Why the finance folks discovered startup investing

There is no definitive "Sociology of the Startup Investor" I know of. What follows is a crude attempt to describe what kind of people invest in startups. It is based on personal observation, questions I have asked and answers I have received, and a lot of guesswork when it comes to the motivation of people. Don't take this too seriously.

Through my work at Verve Ventures, I have access to a lot of people in our investor network. Some of them I have interviewed. Many of them I have met personally. And of even more, I know at least their job title. And I do not cease to be impressed by their backgrounds: Dull people don't invest in startups.

The investor base as a whole is divided into three parts.

Entrepreneurs are by nature closely familiar with the troubles of startup life. They cherish the ups and downs and genuinely want to help their peers or the next generation to succeed.

Domain experts aren't running their own business, but they know a thing or two about their industry. No matter if they're CEO of a multinational or an employee with deep knowledge about computer vision, they like to learn about what is going on in their trade and prove valuable to startups by sharing their expertise and professional networks.

Then, there are the financiers. Those who work in banking and similar professions, and have a certain flair for moving money around. It would be too superficial to describe them being in the game for the return on investment only. This article is about them.

It all began in Amsterdam.

The investing world has a strange geography. There are peaceful places, where you can send your money and expect a safe and steady flow of interest in return. Ok, these places are a bit arid now, but apparently there was a time, long ago, when you could get decent risk-free returns. Then there are the capitals of capital, the stock exchanges, which, since the Dutch East India Company's IPO in Amsterdam in 1602, gather capital from investors in an organized fashion and funnel it to companies so they can set sail. And then there is, farther away than many other exotic regions of quantitative strategies, hedge funds, private equity and what not, the Wild West of startup country, where unproven loss-making companies get monies in return for Powerpoint presentations and grand promises.

An opera singer once asked me if the world wouldn't be a better place if there was no financial speculation. I told him that I don't think so. It might not be productive, per se, to buy stocks or options in the morning and sell them in the evening; but this behavior is just a natural derivative of the original idea that shouldering big risks together with other investors makes big ventures possible. Those who invested in the first two expeditions by the East India company doubled their capital, even as one ship of four was lost at sea; Those who invested in the fourth expedition lost it all because the two ships sank. But people wanted to pepper their steaks, and therefore, more ships and sailors needed to be financed.

Which brings me back to the financiers, and how they discovered startup investing. It can be argued that investing today is a bit more difficult than a while ago. Thanks to central banks, there is too much money in this world, which makes traditional forms of investing look increasingly unattractive. Those who work in the financial industry are best positioned to see that investors need to take more and more risks to achieve their target returns. No banker was ever heard telling their clients: "The markets are a bit frothy, come back in a decade".

Then there is another problem: investing can be incredibly dull. If you invest your fortune passively, which means that you content yourself with following broad markets for the long term, there is logic but simply not much excitement in that. But we're human, after all, and we need to tell stories. "My portfolio of ETFs is doing what it is supposed to" is not material for cocktail conversations.

Most finance professionals I have met are curious people that pride themselves on their analytical capabilities. They want to understand the world more clearly than others, they are constantly on the lookout about clues what might or might not happen in the future, and they want to be investors that people can trust for good reasons. The vast majority of fund managers I have interviewed are genuinely passionate about the companies they have invested in (unless they are long/short investors, which requires them to be pessimistic about some companies, too).

I would also argue that finance guys and girls invest with confidence. If not they, who else?

They are also good with numbers.

A seasoned entrepreneur will judge the resilience and other personal qualities of a founding team. A domain expert will assess the technology and ask about the competition. Someone with a financial background will, no surprise here, tear apart the financials and ask why a startup thinks it can triple its revenue in 2023. All of these, of course, are valid points every investor should think about. It is, perhaps, just a matter of emphasis for different groups.

Because they know such things, financiers might be drawn to venture capital as an asset class because a diversified portfolio of startup investments promises returns equities cannot match. As a group, they also have the means to invest (if they don't blow their salary on consumption).

They came for the illiquidity premium, but they stayed for the fun.

Investing in startup lets finance folks and others harvest important non-financial returns as well: Take, for example, the exit endorphines that are released when a startup is finally sold or goes public. Your investment hypothesis turns out to be valid. This feeling ("I told you so years ago") is hard to beat. Or, the constant exposure to new ideas and people: "Beats going to the cinema", an investor told me after a startup pitch. Some see it as their duty to foster an entrepreneurial spirit in society, create jobs and support innovation. And some simply don't care if they lose money and see startups as some weird form of philanthropy with a call option attached. It confers the kind of non-banal status if your buddy talks about a successful venture and you can say you invested in the Seed round.

To be fair, even for me, it is impossible to pinpoint my exact motivation why I invest in a startup, so I won't try to do that for others. Returns are the fuel that power more investments, for a start. Perhaps it is always an amalgamation of several, maybe even conflicting ideas. In the end, we're exercising our judgement, and not only that, we back up our conviction with a cheque. If it is a dud, I can delude myself into thinking that I learned something in the process. But honestly, I prefer learning and making money at the same time. Even if the sole reason to invest was a purely financial motive: What is wrong with buying low and selling high? There need not be a higher moral standard to invest in startups than in other asset classes. Hedge funds don't need to cure patients to exist.

Back to the finance folks.

These people might not be able to help a startup scale from 10 to 100 employees because they did the same thing before. They might not be able to introduce you to a potential buyer (unless they're M&A professionals, or just know people, and then you can really be happy to count them among your investors). But they will ask relevant question, and if they invest, will be champions of your cause. They are risk-takers in the best sense of the term because they have a keen sense of the risk of your plans and the potential returns, and if they are in balance or not. They will judge you and have a very clear opinion if your expedition is worth financing or not. If you convince them (and not only someone who is enthusiastic of your fancy technology), your business plan is probably rock-solid.

In the end, as I have tried to explain here, backing a ship that might return laden with profit is a matter of shouldering the weight of that expense, which might or not be fruitful, among several people that know what they are doing. Yes, there is a thing to be said about investors who are contributing to your success because they can. But there is also a much less-sung praise: If you have purely financial investors, who will never even talk to you or bother you with stupid ideas and questions, who are confident enough to invest either 10k or 1 million because they believe, for whatever reason, that you are the captain of a seaworthy ship that will return, first of all, and second, laden with profit, then you must count yourself lucky. Yes, capital is a commodity, and many people say that they provide "smart capital". But maybe, for once, especially in a time where capital is more than abundant, it is also worth mentioning that just providing capital is equal to doing an incredibly useful job as well. If you're not convinced, ask the founders of a startup that went bankrupt because their lead investor pulled out last second from a financing round.

To come back to my initial idea of a Sociology of Startup Investors, I admit that dividing them in three camps does not do them justice. I have tried to describe some motivations, but there are a lot more personal stories that contribute to this discourse. If you lost your mother to cancer, you might or might not see startups in that field through a different lens than the general public of investors. But I think there is a common theme here, across the badly defined segments of people who invest in startups: They are not content with the status quo.