By: Ben Freeberg
It is easy to get stuck in a routine way of thinking when evaluating new investment opportunities. Venture capitalists tend to ask the same set of questions and look for standard signs of success potential investments exhibit before investors thoroughly diligencing the opportunity.
AVP sat down with Duke professor Dan Ariely to get a behavioral economist’s take on venture investing. The interview focused on three broad ideas: analyzing early and late stage companies and discussing how the idea of unintended consequences plays a role in venture capital.
For early stage companies…
Ariely believes the process is quite unique. He explains how young companies must keep multiple hypotheses in mind as they develop their business. Think about a physician’s job. If a doctor goes into an appointment with only one potential diagnosis in mind, he may miss signs that would have led to the correct diagnosis.
Next, the ability for and importance of motivation is significant in an early stage company. A big part of productivity is motivation. Investors must determine whether the founders are hiring the right people and analyze how the founders are getting their team to care about the company’s development as a whole. The difference between someone who cares and someone who does not care, Ariely explains, has a large impact on the success of an early-stage company.
Investors should strive to seek out founders who are like poets. Ariely explained how poets are unbelievably dedicated to each sentence and each word, while maintaining the overall meaning of the poem. People join early stage companies out of passion for the solution, problem or team. Keep an eye out for dedicated, passionate and collaborative teams who have a thorough understanding of the market they are attacking.
For late stage companies…
Ariely discussed that the focus should be on the team’s ability to execute. During calls and meetings with management, try to understand what is going well and, just as importantly, what is not going well. What obstacles have they overcome in the last week, month, year? Have those obstacles been centered around competing personalities or the difficulties of selling to large enterprise customers?
Find out what the most detail oriented aspect of their business is and how they are managing that process. The diligence on late stage companies should have a more technical, financial and analytical focus. The diligence effort should help you understand how efficient the team is and how the team manages its day to day operations in relation to its broader 5-year vision.
Unintended Consequences in Venture Investing
One thing we have learned time and time again is that solely providing people with information does not help. For example, fast food restaurants in NYC were required by law to showcase how many calories were in each of their menu items. The city believed that providing people with this information would encourage people to make better, healthier choices. After a deep analysis, there was no statistically significant impact on improving consumers’ ordering habits. Even worse, in low-income neighborhoods, showcasing calories in fast food restaurants had an adverse affect on consumers’ behaviors. Consumers were trying to “get the best bang for their buck”, meaning they found it more efficient to spend $1.00 on a 1,000 calorie meal than to spend $1.00 on a 500 calorie meal.
It would have been difficult to predict consumers would have this reaction, because it is not a rational choice on paper. But, if extensive market and customer research was completed, and the city took the time to learn why consumers choose to order certain items at certain restaurant locations, maybe the approach to sharing calorie counts could have been positively altered.
Unintended consequences will inevitably happen to some startups when they bring new products and services to market. What is truly important is listening to what the data tells you. Ariely explains that it is incredible how often we don’t listen to data. In the NYC fast food example, they had demonstrable proof that, in practice, sharing calorie counts does not work. Now, they are rolling out this initiative across the entire U.S…
Bringing a product to market and understanding the customer’s needs is difficult. It is difficult not to trust your intuition. But, if the data is screaming at you to change some aspect of your marketing campaign or product design, try your best to listen. In this industry you can either be humble or be humbled. Keep an eye out for founders who exhibit humility with regards to their company vision and go-to-market strategy.
In Closing…
Humility, listening to data and experimenting are all important for management teams to keep in mind as they build a business. The challenge is that a company can’t develop 3 products at the same time. Pivoting is sometimes too extreme, so be sure to keep 3 hypotheses in mind while bringing your product to market. It is difficult to balance dedication to a certain path and having an open mind. Therefore, it is important to be intentional about listening to and acting upon data that is received as a startup brings its product to market.