Introducing The Friends of Friends Fund
I have an idea I’d like to share with you called the Friends of Friends Fund.
One of the biggest problems for VCs and startup investors is getting into the best deals.
Because startup returns are distributed on a power curve, there’s a huge difference between getting into the best deal, and getting into the 10th best deal. It’s sort of like the same thing with Google search results, where the #1 results gets 45% of all the clicks.
In other words, the best venture funds tend to be the ones that are able to get into the best deals. They do this by spending time building up relationships with good entrepreneurs, developing strong brands, and also developing resources to help out new entrepreneurs.
Andreessen Horowitz, for example, does a lot to create value for their portfolio companies, and they tend to get better deals and better returns because of it.
That being said, from most of the entrepreneurs I’ve spoken with, many VCs and investors are not really that helpful. They’re just money you need to keep things going.
The Friendship Paradox
So I want to talk about one potential solution to this problem, but first I want to tell you about something called the Friendship Paradox. According to Wikipedia:
“The friendship paradox is the phenomenon… that most people have fewer friends than their friends have, on average.”
Think about that for a second.
Even though it seems paradoxical, it’s real. And it’s relatively simple to understand why. This about it this way:
Imagine a social network with only 100 randomly connected people. Let’s say that most of those people have an average number of friends, but one of those people is friends with almost everyone, and one of those people only has one friend.
If you pick any of those 100 people at random, is it more likely that they’d be friends with the super popular person or the unpopular person?
This holds true for larger networks too: Because any random person is more likely to be connected to super popular people than unpopular people, on average, any random person’s friend has more friends than they do.
There’s another cool consequence of the Friendship Paradox, which is that if you’re trying to get to node centrality (i.e. the most connected people) within a particular social network but you don’t know who they are, your best bet is to just pick someone randomly, then pick one of their friends randomly, then pick one of their friends randomly, and so on.
Because any person’s friends are more likely to have more friends than they do, the more random jumps you make between friends in a network, the closer, on average, you get to the most connected people.
The Friends of Friends Fund
Now this brings me to my idea for the Friends of Friends Fund.
Because it can be hard for VCs to get into the best deals, why not get into them through other entrepreneurs instead?
Let’s say you start out by investing relatively small amounts of money, $10k for example, in a set of entrepreneurs at the very early stage of their startups. But you also give each entrepreneur a special ability: They have the ability to invest, on your behalf, another $10k in any three other entrepreneurs’ startups, no questions asked (or maybe limited questions).
In turn, those three entrepreneurs get the ability to invest $10k into any three other entrepreneurs’ startups, and so on.
The hope would be that good entrepreneurs are able (and have an incentive) to tap other good entrepreneurs in ways that VCs can’t. The other hope is that the vehicle of getting a relatively easy $10k investment from a fellow entrepreneur will help the fund get into deals that they wouldn’t be able to get into otherwise.
There are a few potential criticisms of the idea that I want to highlight:
One is that the amount you need to invest grows exponentially at every stage in the process, so you have to have some limits or else you have to invest an infinite amount of money.
You could set some arbitrary limitations: start off by just investing in 10 entrepreneurs. That becomes 30 in the second round and 90 in the third round, so 140 investments total. At 10k each that requires only $1.4M. (You’d probably want to save some money for follow-on funding of course.)
Other criticisms I can think of that I don’t have good solutions to yet:
Connectedness vs. Talent/Success
The Friendship Paradox says that random jumps lead to node centrality, but that’s only a statement about popularity and connectedness. Does it apply to talent and entrepreneurial skill? I don’t know. But I think with the right incentive system it place, it could. At least it’s worth trying.
People will definitely try to scam the system and try to make money off it. This criticism applies to traditional venture funding as well, but this particular mechanism may be particularly vulnerable. Again, some sort of lightweight check of incentive structure may be required.
My friend Dana Romano points out that this is not exactly a recipe for diversity:
Curious to see how this might help or hurt initiatives to increase diversity amongst funded founders. A lot of people currently speculate the lack of diversity is a result of the friend of friends referral pipeline to VC’s.
I generally agree with Dana’s point here. I think on the whole The Friends of Friends Fund (FOFF) would definitely not increase diversity, but it’s possible that could change depending on the initial set of entrepreneurs chosen.
Anyway, this is just an idea I wanted to share, and I’d love to hear what people think about it. Particularly, what do you think won’t work about it?