Extreme Roulette

Live Roulette

A friend of mine was a professional poker player for years. One of the more interesting things he taught me was that he could predict his earnings when playing online poker. I had assumed, based on my own inexpert poker playing, that, while there were knowable odds that would improve your chances of winning, you always had to deal with other people as an unpredictable variable. That's why you ended up with big pots that could break players - they judged the odds wrong and lost.

As I thought about it, I realized that those scenarios were not mutually exclusive. You could play thousands of games for small stakes and edge up by predictable, if limited, amounts. Part of the positive expected return came from the basic odds of poker, and some came from playing against people who simply didn't understand the odds as well. At the other extreme, you could play single huge games where the variance of outcomes could empty your bank account or massively increase it on a single hand.

The parallel to startups wasn't immediately obvious to me. Risk based scenarios can all be modeled given certain assumptions. If an investor could model those variables accurately, they would know exactly how much return they would expect out of investing x dollars over y companies. If they had enough of the right variables predicted, they could just bet the winners - imagine an investor so good they could divine the information needed to only invest in Google, Facebook, Twitter, LinkedIn. Given how valuable solving that risk equation is, investors are obviously going to do everything they can to solve for those variables.

The dynamic that starts playing out, then, is that you have different investors playing different games, even though they think they're playing the same one. If you start with the assumption that startups are extremely likely to fail [1], then investing with no further information is a bit like roulette. Place your bet, and maybe you get massively lucky - but that's all it is. So the investors seek information to change the game into something closer to poker, where their odds rise dramatically and quantifiably. Meeting the founders, validating the market, testing the product, seeing traction - each of these edge the game closer to one with a positive expected outcome. The best investors find ways to change the game before anyone else does, reaching decisions faster and more accurately (professional players among amateurs). The worst investors don't even realize what's wrong with playing roulette.[2]

Founders looking to raise money can use this dynamic to their advantage. The simplest read on that advantage is that founders should do that by being tricky with the information they release and to whom they release it. By doing that, you could keep all the investors off balance and hyper competitive with one another. That should theoretically drive your value up. This seems clever, and clever seems good. But that's actually a bad idea for a few reasons. The first is that investors talk to one another and so your information will get around anyway, but it will happen out of your control and will probably reflect badly on you.[3] The second, and more important one, is that if you are tricky with releasing information, the best investors, the poker players, won't feel comfortable with you. You'll restrict your potential pool of investors to the roulette players, which tend to be the least good investors.

It's probably better to treat your interested investors fairly similarly in terms of what you tell them. The goal is to build a company so good that the information you release forces investors to rush to a decision they feel good about before anyone else does. You want to help the good investors get past the roulette stage so that they'll make an offer they believe will help you make them a lot of money.

If you do that right, you'll have good, smart, investors who are aligned with you and your interests. If you only have the roulette players, you probably did it wrong.

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[1] I've seen this number pegged as high as 99%, but who trusts statistics?

[2] Of course, since they're playing a game of chance, they might actually get lucky and win big. Some will admit they got lucky, most will call it skill and inspire other similarly foolish people to do the same.

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