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“Smart Money” vs Dumb Money

Over the last couple of days I’ve had a number of conversations with investors about the whole concept of "smart money".  Smart money is the idea that an investor brings more to the table than just a chequebook.  They might bring business acumen, mentoring, customer contacts, or strategic expertise as well.  The smart money argument is one that is frequently used to justify giving a premium to an investor — additional preferences, board seats, and so on.

My view on the whole smart money argument is pretty simple.  I try to assess whether I could buy that expertise by hiring well vs buy it by selling a piece of the company.  After all, an investor may or may not provide the promised value after the transaction is executed, but I can always fire an underperforming an employee.

One investor candidly told me "The difference between smart money and dumb money, most often, is that smart money isn’t stupid.".  What he meant by that is that every VC into the company is going to want a board seat.  Bad board members can be a huge distraction when running a company.  The best board members are "not stupid".  They add value, but don’t take the company don’t blind alleys.

Another investor talked about structuring his investment so that a portion of the equity owned was based on the cash put it on, and a portion was earned based on his performance on behalf of the company.  That sounds great, but it also implies a level of involvement that a traditional investor might not have.  I think you’d have to be sure that you’re very comfortable with the investor in that scenario.

Either way, the concept of smart money is very common.  The challenge is to make sure you’re getting what you pay for.

{ 2 comments… add one }

  • Joan Yang April 18, 2006, 5:24 pm

    "I try to assess whether I could buy that expertise by hiring well vs buy it by selling a piece of the company. " I found this interesting. How do you hire well if you don't much enough money. One purpose of using VC money is enabling company's expanding including hiring elites

  • Alec April 18, 2006, 6:27 pm

    True, Joan. The real question is whether you should pay a "smart money" premium to the VC. There are other ways to raise money. My company, iotum, for instance has raised well over $1 million from non-VC sources, offering much more attractive terms than a VC would at the stage we are at.

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