Hot Deals And Good Deals
In the lexicon of startup investors, there’s a term I’ve felt needs to be unpacked a bit: “A good deal.” What is a good deal, really?
Is a good deal one that’s hot or competitive? Is that a sign of goodness? Or ones that are proprietary, where one or a few investors see it before others and have the option to do it first? Are those good deals? Is it a good deal if an investor can buy ownership for a cheap or reasonable amount? Given that ownership and multiples are what drive venture portfolio returns, does that qualify as the most important marker? Or what about deals which have hung out in the market too long, gone stale, and which could be the victim of adverse selection?
What I’ve observed in conversations among each other or with LPs, investors will often revert back to this term “good deals” and attach a belief to them that may be misplaced — and this is especially true for early-stage investors. When a company has raised some angel and/or seed funding, is growing, has awesome metrics, and a great team, there are 5+ VC firms who compete among each other to win the right to invest in the company. It’s a bit easier to correlate those good deals with hotness, competitiveness, etc.
But in the earliest stages, I am convinced no one knows what is ultimately good in the end. What appears good today could be a turd in a year, and what appears to be a turd today could turn into a jewel. Many folks conflate these properties together, but I believe the overlap happens less often than we presume. It’s easy to perceive from the outside that companies that are good today and growing fast had competitive rounds all the way, but it seems it’s more often the case the breakouts struggle to raise at some point early in their life.
Hot deals may indicate quality of founder or opportunity but I do not believe they automatically indicate it will, with hindsight, be a good deal. A good deal often comes down to the net multiple the investor can book in their ledger. A seed company doesn’t need to have a hot or competitive round to drive a good outcome for themselves and their investors. Every investor, by their nature, likely feels this in their bones but in conversation, will often refer back to designing processes to catch “good deals.” It’s easy to get caught up in the competitiveness of a deal and try to win. Investors are competitive people. It’s also easy to wonder why a company that’s still hanging out in the market wasn’t able to raise, especially given all the money sloshing around here. Investors pay attention to every market single they can find.
I don’t know how to put an endpoint on this post other than to say to founders out there, if you’re the beneficiary of a “hot round” don’t assume it will end up being a good deal, and if you’re on the other side of this, taking forever to raise that first or second seed round, it is quite common. It’s part of the maze nearly everyone has to get through. It’s not fair, it’s not efficient, and it’s often not very fun — but that seems to be a feature, not a bug, given that very few seem to know how to identify “good” until it’s obvious to many.