Why I Am Happy To Fund Failed Entrepreneurs

I attended an interesting TiE meeting for charter members which discussed angel investing because TiE has now started a special interest group for angel investors. One of the topics for discussion was – How do you choose which entrepreneur to back? Seasoned investors spoke about the metrics they use to evaluate a founder, such as: has he been referred by someone they trust? What’s the total addressable market (TAM)? How passionate is he? What are his credentials? Has he been able to put together a sterling team? Pretty standard stuff which most of us are familiar with.

It’s clear that there really is no formula which anyone can use when deciding which startup to invest in. This is why which startup company to fund is always a million-dollar question, and pretty much all seed stage investors have to use their gut, simply because there are such few data points available.

For every success story we tom-tom about, there are at least five failures, and this is what keeps us humble. No matter how many years of experience we have, every new deal is a learning experience, because the space is such a dynamic system which keeps on changing so quickly.

Why I Will Back A Failed Entrepreneur

My most useful rule of thumb is to back a failed entrepreneur. This might seem unusual – why would I want to fund someone who’s not been able to pull off his first startup successfully? Here’s my reasoning.

I think he’s learned a lot of valuable lessons by failing the first time. This has been on someone else’s dime, and I stand to benefit as a result of the knowledge which he has garnered from the school of hard knocks.

Because he’s failed once he has much more at stake and is desperate to prove himself. He will be far more focussed on making sure that this company doesn’t meet the same fate because he knows it’s very unlikely he will get a third chance.

He’s likely to be more receptive to the advice his investors give him because he’s appreciative of the fact that we’ve given him a second chance. He will hopefully try to live up to the faith we’ve placed in him. He’s very likely to be frugal because he understands the importance of cash flow in ensuring a business doesn’t die. Because he’s run a business before, he understands the importance of finding getting paying customers and this means his chances of making mistakes goes down quite a bit – he’s already made quite a few before in his first startup and will not repeat these again.

While entrepreneurs who have a PhD from an Ivy League college have a great resume, these failed entrepreneurs have a PSD ( poor, smart and a deep desire to be rich) from the School of Hard Knocks and I feel this is more valuable in the startup space. The fact that they are willing to try this again rather than give up just because their first startup went belly up means they have emotional grit and this is a very valuable personality trait.

Just because his first startup failed doesn’t mean that his second one will fail as well, and I do believe in giving people second chances if he can show me has absorbed the lessons he has been taught. In fact, I believe he will work extra-hard to make sure that this startup will be successful.

Finally, because this is a contrarian approach, there is not much competition from other funders, as a result of which the valuations he expects are much more realistic.

[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]

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