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September 01, 2005

VCs Blink

It’s the end of summer, so I’m trying to get some last-minute summer reading done.  Like many people, I try to pick a few books that take me away from my day-to-day job.  Unfortunately, I just read a book that had the opposite effect:  Blink by Malcolm Gladwell (author of The Tipping Point).  This book kept bringing my mind back to the VC business.

First, a quick summary of the book.  Blink’s thesis is that human beings make intuitive decisions very quickly, often without consciously thinking or knowing why analytically.  Many times, these decisions are dead on as the brain subconsciously, rapidly absorbs and processes vast amount of observed data.  One amusing example the book provides is a psychologist who can observe a married couple for 15 minutes and with a 90% success rate, predict whether they will still be married in 15 years (begging the question of who would be crazy enough to run a 15-year longitudinal study!  You can imagine the phone call:  “Hello?  Is this Susan?  Hi Susan, Dr. Gottman here.  Yes, yes, we spent time together at my lab 15 years ago?  I just wanted to know if you’re still married to Bob.  Oh you’re divorced?  Wonderful!  Just as I predicted…uh…I mean, I’m so sorry for both of you.  Thank you very much.  Goodbye”).

To be fair, Gladwell also points out that at times these unconscious decisions can be very wrong.  As another psychologist notes:  “When we make split-second decisions, we are really vulnerable to being guided by our stereotypes and prejudices.”

Now why did this make me think of the world of VC?

Simply put, VCs blink all the time.  Ask your VC friends how long it takes them to decide whether a deal will be a good one in a first meeting or call.  Typical answer:  15 minutes.  How long does it take them to decide whether an interview candidate is an “A” player worthy of an executive position in their portfolio companies?  15 minutes.  Everything else is just to fill the time.

You see, although many VCs are typically fairly analytical, particularly those with private equity backgrounds, by and large the VC investment business is an intuitive one.  When analyzing companies without a historical track record pursuing nascent, emerging markets, VCs must heavily rely on their intuition.  When assessing executives without long track records as successful CEOs or department VPs (i.e., young, up and coming and therefore, typically unproven executives), VCs again must heavily rely on intuition.

Test it out.  If you’re pitching a VC or interviewing with them, challenge yourself to get through your opening pitch in 15 minutes and then pause.  Sit back, look them in the eye, and say:  “Let’s hit the pause button.  Based on what you’ve heard so far, what do you think?  I don’t want to waste anyone’s time if you think this would not be interesting.”  I bet you very few VCs will say, “tell me more – I haven’t formed an opinion yet.”  The honest ones will say:  “This is really interesting” or “I’m sorry, this isn’t a good fit – I can tell already”.

And what about the bias issue?  What to make of the insightful comment that intuitive, unconscious opinions and decisions play to stereotypes and biases?  Unfortunately, that’s another factor in the VC business that entrepreneurs need to take into account.  If they wish to break out of the bias, entrepreneurs need a break out approach to their pitch.  Imagine a prospective CEO with a spotty track record starting off an interview by saying:  “Look, I know I’ve worked for three failed start-ups in a row, but let me tell you what I’ve learned from that experience and why I would make an outstanding CEO.”  That would be a refreshing way to start an interview!

Finally, entrepreneurs should know that there are no hard feelings if their 60 minute pitch slot ends after only 15 minutes.  The VC will respect them all the more for being efficient and straightforward rather than dragging out the inevitable.

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Jeff, that's a fantastic post.

I am not sure if the term made it into the book, but humans develop heuristic-driven bias when working on similar issues over time.

In other words, we develop rules of thumb which can quickly give us correct answers, because the rule has been extensively tested in our experiences and the minds of others.

The whole thing has heaps more to it. Like, confirmation bias for example. In other words, it's who else has invested in the venture which is often the more important investment criteria to the human mind than the actual merits of the venture. The old endorcement anomaly.

And all this experimental psychology stuff aside, it's worth mentioning that we owe everything to the magnitude of our collective delusion.

People, for example, wouldn't do startups if they accounted properly for the opportunity costs of doing a startup, or calculated the ventures projected risk adjusted returns. Likewise, other psychological anomalies, like overconfidence, play a huge role in the entrepreneurial process and the decision to not only originate, but to stick with long shots like Ebay, Yahoo, Google...or any other historically significant industry leader.

Thanks for the post! Behavioral finance has a lot of answers and it's definitely a worthwhile topic area.

If you like Malcolm Gladwell, you might also like Nassim Nicholas Taleb, who wrote "Fooled by Randomness" ... Gladwell is a huge fan of Taleb's.

Incredibly blunt, insightful, funny, erudite author. Talks about the role of luck/chance in our lives (his day job is Options Trading).

The first half of the book makes fun of people who don't embrace math and science; the second makes fun of mathematicians and scientists who take themselves too seriously.

I just finished reading it the first time and have started re-reading it.

BTW, I love the idea of a VC blogging and reaching out to entrepreneurs. Major brownie points.

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