This post continues the discussion about how behavioral psychology might affect a pitch. You can get caught up by reading part I. My goal with this series is to offer some advice on how entrepreneurs pitching to early stage investors might prepare to mitigate the problems that might arise due to the behavioral traits of investors.
The next set of errors I will discuss arise from investors’ inherent limitations in processing information that is complex and ambiguous. ((I am focusing on those errors described in the CFA Institute’s Level III curriculum. There may be others not discussed here that are nevertheless worth studying and understanding.))
Cognitive Errors – Information Processing:
- Anchoring Bias: This occurs when a prospective investor tends to use some experience from his past as an “anchor”, and then draws a direct parallel between that anchor and your startup. This anchor can become a strong frame of reference that dominates the remainder of the discussion and might become the single factor that determines the investor’s ultimate decision. ((My favorite example is the story Andrew Chen tells of his thoughts about Facebook after meeting the team in 2006. You should read it: Why I doubted Facebook could build a billion dollar business, and what I learned from being horribly wrong.))
- Case: Steve is pitching Disruptive Technology Startup (DTS) to a well respected early stage investor. Steve is excited, and is really hopeful that the investor will say ‘yes’ because Steve believes that this investor will add a lot of value as an investor and as an advisor to DTS as it searches for a profitable, repeatable, and scalable business model. This investor has conceived and built a handful of startups in the past and Steve believes that the investor’s experience as an operator will be invaluable. During the pitch the investor quickly focuses on one aspect of the product DTS is bringing to market. He thinks that the absence of a specific feature is a fatal flaw in the product design, and he uses his experience from one of the startups he co-founded in the past as justification for his opinion. Steve disagrees with that assertion. Steve has studied the topic thoroughly. He and his co-founders have discovered that the feature in question is not considered critical or even important by the customers that are adopting the DTS product now and paying for it. Their product roadmap proposes adding that feature about 18 months from when they get funded. They are raising a series A round of financing that will allow them to start aggressively acquiring the enterprise customers that they have built the product for. So far they have built up a relatively large customer base with little marketing, public relations, or sales efforts. Steve never gets through his presentation, because the investor keeps going back to that feature. At the end of 90 minutes Steve leaves the meeting feeling frustrated because he did not get to discuss any topics that he felt were important for the investor to understand. He’s almost certain DTS will not get a positive response from this investor. He is right. Two days later the investor emails Steve to say he has decided to pass because of the issue he identified.
- Mitigation: This is a tough one. If I were in Steve’s shoes I would not debate this investor’s opinions about this specific feature too strongly during the first pitch. I would listen to their reasoning. Then I would ask that they table those opinions so that I can go through the rest of the pitch. After that, I would request a follow up meeting focused specifically on the objections the investor raised – presumably DTS has valid reasons for choosing the approach it chose. The second meeting will be devoted to “un-anchoring” the investor and hopefully getting them to see things as Steve and the rest of the team at DTS sees them. It may also be necessary to send some written documentation and some operational data that the investor can study independently in order to determine for himself that DTS should not be compared too closely to his past. This approach assumes that the investor is open-minded and willing to admit that he could be mistaken. If the investor is adamant, then may be Steve should move on. This investor may not be a good match for DTS.
- Framing Bias: This occurs when an investor interprets information about your startup in different ways depending on how the information is presented, or depending on who presents the information. In other words the same information presented in different ways or presented by different people leads the same investor to opposite conclusions about your startup depending on how, or by by whom, the information is presented.
- Case: Hannah is an early stage investor. She has an engineering background, and is meeting Alice, a co-founder of Super Disruptive Technology Startup (SDTS). Alice has a co-founder, Janice, who is SDTS’ CTO. Alice does not bring Janice with her to the meeting with Hannah. Alice leaves the meeting thinking that it went very well, and tells Janice she feels they will get an investment from Hannah. She is dismayed when Hannah decides to pass because she ‘did not feel confident about the technical side . . . ‘ Alice does not have a technical background. She studied philosophy for her first degree, and then she studied for a master’s degree in marketing, strategy, and management.
- Mitigation: In this case Janice should have attended the meeting with Alice. Given Hannah’s background, they should have foreseen that she might be more interested in the technical aspects of SDTS than the typical investor. It is likely that Hannah did not feel convinced by Alice’s efforts to discuss the technical innovation behind SDTS. She may have interpreted the same information delivered by Janice more favorably than she interpreted it coming from Alice. Alice and Janice should both attend meetings with any investor that might make a large investment in the SDTS financing round, or who they want to win over because of the potential investor’s industry network or expertise.
There are other information processing errors worth studying; the availability bias and the gambler’s fallacy come to mind. Wikipedia’s entry on cognitive biases is here. Wikipedia also has a much more extensive list of cognitive biases here. If you have the time, you should invest in a copy of Daniel Kahneman’s ((If you purchase it through this link I will receive a small portion of the sales proceeds from Amazon to help me maintain this blog.)) Thinking, Fast and Slow.
In the next post on this topic I will discuss a number of emotional biases that an investor might exhibit during your pitch.