the greater fool).
  3. $5 million series A round. Company is worth $40 million – Company founders start planning purchase of private jets.  The new investor has made the previous investor and founder very happy but this investor knows theres gold in them hills.
  4. $25 million series B round.  Company is worth $100 million – Company founders submit order for the private jet.  The new investor has made the previous investors very happy but this investor thinks there’s even more gold in them hills.
  5. $100 million IPO – Company is worth $500 million.  Company founders are dancing on top of yachts in San Tropez.  The new investor (underwriting bank) has made all the investors very happy but this bank and it’s clients think all the others were stupid because there’s diamond in them hills!
  6. Secondary Market – Company is worth $1 billion.  Company founders are sitting court side next to Jay-Z and Beyonce.  All the previous investors are happy as can be.  The new investor is a dude like me sitting in-front of his computer looking at stock tickers when he see’s a new IPO opportunity, except that it’s no longer an IPO it’s trading in the secondary market (stock market).

Hello Greater Fool, we found you.

 

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