The Logic of Start-Up Bets

 

"In the start-up world, there can be big payoff for investing and little incentive for asking questions.

Start-up investors pride themselves in finding promising young companies, but their job is kind of a crapshoot. All investing is a lot of luck. But backing young companies is essentially a bet that a tiny number of wins can make up for a whole lot of lemons. Start-up investors, in theory, can lose all their money 99 times out of 100, and they’re golden if one is the next Google.

This start-up venture capital system has been, until recently, a small corner of finance, but it has outsize influence. It helped bring us iPhones, electric cars, social media and live-saving medicines. The system also has baked-in incentives to sometimes not look too hard for shoddy finances and to overlook bad behavior.

But believing in too-good-to-be true promises is not necessarily disqualifying in start-up investing. If the mission is to find a handful of diamonds in a sea of garbage, it might not be worth spending time and resources on weeding out the potential failures or frauds.

Sometimes I wonder, only half jokingly, whether the people who scour the globe for budding tech superstars and nurture them to success would be better off throwing cash at everyone with a business idea and leaving them alone. That is not too far off the strategy of SoftBank, the Japanese conglomerate that is one of the world’s biggest start-up investors.

This isn’t without consequences. Investors and boards of directors often give start-up founders a lot of power and not much oversight. Some start-up executives spend years building rickety businesses without their backers calling them out for it. Others pay themselves a bunch of money or run their businesses like a frat house.

Start-up investing is about believing in a fantasy. Sometimes that yarn becomes Tesla, and lots of people get rich. And sometimes that fantasy evaporates. It’s part of the package."