The bandwagon effect is a cognitive bias defined by Wikipedia as the tendency to do (or believe) things because many other people do (or believe) the same.
Investors follow the lead of others. The more investors following a deal, the more investors are willing to join.
Investors look for lead investors who will negotiate the terms and diligence it.
To avoid the bandwagon effect in funding a startup, look for experienced investors to follow.
Review carefully the diligence report to see if it matches your expectations.
Verify stated information with other sources.
Challenge the assumptions to understand the deal in more detail.
For example, if the startup indicates they have revenue, investigate further the quality of that revenue.
Is it recurring revenue? Is it concentrated revenue?
Avoid situations where the investors are excited about the deal but no one is actually leading the deal and no one is reviewing the diligence.
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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.