As an angel investor, I try to learn from what's happening in the world of finance. I look up to VCs, because they are the big boys in the startup space - trained professionals who have a lot more experience and expertise , and far more money. This is why when VCs do things that I can't understand, I worry about what I am missing in the big picture. My assumption is that VCs are smarter than I am, which means they can see stuff which I am overlooking.
This is why it's very hard to understand why VCs will fund companies which are burning money . They don't seem to have a profitable business model, and seem to be doing the same old same old stuff for many years , without making any changes. All of it seems extremely irrational , and I wonder why a VC is willing to invest a company which loses money on each order , in order to buy customers. There are now many companies like this which litter the Indian startup space, which have raised so much money that they have gone on to become unicorns.
Sometimes I start doubting my own sanity , because I am unable to see the point of funding companies which seem to be basically flawed. However, the fact that VCs who are much smarter than I am are competing with each other to fund these companies means I must be short-sighted.
This also complicates matters when I talk to founders . They use the VC funding as the benchmark for the valuation of their own startup , which means these companies are way too expensive for us to be able to invest in, as a result of which they are never able to get off the ground.
In fact, VCs can end up doing a lot of harm to the sector and the startup ecosystem as well. Because the company they fund is so flush with funds, it often does some remarkably stupid things, just because it can afford to burn money . Not only can this be suicidal, it drives the other startups in the space ( whose founders may be smarter , more frugal , and have developed better technology) out of the market, so that the best man no longer wins.
I think the reality is that professional investors are also human beings , and they make the same cognitive errors which all human beings , do no matter how experienced or expert they are. After all, they work with the same brain we all have , and they don't always use logic and discipline to make sure they're making the right decisions. They end up competing with each other, which can become an emotionally charged race to the bottom; or are willing to take irrational gambles , because they can afford to play a high-stake poker game. Perhaps the exit of Nikesh Arora from SoftBank marks the fact that VCs have now regained their senses.
The truth is that it's not that the VCs are irrational . We're all normal , and we need to understand behavioral economics if we want to overcome our cognitive errors in order to become smarter investors. VCs fund unicorns because they're fallible human just like the rest of us, not because they are super human.
[Dr Malpani is Director at Solidarity Investment Advisors]
Image credit : wikipedia.