Venture capital investing is a complex dance of intuition, data analysis, and timing. It’s an art that requires a deep understanding of human psychology, business acumen, and a knack for spotting potential where others might not. I’ve been passionately exploring the dilemmas that come with investing in people, the significance of timing, the importance of numbers, founders’ backgrounds, luck, and many other factors from the business an psychology perspective.
Investing in People
One of the most profound dilemmas in venture capital investing is the decision to invest in people when there is just a blurry idea in their heads. As Ilya Strebulaev notes in “The Venture Mindset: How to Make Smarter Bets and Achieve Extraordinary Growth,” “Investing in people is not just about providing capital; it’s about believing in their potential and helping them realize it.” This involves assessing the founders’ character, resilience, and ability to execute their vision. However, this assessment is fraught with psychological challenges. VCs must navigate between their own biases and the need for objective evaluation. The “halo effect” can lead investors to overvalue charismatic founders, while the “similarity-attraction effect” might cause them to favor founders who remind them of themselves. How can you possibly find the ‘magic number’, draw the hokey stick, envision the decacorn potential, or assess the MVP when the product does not exist yet and most probably the founders will pivot a few times before they hit the product market fit!? Overcoming these biases and navigating ‘non-tangible’ resources definitely requires self-awareness and a structured approach to founder evaluation. The greatest investors of the last decades have those qualities, and I believe it’s possible to grow them over time and master the VC game in the long term.
Timing and Stage of Investment
Timing is another critical factor in venture capital investing. Each stage presents its own unique challenges and opportunities. Investing at the idea stage offers the highest potential returns but also carries the greatest risk. As Strebulaev points out, “The greatest rewards often come from taking the greatest risks.” The psychological challenge here lies in managing the tension between FOMO (fear of missing out) and the need for careful due diligence. Early-stage investing requires a high tolerance for ambiguity and the ability to envision potential in nascent ideas. Later-stage investing, while less risky, demands the psychological fortitude to enter at higher valuations and potentially miss out on exponential early growth.
Numbers and Data Analysis
Numbers provide a tangible measure of a startup’s performance and potential. They can help investors evaluate the market size, growth rate, customer acquisition cost, and other key metrics. However, as Ali Tamaseb notes in “Super Founders: What Data Reveals About Billion-Dollar Startups,” “Data is crucial, but it’s not everything. The best investors combine data with intuition and experience.”
This integration of quantitative analysis and qualitative judgment calls upon both System 1 (intuitive) and System 2 (analytical) thinking, as described by Daniel Kahneman. VCs must be adept at switching between these modes of thought, using data to inform their decisions while also trusting their instincts when the numbers don’t tell the whole story. It’s like applying synthetic data to the model in order to make it more complete and generate better outcomes. Here we simply apply intuition as an ‘art’ to complement the remaining hard facts from the data room and paint the fuller picture.
Founders’ Background
The founders’ background is another factor that often influences investment decisions. Tamaseb’s research shows that many successful founders do not fit the traditional mold of a successful entrepreneur. They might not have prestigious degrees or impressive resumes, but they possess the drive, creativity, and resilience needed to build a successful startup. This insight challenges VCs to look beyond surface-level credentials and dig deeper into a founder’s character and capabilities. It requires overcoming the “education bias” and recognizing that past performance in traditional roles may not be indicative of entrepreneurial success. Previous exits, however, can demonstrate a founder’s experience and competence in navigating the complex journey from startup to a successful business. They show that the founder has been through the process before, understands the challenges and pitfalls, and has the skills and knowledge to lead a company to a successful outcome. This can provide reassurance to investors and increase their confidence in the founder’s ability to deliver results. Moreover, founders with previous exits often have established networks within the industry, which can be invaluable for a new venture. These networks can provide access to potential customers, partners, and talent, as well as advice and mentorship. However, it’s important to note that a lack of previous exits does not necessarily mean a founder is less capable or less likely to succeed. Many successful entrepreneurs are first-time founders who have not previously started and exited a company. As Ali Tamaseb points out some of the most successful startups were founded by individuals with no prior experience in entrepreneurship. Confusing? Yes, it’s supposed to be, as it proves again that there is no perfect background for VC investors, and so there is no ideal background for startup founders, and it’s all a combination of skills, passion, drive, network, timing, grit and luck(?)🤫.
