I like reading academic papers. They are a glimpse into the minds of talented researchers and provide a great view of what’s next in the infrastructure startup world.
A colleague recently forwarded me a tweet about a paper by Cormac Herley of Microsoft Research. It had one of the most attention-getting titles I’d seen in a while: Why do Nigerian Scammers Say They are from Nigeria?
It’s a great question. Most everyone is familiar with the Nigerian email scam by now. A distant relative of a prince, dictator, or civil servant claims to be in control of a pile of money they must transfer out of their third-world country. The scammer emails the victim with an impassioned plea for their help, and in exchange they offer to split some of the (fictional) money with the victim. The victim is ultimately convinced to put up some of their own (real) money to cover transfer fees, expenses, etc., and disaster ensues.
I’ve always wondered why scammers continue to send emails that the average person can quickly detect as bogus. Why not improve them in some way to get around the defenses we’ve built up to this scam and draw us in with something more compelling? In thinking about “scam optimization” my questions always focused on how to modify victim behavior to attract more attention and lure in more potential victims (improve the pitch, fix the crappy English, come up with a more original ruse, etc.) However, Microsoft’s Herley thinks a bit differently. He looks at the problem from the perspective of the scammer, and draws some good conclusions about how and why they optimize this particular type of “attack”.
The answer to his original question is pretty straight forward. The scammer’s biggest problem is getting false positives. There just aren’t enough victims who’ll fall for the pitch to begin with, regardless of how well constructed the pitch might be. But there are clearly enough prospects out there to make the entire exercise a good use of time — assuming the scammer can focus on the likely victims instead of every potential victim. By weeding out the vast majority of victims who will never reach fruition, despite early interest, the scammer can pursue the potential victims who do show interest in a pitch with much more confidence.
Essentially, scammers face an optimization problem. Touching a huge number of potential victims is easy. The real cost is the time spent converting a prospective victim into an actual victim. The scammer has to spend time to build the victim’s confidence to the point where they wire some amount of their money to the scammer. The opportunity cost here is massive. Spending time on a prospect that ultimately gets cold-feet is the worst possible outcome for the scammer. Not only did they fail to collect any money, but they wasted a bunch of time getting a “no.” The longer that victim took to ultimately back out, the higher the scammer’s cost. Since time is a real constraint, finding a way to steer clear of people who start a conversation but won’t ultimately send money is just as important as nurturing the rare victim who will end up handing over his or her cash.
Now, re-read the preceding two paragraphs, and replace the word “scammer” with “entrepreneur”, and the word “victim” with “investor”.
I’ll wait while you do it.
The parallels are real, and worth thinking about. Of course there are many differences between startup fundraising and Nigerian email scams, but there are lessons to be learned. I believe strongly that entrepreneurs must recognize that fundraising is also an optimization problem, and that they will be faced with tough questions like: Should I talk to 15 prospective investors or just five? Am I comfortable missing one investor who would have said “yes” if it means avoiding 10 conversations with investors who would never fund me to begin with?
The constant limiting factor facing an entrepreneur is time. It is often said — quite accurately — that getting to a “yes” is the best outcome, getting to a “fast no” ranks a close second, and that the “slow no” is the worst outcome of all. In a frothy fund-raising environment filled with angels, seed funds, and VC firms, the false-positive problem is very real for entrepreneurs. Everyone wants to play investor. Nobody wants to miss out on hearing a hot pitch. Getting the first meeting is easy, but separating the tire-kickers from the likely investors is the hard part. Spending your time with the former distracts you from the latter, and, more importantly, sucks time away from building your product and you growing your team.
Entrepreneurs need to develop their own framework for detecting false-positives among investors that fit their particular situation. Here are some questions you should be willing to apply as filters to every potential investor you consider:
• Have they invested in my industry before? At my current stage?
• Do they write the size check I need? Am I too big or too small of a deal for them?
• Is there any evidence that they are trying to invest behind the trends driving my business? Can they articulate a theme or thesis that maps to my market space?
• How much due diligence will they do? How can I stage the diligence to get them to a “fast no” rather than a “slow no?”
• How involved do they get with other investments they make? Is that a fit for what I want out of my investment partners?
• Do they have other investments in their portfolio that corroborate / contradict my world view and mission as a startup?
Being realistic in your answers to these questions will save you tremendous amounts of time. The reality is that most companies are not a fit for most prospective investors. The simple math says that for every “yes” there will likely be many, many “no’s”. Modifying behavior to fit that dynamic is tough for almost everyone. It doesn’t feel good to be told “no”, and it’s much easier to spend time with people who give you distant hope of getting to “yes”. It’s even easier to modify your message, tweak your pitch, or otherwise hope to change the ingrained biases of most investors, instead of hunting for the much smaller number of investors who are ready, willing, and able to fund your company.
Optimize your fundraising behavior. Confidently weeding out the likely “no’s” will pay dividends as you focus your time on the investors who have a real chance of getting to “yes”.
Sunil Dhaliwal is a general partner at Battery Ventures, where he invests in IT infrastructure, distributed systems technology and data analytics. His investments include Agari, Continuuity, Fastly, Netezza, Opscode, Precidian Investments, and Splunk. He blogs at The Whole Stack. Reach him on Twitter or at email@example.com.
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