That thumping sound you just heard is a bunch of diehard Apple shareholders -- the ones who bought on Steve Jobs' first day and held on -- falling off their chairs in helpless laughter.
But I feel for you: I'm sure it's nigh-impossible to look your potential investors in the eye and tell them that they don't understand how business works. I'm sure they're all so focused on becoming the number-one player in a small and obscure market that they ignore the advantages of being the second (or third, or twelfth) player in a large and buzzing market.
Someone mentioned in another comment that startups should be more agile than the big corps, and they were absolutely right. In the vein of 37signals, we should have been focusing on one problem instead of a class of problems.
But I certainly think it's plausible that a startup could out-develop Google in a relatively unexplored area over the course of a year or two—and that's all they need, since their exit strategy is (presumably) getting bought out, not IPOing.
Every single of one of them called me to say "Well, Microsoft is going to be doing this now, we don't want to throw our money away."
It's one thing to have market validation by companies you could theoretically catch up to; it's an entirely different beast to try to compete with Google or Microsoft.