In the past few days, I’ve been finding it hard to make an important decision. I’ve been reviewing a number of investment opportunities for us at Remagine Ventures that were super interesting, but not a straight yes/no answer. In the process of learning about the the startups in depth (the team, its market, product, competition, etc) I went through the usual process/checklist, but something, call it a gut feeling, wasn’t sitting right.
I found myself swinging between FOMO and YOLO. On one hand, a quick moving deal forces a decision, and one can’t help but wonder “what if I’m wrong”. On the other hand, venture capital is by definition ‘risk’ capital, an we’re accustomed to make decisions in uncertainty. The deadlock between the two has a real risk of ending in “Analysis Paralysis”. This is of course not unique to me. Many VCs experience the same, and some have written about their process, or the psychology of it.
To get smarter about ‘the right’ answer or at least in an effort to better understand decision making, I started reading. The academic research in the space of decision making is large and growing. For the last five decades (!), researchers have been studying the role of cognition, emotion and intuition in human decision making.
You might be familiar with Daniel Kahneman’s award-winning Thinking Fast and Slow, where he summarises a life-time of cutting-edge research that won him the Nobel prize in economics. One of the distinctions he draws is that of the two systems we use to process information in order to make decisions:
- System 1 (thinking fast) operates automatically and quickly, with little or no effort and no sense of voluntary control.
- System 2 (thinking slow) allocates attention to the effortful mental activities that demand it, including complex computations.
The book then describes in detail the biases and heuristics that affect our decision making, shining a light on human decision making as a result of hundreds or thousands of experiments Kahneman and Tversky conducted over the years since first discussing this topic in their 1974 article titled “Judgment Under Uncertainty: Heuristics and Biases”. These include Sunk Cost, Availability Bias, Framing Bias, Loss Aversion, Regression to mean, Substitution, etc. (Michael Lewis wrote the story of the Kahneman-Tversky collaboration as an adventure novel, called The Undoing Project.)
There is a growing body of literature that applies the work of Kahneman, behavioural economics and cognitive psychology more broadly, to the world of entrepreneurial finance. A 2018 paper in the Academy of Management journal, “The role of investor gut feel in managing complexity and extreme risk” by Laura Huang at Harvard Business School, concluded that early-stage investors – as a whole – cannot be depicted by operating any one decision-making mode. We are not all rational, checklist-focused, and we are also not all affective, or cognitively-inclined. She conducted over 100 interviews with investors and found they largely fall into two groups as described by Huang in an interview to HBR:
- “checklist investors” – focus first on quantitative information, including financials, markets, and intellectual property. Once the company checked all the boxes, the investors then take a leap to investing based on a more intuitive feeling of rapport with the entrepreneurs.
- “syncopated investors” reverse that process, focusing first on whether they relate to entrepreneurs on an emotional level—judging whether a fledgling company has the grit and passion to succeed. If it clears that bar, they verify their gut with a more quantitative analysis.
I would say that, more than individual VCs and firms being different, even within each one of us, we operate according to these different decision-making approaches, at different times, in response to different pitches, etc. In short, VCs are all, individually, likely to oscillate between YOLO, FOMO and “analysis paralysis” as I have experienced.
“Putting it into baseball terms, investors who relied on their gut feel had a lower batting average, but more home runs”
Laura Huang, HBR
What are the implications for startup founders?
Investment decisions in a startup are complex. It’s not enough for founders to come armed with compelling research and numbers and appeal to the ‘checklist’ or the brain. They also need to appeal to the heart and gut of the investor and focus on building a relationship. After all, the investment decision is just the first step in what should be a years-long working relationship.
Because most investors have a degree of both ‘checklist’ and ‘gut feel’, founders will be smart to have both the ‘hard facts’, like an MVP, strong IP and market research, but also develop that chemistry and relationship with the VC. It’s not about gaming the system, but about covering your bases.
The latter, striking a personal connection, is more difficult to achieve via Zoom in the times of social distancing. It might also have negative implications on diversity, as one of the biases investors face is to look for pattern recognition or similarities to what has worked in the past. This is why it’s even more important than ever to focus on both.
As for the startups I mentioned in the first example, one was a pass (combination of gut and ‘checklist’ conditions that couldn’t be fulfilled), and the other one is still in play. Wish me luck!
*Special thanks to Robyn Klingler-Vidra for the academic and editorial wisdom, Adi Hoorvitch-Lavi for the reference material and Yoni Blau for the encouragement to write this post.
I'm a former general partner at google ventures, head of Google for Entrepreneurs in Europe and founding head of Campus London, Google's first physical hub for startups.
I'm also the founder of Techbikers, a non-profit bringing together the startup ecosystem on cycling challenges in support of Room to Read. Since inception in 2012 we've built 11 schools and 50 libraries in the developing world.
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