From time to time, entrepreneurs ask one investor for referrals to other investors. After all, investors network frequently, work together and have long term relationships with each other so a referral should go a long way. But not all introductions are equal.
The most successful investor-to-investor referrals are those where the referring investor is investing in the business and is seeking to fill out the round with complementary capital. By investing, the referring investor sends a strong signal to others about his/her excitement about the company. This happens most often in seed rounds but also occurs in Series A, B and later.
The next most successful referrals are sent by an investor with expertise in a category who is precluded from investing in a company for some reason but is enthusiastic about the business. Most often, the investor is blocked because a portfolio company is potentially competitive with the startup.
The most challenging referrals are those where the referring investor is not committed to investing or hasn’t decided to invest. These kinds of referrals introduce some ambiguous signaling. Why would a potentially competing investor refer me to an investment opportunity he didn’t pursue? It’s an adverse selection issue.
These dynamics resemble hiring referral dynamics. The most successful candidate referrals are those from someone who has worked with the candidate in the past and would hire them, but can’t for an unrelated externality (no hiring budget, role already filled within the company, etc).
Investor to investor referrals can be powerful tools for startups. But as with any tool, it’s important to think about how to implement the tool to maximize success.