2 min read Whether you are a new investor or you have been in the industry for decades, you may be falling prey to one of these common investor biases.
Read them, study them, maybe even write them down and keep them on your desk. The more familiar you become with these biases, the easier it will be for you to avoid them and make fair and profitable decisions going forward.
Confirmation bias is a cognitive bias defined by Wikipedia as the tendency to search for, interpret, focus on and remember information in a way that confirms one’s preconceptions. Investors bring their recent investment experiences to funding new startups. If the investor recently lost their investment on a deal in a specific sector, they will most likely look unfavorably on other deals in that sector.
On the other hand, if the investor found success in investing in a particular type of company, then most likely, the investor will look for similar companies. It’s important to understand these forces when setting up an investment thesis and a criterion for funding startups.
To overcome confirmation bias, consider the following:
Try to view the deal from other angles than you traditionally use. Ask other investors for their view on it and note the ones with strong objections. Discuss your thought process with other investors to see where you might be off the mark. Expand your connections to include people with different experiences and viewpoints. Give prominence in your thinking to views divergent from your own.
Wikipedia defines Courtesy bias as the tendency to give an opinion more socially correct than one’s genuine opinion to avoid offending anyone. Courtesy bias arises when an investor tells the startup what they think it wants to hear rather than what the investor thinks. The investor spares the feelings of the startup but, in the process, withholds feedback the startup needs to hear.
Feedback should be candid, even if it’s not all positive. If the feedback is all positive and negative, it may signify that the investor is under courtesy bias. Consider giving a more balanced view of the startup with both positive and negative feedback to learn from the experience and have something to work on.
Another form of courtesy bias is investors who hide their social, political, or other leanings. For example, some investors believe that only those from their social or political circle are reliable investments, but they call out some other facet of the startup for passing. To overcome the courtesy bias, investors should take note of the deals they fund and identify factors swaying their decision.
Present bias is a cognitive bias defined by Wikipedia as the tendency of people to give more substantial weight to payoffs that are closer to the current time when considering trade-offs between two future moments. Early exits weigh stronger on investors than further out exits, even if substantially larger. Under present bias, investors forgo longer-term gains for immediate gratification.
To overcome present bias, consider yourself in the future compared to today. Ask what your future self wants rather than your present-day self. If holding the investment longer will make your future self happier, that can outweigh what your present self wants. Another way to overcome present bias is to set goals and criteria for buying and selling and use those for determining when to buy and sell.
Finally, the time value of money measures how much future returns are worth based on the time to return. By using these calculations, you can see the quantitative difference between the two investment choices.
Shared Information Bias
The shared information bias is a cognitive bias defined by Wikipedia as the tendency for group members to spend more time and energy discussing information that all members are already familiar with and less time and energy discussing information that only some members are aware of. Investors focus on information their investor group already knows and talks about but spend less time on information not well understood. In diligence, investors focus on the areas they already know and give less attention to the unknown areas.
To overcome shared information bias, consider creating a checklist of critical topics to discuss and move the group forward through the list. Give weight to the voices discussing diverse opinions. Look for those who have experience with the topics and highlight their views. Expand your group to include others who have more varied experiences. Capture the dialog into written form for a follow-up review. It’s easy to talk about the things you know and more challenging to discuss new things.
Wikipedia defines hindsight bias as the tendency to see past events as predictable when those events happened. Early indicators come back to the investors ‘ minds when an investor witnesses a startup fail or succeed. In some cases, investors selectively remember specific events or facts that later confirm the outcome, leading to overconfidence. If one believes he can predict the outcome, he’ll make mistakes erroneously, thinking he can envision the result of any startup. Often, success or failure is a combination of market selection, timing, team dynamics, and not just one facet of the business.
To overcome the hindsight bias, remember you cannot predict the future. Review the facts of the startup and not just how you feel about it. Write out your thought process, including the facts at hand and the justification for investing. When the investment outcome becomes known, you can refer back to the notes to check your decision-making. Consider other outcomes aside from the one you expect and keep an open mind throughout the process. Build a decision-making process and focus on it rather than guessing the outcome.
Read more in the TEN Capital eGuide: https://tencapital.group/startup-and-investor-biases/
Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: firstname.lastname@example.org