Whatever You Do, Be Aware of These 21 Biases!
DDVC #56: Where venture capital and data intersect. Every week.
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Cognitive biases in the VC investment process
VC has long been the lifeblood of budding startups, offering them the financial springboard they need to bring their innovative ideas to fruition. Yet, beneath the surface of multi-million-dollar funding rounds and high-profile success stories, lies a nuanced landscape of decision-making, influenced by a range of overt and subtle cognitive biases.
These biases can shape the fate of young companies, often determining which ventures are given a chance to soar and which are left grounded.
Talent is distributed equally but capital and opportunity are not.
VCs are the gatekeepers for capital and opportunity, thus understanding the underlying decision-making process and potential flaws is key. In this article, I will share what a typical VC investment process looks like and provide an overview of the potential biases involved.
After reading it, you as an investor should be able to better recognize your own and your team’s biases, to make better, more objective decisions. As a founder and operator, you should gain more clarity on the VC investment process and how to leverage the VC biases to optimize the chances for an investment in your company.
Snapshot of the VC investment process
Depending on the target stage of an investor, investment processes vary. The earlier (later) they invest in the development cycle of a company, the leaner (more extensive) the process. For typical early-stage investors at Seed to Series A stage, a process looks something like the following:
Sourcing: Historically mostly inbound, meaning founders need to reach out to the investors either via email, LinkedIn, website, or any other channel. In light of the rising competition among VCs and with the help of data-driven approaches and AI, VCs gradually increase the relative share of outbound activities, meaning that VCs reach out to the founders directly, oftentimes even before they’ve officially announced their new venture.
Screening: For most inbound requests, VCs will ask for a blurb and/or a pitch deck to check the fit with their internal investment criteria such as location, stage, industry, business model, or even whether they have a competing investment already. Outbound dialoges require less information as VCs have oftentimes done their homework on the person and the business already, knowing exactly why they want to talk to an entrepreneur.
Intro call/meeting: Depending on the internal structures of a VC firm, either the lead partner for a specific vertical/technology of the respective company and/or a more junior investment professional who works closely with the check writer takes the first call. It’s important for founders to note that within larger VC firms, investment professionals oftentimes act as the gatekeepers to the investment committee. They can be your greatest cheerleader but also your biggest blocker, thus it’s super critical to treat them with the respective care and not tell them “I only want to talk to the Partner”.
Deal flow call #1: Following a short debrief within the “deal team” (= lead partner for a specific vertical and investment professionals supporting on the deal; typically 2-3 people, can also include who support on the groundwork DD), the most promising opportunities get presented to the broader partnership and investment team. This deal flow call typically runs on a weekly basis to benchmark the most interesting opportunities in the funnel, collect questions, and decide on go vs no-go.
Due Diligence: While some basic DD can start before the intro call already, post deal flow call is typically where the wheel starts to spin, kicking off deep dives on product, competitive landscape, metrics, user/customer references, hiring, and a lot more. This process is oftentimes a ping-pong between the deal team and the founders on the other end, bouncing back questions, findings, and ideas. Of course, this is the best experience as a trial period to see how a mutual collaboration may look like.
Deal flow call #2: Once all work got done and major questions got answered, the results will be presented to the broader investment team in the second deal flow call. This is where most teams then decide to invite the founders to an investment committee or discontinue the process. Rarely they decide to do even more work.
Investment Committee: While in the past these meetings were on a recurring basis like every Monday or so to benchmark as many opportunities as possible, COVID and remote work broke many of these rigid processes into more opportunistic scheduling, meaning that few firms today still have these IC days but rather adapt to the individual fundraising process dynamics. ICs consist of voting IC members (typically General Partners and Partners) and the deal team. Depending on firm culture and size of the Partner group, more or less investment professionals from the broader team join this meeting. There are different formats of debriefing and voting, but for us at Earlybird every team member has a voice, we collect these unbiased perspectives via a survey, then look at the results together and discuss perspectives bottom-up, starting with the most junior professional in the room.
Term sheet & confirmatory DD: Following the debrief comes the term sheet negotiation and the stage where confirmatory due diligence (legal, tech, financial, etc.) kick off in parallel streams.
That’s what a typical Seed to Series A stage investment process looks like. Screening, Deal Flow calls, Due Diligence, and most obviously Investment Commitees can all be understood as a fork in your decision tree: go vs no-go. As different individuals are involved throughout thes process, the underlying discussions are prone to a variety of biases.