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Heisenberg Raises Money

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The principle of quantum uncertainty, published by Werner Heisenberg in 1927, approximately states:

Certain pairs of physical properties of a particle — such as present position and momentum — cannot be simultaneously measured beyond a certain arbitrarily high precision.

Stated another way, simply measuring the system will cause a change in its state, making precise knowledge of both position and momentum impossible. That theme — that a system can be changed merely by observation –is common in quantum mechanics (see Schrödinger’s cat) and is one of the most challenging concepts for non-practitioners.

But I think the concept is more broadly relevant, which is why I’m bringing it up here. As my fellow General Assembly partner Jake Schwartz noted, the uncertainty principle can be applied to raising money for your startup. He doesn’t blog, so I’m taking the liberty of explaining on his behalf.

In much of economics, there’s an assumption of perfect information — in this context, that entrepreneurs know the market interest and valuation of their companies, or can at least discover it with minimal transaction cost. But economic principles rarely translate perfectly to the real world. In reality, it is impossible to discover the interest in and valuation of your company without changing it.

This is often referred to as a part of the social proof you need to raise capital. According to that point of view, early stage financings are driven less by the fundamentals of companies and more by investors’ pscyhology. The positive filter of social proof has been reasonably well-discussed: specifically, how “in demand” the deal appears to be and which other investors are participating. But the negative filter of social proof –that is, the risk that a deal seems to have been “shopped” or been on the market for too long – can be far more insidious and powerful.

This is where the Uncertainty Principle of Capital comes in. Since early stage valuations are so dependent on social proof, the mere act of discovering the “market” interest and valuation of your company will inevitably change it. Or more formally, in the early stages of fundraising, the accuracy of a valuation and the momentum of a deal cannot be simultaneously known beyond an arbitrarily high number. A quick attempt to get a “market” valuation on an early-stage company can send the interest level in a deal spiraling downwards as it gives the company the feel of being “shopped” and alienates potential sources of capital.

Much of the game entrepreneurs play when talking to investors is about minimizing the effects of the Uncertainty Principle of Capital. This can explain the adage

“If you ask for money, you’ll get advice. If you ask for advice, you’ll get money.”

This doesn’t mean “be sneaky”. But it does mean that, as an entrepreneur, you’ll need to be able to deal with no small amount of uncertainty — and will need a compensating amount of patience. For veteran entrepreneurs, this shouldn’t be a surprise. For those of you just launching entrepreneurial career, get used to the queasy feeling of uncertainty now, as it surely won’t be the last you’ll see.

Written by Brad Hargreaves

June 23rd, 2011 at 5:34 am