Psychological Resilience
Lastly, the psychological resilience required in VC investing cannot be overstated. As Strebulaev emphasizes, “Failure is not just common in venture capital; it’s expected.” The ability to bounce back from failed investments, learn from mistakes, and maintain optimism in the face of frequent setbacks is crucial for long-term success in this field. Coming from Europe I had to learn that it’s actually the opposite of what I was taught to be right. There are countries where failure is still a big fear and blocks the entrepreneurial spirits that could otherwise be unleashed and thrive in more open-minded environments, like Silicon Valley. Failing is expected, and it accelerates learning, but we need to remember that people in some places can afford to fail and others cannot.
Venture capital investing is a psychological journey filled with dilemmas and uncertainties. It requires a delicate balance between trusting one’s intuition and relying on data, between taking risks and mitigating them, and between believing in people and evaluating their capabilities objectively. Success in this field demands not just financial acumen, but also a deep understanding of human psychology and the ability to navigate the complexities of the startup ecosystem.
Key psychological aspects of venture capital investing and how to deal with them.
People ask how it is to be a venture capitalist. It is, indeed, the best thing you can do for a living, but only if you have the right personality. If you can constantly live out of your comfort zone, handle ambiguity, postpone rewards and payoff, and learn if you are good at this job only after 5–10 years, go get it! It will not feel like working; it’s more a way of living if you can hustle and thrive in this unstructured environment. Here are a few psychological aspects and challenges that venture investors frequently face, and many of us spend years mastering the art.
Decision-making under uncertainty: VC investing inherently involves making high-stakes decisions with limited information. This triggers various cognitive biases:
➡️Overconfidence bias: VCs may overestimate their ability to pick winners.
➡️Confirmation bias: Seeking information that confirms pre-existing beliefs about a startup or market.
➡️Availability heuristic: Overweighting recent or easily recalled events in decision-making.
To combat these, successful VCs often use structured decision-making processes and seek diverse perspectives.
Risk perception and management: VCs must constantly balance risk and potential reward. This involves:
➡️Prospect theory: People tend to be risk-averse for gains but risk-seeking for losses. This can lead to suboptimal investment decisions if not recognized.
➡️Sunk cost fallacy: The tendency to continue investing in a failing venture due to past investments.
➡️Risk compensation: As portfolios grow, VCs might become more risk-tolerant, potentially leading to poorer decisions.
Effective VCs develop a calibrated sense of risk and use portfolio theory to manage overall exposure.
Pattern recognition and intuition: Experienced VCs often rely on pattern recognition to quickly assess opportunities. This involves:
➡️Heuristics: Mental shortcuts used to make rapid judgments.
➡️Tacit knowledge: Accumulated wisdom that’s difficult to formalize but informs decisions.
➡️Thin-slicing: The ability to make accurate judgments based on limited information.
While powerful, these intuitive processes can also lead to errors if not balanced with analytical thinking.
Emotional intelligence and relationship management: VC investing is fundamentally a people business. Key aspects include:
➡️Empathy: Understanding and relating to founders’ experiences and challenges.
➡️Emotional regulation: Managing one’s own emotions in high-stress situations.
➡️Social skills: Building and maintaining networks, negotiating deals, and managing board dynamics.
High emotional intelligence is crucial for both assessing founders and adding value post-investment.
Cognitive flexibility and adaptability: The fast-paced nature of startups requires VCs to be mentally agile:
➡️Open-mindedness: Being receptive to new ideas and challenging one’s own assumptions.
➡️Cognitive reframing: The ability to see situations from multiple perspectives.
➡️Adaptive expertise: Applying knowledge and skills flexibly in novel situations.
This flexibility helps VCs navigate rapidly changing markets and technologies.
Dealing with failure and success: Both failure and success present psychological challenges:
➡️Resilience: The ability to bounce back from failed investments, which are common in VC.
