Investment Bias: Get Rid of the Pesky Impediment to Success
Why being able to spot and stop bias it in its tracks is essential to becoming an effective venture capitalist.
The human brain is a stupendous organ, yet subject to constraints. There are unlimited data points around us… unlimited information to which we are exposed, and it is bias that enhances our sense of control, in part by simplifying information processing and so reducing our anxiety when faced with decision-making. As a result, biases are simply natural, but giving into them can distort both critical thinking and reasoning objectively — two particularly essential skills in the world of assessing startups.
This is never truer than when it comes to early-stage VC investing. At this point, founders most likely have no traction, no revenue and no past success to evaluate, just potential, so a great many factors needed to be assessed. Given the magnitude of the decision at hand — often millions of dollars — reverting to bias is incredibly tempting. The question is, how do we disentangle our biases and make the most objective and unprejudiced decisions?
Related: Getting Started With Angel Investing
As a startup psychologist and operating partner at F2 Venture Capital, an early-stage VC in Tel Aviv, I’ve found that the first step in the anti-bias process is understanding that it exists, being aware of which ones you personally fall into and understanding how they could be hurting your ability to make the best objective decision.
Mapping bias types
Let’s explore some of the most common biases we find in the world of VC:
- Contrast effect. This one can sneak up on investors, especially after days of back-to-back founder pitches. It occurs when two objects are judged in comparison, instead of being assessed individually. One example might be sitting through a string of five average company pitches, followed by a simply okay one, which can skew one into an unnecessarily favorable opinion. So, when assessing a startup, think about the context, then ask, “Have we just seen a string of below-average companies that may be coloring how we view this opportunity? If we had seen this first thing in the morning, would our outlook be the same?”
- Halo effect. This is a cognitive bias in which perception of a single trait of a person carries over to how you perceive other aspects of that person. In Israel, this can be especially prevalent when it comes to military background. If a founder comes from, say, special intelligence units, it’s common to attribute to that individual other leadership, intellectual and technical abilities that simply might not be there. This can cloud judgement, and blind us from negative traits as well.
- FOMO. Everyone in the VC industry is intimately familiar with “fear of missing out”. While it can be a positive tool for pushing ourselves not to miss out on the next market leader, it can also cause us to make rushed or uncharacteristic decisions, so it’s vital to be able to thoughtfully analyze deals by removing them from surrounding events. For example, right now, everyone wants a piece of the NFT market, but FOMO investing in an NFT company without spending extended time on an objective assessment of its team, technology and market opportunity is potentially destructive, and certainly unwise.
In this industry, there are also times when a specific startup has managed to position itself as the “hottest deal around”. We may be tempted to run after signing these companies just because others are, yet this is another form of FOMO investing. So, make a habit of asking whether your desire to invest is based on wanting to be part of the trends around you. Is it to win the “hot” deal that everyone is chasing? If so, FOMO may have fogged your objective goggles.
Related: How to Tune Out FOMO When Investing
- Affinity bias. This one, arguably the most destructive of the lot, is the tendency to gravitate towards people like ourselves in appearance, belief or background — a bias that leads to lack of diversity both in female and non-white representation when it comes to founders. Stats like African Americans making up only 1% of Fortune 500 CEOs, East Asians or South Asians 2.4%, and women just 6.8 % are testament to its pernicious effects.
Inclusion is not only better for the global community, it also produces financial gains for the investors themselves. A diverse portfolio supports a diverse community, and the ability for a company to reflect and support a multi-faceted population can only help increase outreach to bigger market shares. So, when making a decision on a startup, determine whether you see yourself in its founders. Are you possibly over-identifying with them, and could that be affecting the way you are assessing the opportunity?
Using experience to empower
Much like good psychologists, VCs should try to come to a pitch as an empty vessel and avoid analyzing companies through personal paradigms and past experiences. Rather, we should use our expertise to empower us as holistic investors — be able to see and assess all the moving parts that go into a successful startup, including its team, product and market. The power to spot, acknowledge and understand which bias we fall prey to is the best way to release ourselves from them, and so become the best investor possible.
Entrepreneur Leadership Network Contributor