But in reality, pitch nights are generally garbage anyway. Investors put a lot of weight on "Who introduced the entrepreneur to me" and that carries more elitism than MIT. Again this is to get through all the noise.
If you have a project with traction and a large addressable market, the investors will follow the signal and stop worrying about pedigree.
I think the contention is that it's not actually a signal, we just believe it to be true, and it's a confirmation bias.
1) They presumably have other opportunities available to them that they gave up to pursue the venture. It's hard to gauge the passion of a founder if they couldn't have gotten a job at google instead.
2) Investors want innovative products that eventually turn into companies, which means they want smart people who have a cool idea and can tweak the model when needed rather than people who just follow a business plan. Snapchats business plan would have been horrible if they had one.
As for upward mobility, pedigree is not something you're born with. Anyone can go to MIT, Stanford, or Harvard (and they give out quite a bit of financial aid as well).
For the tl;dr crowd, what mattered most to investors is the quality of the founding team. The paper finds that operational abilities and expertise of the founders is important. Relevant paragraph:
"Given the importance of team information, what is the channel through which human capital information is important for early stage investors? One explanation is that the operational or technical capabilities of the founding team raise the chance of success, especially in the earlier stages of a firm’s lifecycle, when experimentation is important. An alternative explanation is that high quality teams have attractive outside options, and can therefore credibly signal the quality of the idea. We find evidence that human capital is important at least in part due to the operational capabilities and expertise of the founders."
That's not a statement of pedigree.
"operational capabilities" basically means that investors have some way to figure out that the founders can organize labor, manage money, define the product, find customers, ect.
How is such a judgement made, though?
At the same time, there are a lot of companies that fail into success-- where the market is right and the funding is sufficient that they can make mistake after mistake and still end up being successful.
So I think the part of the abstract that claims that this is "rational" to fund based on pedigree is confusing correlation for causation-- if people with pedigree but no ability tend to get a lot more funding than people with the same lack of ability but no pedigree, obviously more of them are going to be more successful. And the people with ability whether they have pedigree or not, may be more successful overall, but this study isn't controlling for that. (and it's hard to identify ability, that's for sure.)
I have no doubt that pedigree, as you refer to it, does stochastically index quality. There's too much evidence from various studies that it does. But the strength of relationship between pedigree and quality, is much, much, much weaker than people typically assume. We end up relying on things like test scores in school, and degree in the workforce as a proxy for talent or ability or motivation or whatever, when it's more like a weak predictor. In the process, we end up granting monopolies to meritocracies and driving up things like income inequality, where income distributions don't parallel skillsets.
I agree that this paper probably reinforces false beliefs, but my guess is that it does so because it oversimplifies a kernel of truth, not because there's no truth to it to begin with.
>Talent or ability and willingness to work hard and take responsibility are important.
In reading the paper, that seemed to be the other factor in the human capital evaluation. Investors need to feel good about the abilities of the founders.
So pedigree matters.
If I got a buck for every startup story of the form "When I was a freshman at Stanford...", I could probably afford to go to Stanford.
On the upside, there's a juicy chance here for canny investors to try and find underpriced opportunities of the form "When I was working at the video store ..."
Early stage investors are gambling even more than late stage investors. The best they can hope for is to find 50 reasonable deals and let the math work itself out.
So the better part of their decision could easily be based much more on what their peer early stage investors think of them. Founders with pedigree are easy to justify and obviously more socially valuable than founders without pedigree (like buying IBM). So being the angel who keeps getting those founders means other investors will look up to you.
And, if things go wrong, nobody can blame an investor for getting into bed with pedigreed founders. It's an obvious decision, so it won't invite ridicule. Since it's obvious, there will be more competition, and that's something the angel doesn't have to rely on luck to win.
TLDR:
>> Introduction
Start-up firms are particularly difficult to finance because their prospects are highly uncertain, they lack tangible assets that can be used as collateral, and they face severe information problems (Hall and Lerner (2010)). Given these problems, how do investors choose which start-ups to fund? What factors drive their selection process? (…)
This paper provides, to the best of our knowledge, the first experimental evidence of the causal impact of start-up characteristics on investor decisions. (…)
Based on competing theories of the firm, we focus on three key characteristics of start-ups: the founding team, the start-up’s traction (such as sales and user base), and the identity of current investors. (…)
We sent approximately 17,000 emails to nearly 4,500 investors on the platform, spanning 21 different start-ups, during the summer of 2013. The randomized experiment reveals that the average investor is highly responsive to information about the founding team, whereas information about traction and current investors does not lead to a significantly higher response rate. This suggests that information about the human capital of the firm is uniquely important to potential investors, even after controlling for information about the start-up’s idea. (…)
We find that the more experienced and successful investors react strongly only to the team information, which provides indirect evidence of the viability of an investment strategy based on selecting on team information.
>> Why do Investors React to Information on Founding Team?
We find evidence that human capital is important at least in part due to the operational capabilities and expertise of the founders. (…)
>> Is it Rational to Invest Based on Founding Team?
It is challenging to answer this question directly, for several reasons (…) We can, however, take an indirect approach by exploring how successful and experienced investors react to various information (…)
The inexperienced investors with no prior investments, who make up 18% of the sample, react not only to the team information, but also to the traction and current investors.(…)
The experienced investors still only respond to information about the team, while the significance of the response to the traction and current investors categories among inexperienced investors weakens somewhat.(…)
>> Conclusion
Overall, the results in this paper present evidence for the causal importance of human capital assets for the success of early stage firms, and contribute to the debate around the importance of various key assets to organization success. Our results, however, do not suggest that non-human assets are not essential. Rather, the results are consistent with the model by Rajan (2012), in which human capital is initially important for differentiation, but needs to be replaceable in later stages so that outside investors can obtain control rights, thus allowing the firm to raise large amounts of external funding
I think that is pretty well designed experiment given the difficulty of researching such topic.
I think a tl;dr would be that early stage investing is more of a social decision about who and what you want to help than a rational decision ala the mythical "homo economicus."
No "$40 for a day" overlays, no searching for the authors' websites to get a preprint version. Just one person with his curiosity satisfied. Thank you to whoever paid for it.
The abstract:
"This paper uses a randomized field experiment to identify which start-up characteristics are most important to investors in early stage firms. The experiment randomizes investors’ information sets of fund-raising start-ups. The average investor responds strongly to information about the founding team, but not to firm traction or existing lead investors. We provide suggestive evidence that team is not merely a signal of quality, and that investing based on team information is a rational strategy. Altogether, our results indicate that information about human assets is causally important for the funding of early stage firms, and hence, for entrepreneurial success."
