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November 9, 2010

Is following “social proof” an investment strategy?

The concept of “social proof” has been around forever, but has recently become popularized through the democratization of angel investing. Everyone now seems to be an angel investor. Large and developed networks of friends and entrepreneurs invest in the same deals, quickly making up syndicates to bring seed rounds to closure. The concept is simple: if a person or people whom I trust like a deal, then it is likely to be a good deal and therefore I should invest, even with little or no due diligence. This is how mammoth angel portfolios get built, either with own money or other people’s money. 100, 200, 300 portfolio constituents and more. It is the kind of strategy that really hasn’t been seen in the venture investing arena.

But is putting money in a company merely because someone you know and trust has done so really “investing?” Or is it the difference between a “thrower” and a “pitcher?” I’d argue that deploying capital on the basis of “social proof” isn’t investing at all; it’s somewhere between gambling and wishful thinking. I’m sure there are many who will say I’m wrong, call me names and say that what they are doing is investing. I respectfully disagree. There is little doubt that I’m biased. I am firmly in the camp of thematic investing, where by sticking close to the stuff you know that you believe has macro-tailwinds that you substantially increase your chances of success versus a generalist strategy. In a sense, I am espousing a modified Peter Lynch approach to venture investing. You know it. You like it. You buy it. Otherwise, stay away. But this is merely my gross screen of what deals I want to dig into. The fact that others might have reviewed and turned down a particular deal is of little consequence to me. If a person I respect has issues with a particular company, I will certainly listen hard and get behind their objections. But if I either disagree or find other information that mitigates the issue, then I am happy to be contrarian and make an investment that others deem too risky.

At the end of the day the most important social proof I need is my own. It is fascinating that when I see these crowded deals with big name people, many of whom I like a lot, my first reaction is “Aw, damn, why didn’t I invest in that?” And then that moment passes in roughly a nanosecond and is replaced by “I am so thankful for my tight thematic focus and discipline that if I miss a few good ones, I’ll do plenty more of my own in my comfort zone that will yield even better results.” But most importantly, I am staying true to myself, my mission and my investment process. And however I do, good or bad, I’ll have no one to cheer or blame but myself. Just the way it should be.

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