Am I an above average Founder?
Periodical Article No. 03 | Kavedon Kapital Behavioural Science Team
How many islands comprise the archipelago off the coast of Stockholm?
Typical answer: “I have never been to Stockholm or even Sweden for that matter, but I am 90% sure the answer is between 3 and 65” (overconfidence test participant)
As individuals we are prone to make decisions based on headlines without delving too deep into what is actually the substance of a story. Successful Founders and Investors need to differentiate between what is noise and what are pertinent facts related to an event. This is easier said than done and in behavioural science terminology this is expressed as the overconfidence bias: the tendency to systematically overestimate the probability of an event to occur.
There are many exercises that can test an individual’s level of overconfidence; one test we frequently use at Kavedon (which is well documented in behavioural science literature) is to ask founders ten questions obscure enough that the individuals are unlikely to know the answer. Examples include: litres of paint required to paint the exterior of an A380 Airbus; how many islands comprise the archipelago off the coast of Stockholm; what is the total distance travelled by London Underground trains in 2019? We then ask them to respond with a range within which they are 90% sure the true answer lies. We ask 10 questions and most individuals score no more than 3 out of 10. Given that I am asking the participants to state their range so that they are 90% sure the correct answer lies in this range, it is rather surprising that the average is 2 and not closer to 9.
Or perhaps it isn’t. We have a tendency to state very narrow intervals, even on subjects we know nothing about, so when it comes to subjects we believe to be knowledgeable about, the intervals become even narrower. Such unfounded overconfidence is concerning as it relates to how we view the world and how we make predictions.
How can we correct for the bias?
Overconfident individuals can be myopic: they often fail to see the bigger picture and once they have formed a view — it is very difficult to shift the narrative. This is exacerbated in Venture Capital as a significantly large proportion of Founders have never failed before or have never encountered a down cycle in the market. For example, the Founder who leads a company through Series A may not be the correct candidate for the Series B round, however it can be difficult for the Founder to accept this and not consider the bigger picture. Even the most successful Founders get things wrong and individuals who believe they are always right is a concern. Their approach is often simply to seek out information which confirms their hypothesis. Over the long term, we believe this leads to sub optimal outcomes for the Founder, the VC firm and the LP.
Learning from failings is an important part of any decision process. We discussed pre mortems in the first behavioural science article and post mortems add equal weight to the process. Founders need to be objective, however, bad outcomes do not necessarily yield bad process and good outcomes are not always a result of good process.
The way behavioural science is integrated into our investment process at Kavedon is to identify biases with Founders and if present, find solutions to combat them. In our experience biases cannot be removed by education, but through identifying practical solutions to overcome them. Humans systematically display these biases, so we will all display the overconfidence bias, probably on a daily basis. How many reading this would say they are above average Founders or Investors? Likely over 80% of the readership will. As such we need solutions to prevent this behaviour. Ultimately, we create an environment for Founders which diminishes their reliance on behavioural biases which produces better quality decisions benefiting the Investee Company, Kavedon and LPs.
One way to counter overconfidence of this nature is to actively seek out information that disproves the hypothesis. Much attention in Venture Capital is attributed to appraising why this idea is a great investment opportunity. But one of the most important elements in any opportunity is: What are the conditions in which this investment will not work? It surprises us how few Founders and Investors consider this question thoughtfully, given that it forces the Founder/Investor to think carefully about the downside risks associated with the investment idea which, in turn, encourages them to explore material which runs counter to their hypothesis. Inevitably, questioning of this type results in a much more rounded appraisal of an investment idea and should, in our view, be a systematic function of any investment process.
Process over panic
The key to eliminate most behavioural biases in investment decision-making is to stick with a process: in times of heightened uncertainty the successful Founders and Investors are those who stay true to their process and are not distracted by high profile events. When these events start to dominate remember to stick to a process and to constantly question yourself “where could I be wrong?”. It’s a great filter for removing overconfidence.
There are approximately 32,000 islands off the coast of Stockholm.
(1. See Russo and Schoemaker (1989) Decision Traps: Ten barriers to brilliant decision making and how to overcome them, Simon & Schuster)