MOOC

Innovating in a Digital World

Lesson: The new rationality of seed funds

Associate Pr. Thomas Houy

MOOC Innovating in a digital world – R.Maniak, T.Houy, V.Fernandez, L.Gille

A MOOC From Institut Mines-Télécom – All rights reserved - 2015
Introduction
“Brian, I hope you’re working on other ideas too … because this one will never work.”

This sentence concluded AirBnB founder Brian Chesky’s first meeting with a seed fund. Five
years later, the valuation of AirBnB was over $10 billion.

We can’t just challenge the quality of the fund. Why not? Because digital entrepreneurship is
a black box. In the early stages, no one can predict a start-up’s future, not even the best-
informed people, since seed funds’ average internal rate of return is negative.

Yet seed funds are investing billions of euros annually everywhere in the world. If
entrepreneurs want to raise money, they have to understand investors’ expectations.

How has the new entrepreneurial context changed seed funds’ demands?

Bringing the future to the present

Many entrepreneurs’ mistake is to try and convince investors of the relevance of their idea by
using theoretical arguments. This way of pitching may have worked at the time of the Internet
bubble in the late ‘90s, but those days are over.

Entrepreneurs must therefore not misunderstand investment funds’ new rationality. Seed
funds don’t work on belief! They don’t judge an idea’s potential on the basis of theory or
subjectivity. Seed funds take decisions knowingly in a particularly uncertain environment. So
they expect start-ups to provide tangible facts that reduce the level of uncertainty of their
investment.

Take Bessemer Venture Partners, one of the best-performing investment funds in the US,
which has shares in LinkedIn, Skype, Yelp and Pinterest. It is one of the few to communicate
on its anti-portfolio, for the sake of transparency. This means it publishes the name of the
firms to which it regrets having said “no”. FaceBook is on this list. Bessemer declined to
invest in summer 2004 because it was too soon in the start-up’s life. Co-founder Eduardo
Saverin’s pitch failed to convince Bessemer that Facebook could overtake Friendster, the
leading social network at the time.

In other words, an investment is a bet on the future. But entrepreneurs must understand that
to convince an early-stage investor, they have to “bring the future to the present”. Promises
must therefore be based on facts that are observable today.

Power of the prototype

In a context where start-ups can now easily produce a Minimum Viable Product, seed funds
want a prototype. This is not only meant to represent the product; it is above all evidence that
the founders can actually execute their project. .

MOOC Innovating in a digital world – R.Maniak, T.Houy, V.Fernandez, L.Gille

A MOOC From Institut Mines-Télécom – All rights reserved - 2015
Business Angels don’t necessarily have the same expectations as seed funds. Yet David
Cheriton, Google’s second investor, was convinced on the sole basis of a successful test run
of a beta version of the search engine. Impressed by the quality of Google’s results in a
search on the Canadian dollar’s exchange rates, the Stanford professor invested $100,000 in
the start-up. To persuade an investor, a prototype is worth more than any blurb.

Key Performance Indicators

In the new entrepreneurial context, early adopters’ commitment can be tested without money
and in real life situations. Investors therefore expect entrepreneurs to show convincing
figures of customers’ acceptance of the start-up’s proposal.

For example, if you want to raise money for a mobile application, you have to provide
concrete data on your first users’ “stickiness”. For example, show the cohort analysis of your
application. It will prove your customers’ use of the product, according to the date on which
they downloaded the app.

To maximize your chances, you therefore have to be able to show Key Performance
Indicators better than those of the market in which you’ve positioned yourself. And they must
reflect real purchases by customers.

Finally, seed funds are rational economic agents. In a situation of uncertainty, they wish to
limit their risks by basing decisions on proven facts. Is this the best way to spot gold in the
digital world? There’s no easy answer. But it’s worth exploring.

MOOC Innovating in a digital world – R.Maniak, T.Houy, V.Fernandez, L.Gille

A MOOC From Institut Mines-Télécom – All rights reserved - 2015