A billionaire investing in Silicon Valley startups told to me the other day that he invests using the same strategy he uses to play poker, specifically Texas Hold'em.
In Texas Hold'em, each player gets two cards for themself. Then, through sequential rounds of betting, five cards are layed out on the table in front of all the players. After all five cards are on the table, and another round of betting, the player who can make the best five-card combination out of the two in their hand and the five on the table wins.
In poker, our billionaire likes to pay a lot of antes. That's the small, minimum bet a hold'em player has to pay to keep playing after they've seen their own two cards and before any cards go in the middle of the table.
The analogy in startup investing is investing very small amounts in a LOT of startups. In an age of $35 million first round capital raises for startups, our billionaire will invest amounts as little as $25,000 if he likes a startup idea and the entreprenuer behind it. If he likes them at all.
In poker, our billionaire will, when he has a hand that is still showing some promise, pay as little as he can during each round of betting to see the next card that falls on the table. He'll do the same in startups, joining each investment round for a minimum investment – to help keep the business running and to maintain a relationship with its founders.
Most of the time, this billionaire will find out that, in the end, none of the the cards on the table or in his hand will make a great, winning hand. So he'll fold. In startups, he'll stop investing when its clear the business is a failure or its not going anywhere great.
But sometimes – often enough to make the guy a billionaire – the next card to hit the table does make his hand a winner and entreprenuers can prove they are on to something huge.
That's when, in poker and in startups, our billionaire will, as he put it, "back the truck up."
In poker, he'll go "all in," pushing all of his chips into the center of the table. In startups, he'll infuse the promising business with huge amounts of capital in an effort to help them seize the moment and grow as fast as their market will allow.
This may sound like an obvious strategy. But it's not ubiquitious. Not nearly. USV, which bet on Twitter, Zynga, and Indeed, made all its investments early, and did not invest more capital later on. Ron Conway has a "spray and pray" stragegy, putting little amounts in lots of startups. But he doesn't have the capital to "back the truck up." Lately, Sequioa and Kleiner Perkins have mostly skipped to the "back the truck up" part, missing out on the bigger ownership stakes that go to early investors.
There might be one element to our billionaire's poker game that does not have an analogy in poker: bluffing.
Like any good poker player, our billionaire will sometimes go through the motions of having a great hand – betting and then backing the truck up – even when he doesn't have a great hand. The idea is to convince other players that they should fold their hands and let him take the pot instead of continuing to bet on their own.
You wouldn't guess that there's a lot of bluffing going on in startup investing. But maybe it does happen.
Maybe sometimes the best way to make an earlier, expensive investment look like a successful company – one that should be acquired or even IPO – is to keep betting on it like it's a successful company, in hopes that some "greater fool" (or collection of them on the public markets) will come along and swallow the thing up.
Along with poor judgement, that might explain some of the very hefty valuations startups with limited business models and flat-user engagement get from VCs.
So in review:
- Pay the ante an every hand and startup that shows any promise at all.
- Pay as little as possible to stay in the hand, see the next card, or keep the company alive.
- If a great hand never comes, fold/quit investing, figuring the loss is a cost of doing business.
- If a great hand does hit, "back the truck up."
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