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Why (Private) Investors are Herd Animals.html
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Why (Private) Investors are Herd Animals.html
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<p>
It’s a common complaint – venture investors are driven by what other
investors think, and therefore lack imagination and spine.
</p>
<p>
There’s some truth to it – it is human nature, after all, to look for
social proof and authority when making decisions. However, that’s not the
whole story.
</p>
<p>
In public markets, Investors make their decisions to invest in parallel,
and in theory, most of the relevant information about a company is
publicly disclosed, by law. Businesses are also much more mature, and
therefore easier to value. Finally, the market is very liquid and very
deep, so there isn’t much uncertainty about the supply of money available
and availability of money in the future.
</p>
<p>
In a public market, it’s unlikely that I have access to private data about
a company’s prospects, and if I do, I buy or sell the stock and move the
price. Your ability to act on my knowledge is zero – by the time you learn
about it, it will already be built into the price.
</p>
<p>
By contrast, in private markets, there is a lot more non-public
information scattered across many individuals, and they have the luxury of
deciding in series. Businesses are brand new and immature, and very
difficult to value. The market is shallow and illiquid, and a “<a
href="http://en.wikipedia.org/wiki/Keynesian_beauty_contest"
>Keynesian Beauty Contest</a
>” means that you want to finance a company now just because it is likely
to be financed in the future.
</p>
<p>
Therefore, when you see other investors piling into a company, you can
infer: – They probably know something about the company or the market that
you don’t, given that a lot of the information (quality of founders, state
of competition, true size of market, etc.) is private and scattered across
many minds<br />
– This company is more likely to get financed in the future, since it
seems able to attract many, high quality investors (the aforementioned
Keynesian Beauty Contest)<br />
– And you <em>still have time to act at the same price</em> on this new
information
</p>
<p>That last fact more than any other causes Investors to move in herds.</p>
<p>
It is rational for private investors to move in herds. They have the
strong incentive – limited and diffuse knowledge. More importantly, they
have the means – financings in which the price doesn’t change as the
investors decide in series.
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