There is a common view in the start-up investment world that “smart money” is worth a lot more to a company than “dumb money”: the latter being worth just its monetary value, while the former might warrant additional considerations (e.g. board seats, etc.).
The use of a pejorative word like “dumb” has an unfortunate effect. Easily 90% of the Angel investors I know would describe themselves as “smart money” for the simple reason that no one wants to be dumb. Yet, I would argue that there is nothing wrong with “dumb money” as long as you know what you are getting into and keep the privileges narrow. I have raised financing from, or co-invested with, almost 100 Angels over the years. I would peg at least 90% of them as “dumb money” (including myself on some occasions).
That doesn’t mean that these individuals are dumb themselves. Most Angel investors, at least the true sort that made their own money, are highly accomplished professionals. But their money can still be dumb. There are 5 common reasons for this:
The most obvious reason for an investor to be “dumb money” is a lack of relevant expertise. You can be a genius entrepreneur in real estate and make no contribution of value in a biotech investment.
2. Time (and Interest)
While expertise is the most obvious criteria, time is usually the biggest failure point. All the relevant expertise doesn’t help if the investor isn’t reachable (often in the tight time frame that a start-up needs). And good intentions don’t count. We all want to help, the question is whether or not we have the time to really do so.
In the days of the internet, one of the most common and less time-hungry, ways to help your start-up is to make introductions to other important people. In my experience, this only really works for people who are truly stars in a major hub (e.g. Silicon Valley). Anybody else will be of limited value. Just knowing others isn’t very helpful as any half-decent entrepreneur will be able to get those connections herself via tools like LinkedIn. What really matters is whether those important third parties actually care enough about your investor to do something for you. There are probably 1,000+ Angels who have Ron Conway or Dave McClure in their address book, but how many can make them actually invest in your venture? Similarly, corporate connections are also common but very difficult to convert into real value unless the connection has real interpersonal or professional depth (and the investor is willing to leverage this on your behalf)
4. Company Leverage
Even if the investor has plenty of relevant expertise, time and deep connections, it’s all for nothing if the company doesn’t leverage it. In my experience, a fair number of companies simply don’t reach out to their Angels beyond the legal requirements. Game over – everybody is dumb money at this point.
Finally, “smart money” needs a strong relationship with the founders. If the investors don’t feel comfortable offering honest advice or the founders don’t listen then all the expertise in the world isn’t going to help.
Any one of these issues is enough to pull your investment into the “dumb money” bucket, regardless of how smart or successful your investor might be as a person. The key is to know what you are getting yourself into, what you expect out of your investors and how to match up privileges to those expectations.