Startup and Investor Biases

Chapter 1: Investor Biases

Base Rate Fallacy

The base rate fallacy is a cognitive bias defined by Wikipedia as the tendency to ignore base rate information (generic, general information) and focus on specific information (focusing on a particular case).

One-off sales to specific companies, while helpful, do not define the startup’s growth forecast. Investors should look at the core systems of a startup to understand their acquisition, conversion, and revenue. Consulting work and other non-recurring revenue models make it difficult to predict revenue, and recurring revenue becomes a strong indicator of future revenue growth.

To overcome the base rate fallacy, look for metrics across a broader range of customers and not select ones. The presence of metrics is a good sign. Focus on recurring revenue metrics to understand the acquisition, activation, and retention rates. Hockey stick projections should be avoided as it assumes something will occur outside the business’s everyday operations to increase its revenue.

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