➡️Attribution bias: The tendency to attribute success to skill and failure to luck, which can hinder learning.
➡️Impostor syndrome: Despite success, many VCs struggle with feelings of inadequacy.
Developing a growth mindset and focusing on continuous learning can help manage these challenges.
Long-term thinking vs. short-term pressures: VCs must balance long-term value creation with short-term metrics:
➡️Delayed gratification: The ability to forgo immediate returns for potentially larger future gains.
➡️Time discounting: The tendency to undervalue future outcomes compared to immediate ones.
➡️Patience: Maintaining conviction in long-term bets despite short-term setbacks.
Successful VCs cultivate the ability to think in extended time horizons while managing near-term expectations.
Group dynamics and decision-making: Most VC decisions involve multiple stakeholders:
➡️Groupthink: The tendency for groups to converge on a consensus without critical evaluation.
➡️Social proof: Being influenced by the actions of others, particularly in co-investment scenarios.
➡️Power dynamics: Navigating relationships within VC firms and with co-investors and board members.
Effective VCs foster environments that encourage healthy debate and diverse viewpoints.
Cognitive load and information management: VCs must process vast amounts of information:
➡️Attention management: Focusing on the most relevant data amidst a sea of information.
➡️Decision fatigue: The deterioration of decision quality after making many decisions.
➡️Information synthesis: Combining disparate pieces of information into coherent insights.
Developing effective systems for information management and decision-making is crucial for sustained success.
FOMO (Fear of Missing Out): FOMO plays a significant role in VC decision-making and can have both positive and negative impacts:
➡️Urgency in decision-making: FOMO can push VCs to act quickly on promising opportunities, which can be advantageous in competitive deal situations.
➡️Herd mentality: The fear of missing the next big thing can lead to following investment trends without sufficient due diligence.
➡️Overvaluation: FOMO can contribute to inflated valuations as investors rush to get into “hot” deals.
➡️Opportunity cost focus: It can cause excessive worry about missed opportunities, potentially leading to overcommitment or scattered focus.
➡️Deal flow anxiety: FOMO can drive VCs to constantly seek new deals, sometimes at the expense of properly supporting existing portfolio companies.
➡️Network effects: FOMO can be amplified within VC networks, as information about promising deals spreads rapidly.
Self-awareness and continuous improvement: Top VCs engage in ongoing self-reflection:
➡️Metacognition: Thinking about one’s own thought processes and decision-making.
➡️Feedback incorporation: Actively seeking and integrating feedback to improve performance.
➡️Learning agility: The ability to learn quickly from experiences and apply those lessons to new situations.
This focus on self-improvement helps VCs stay ahead in a rapidly evolving industry.
Understanding and managing these psychological aspects, balance an existence of duality as a half-human who cares about and believes in people, and a half-machine that cares about the hard results, can significantly enhance a VC’s performance, leading to better investment decisions and stronger relationships with founders and fellow investors, as well as making this work tremendously satisfying!
If you are looking for more resources around this topic, here is a picture of my very own bookshelf with some recommendations.
- The Creator’s Code by Amy Wilkinson
- Abolish Silicon Valley by Wendy Liu
- Blitzscaling by Reid Hoffman and Chris Yeh
- Gates by Stephen Manes and Paul Andrews
- The Code by Margaret O’Mara
- The New New Thing by Michael Lewis
- From Concept to Wall Street by Ron Grover
- Fundamentals of Venture Capital by Joseph W. Bartlett
- Secrets of Sand Hill Road by Scott Kupor
- The Hard Thing About Hard Things by Ben Horowitz
- The Lean Startup by Eric Ries
- Boulevard of Broken Dreams by Josh Lerner
- Principles by Ray Dalio
- The Venture Mindset by Ilya Strebulaev and Alex Dang
- Startupowcy by Agnieszka Domaradzka and Jakub Kurasiński
- Valley of Genius by Adam Fisher
- Super Founders: What Data Reveals About Billion-Dollar Startups by Ali Tamaseb
Thank you for reading! I’ll be happy to continue the conversation so feel free to reach out.
