Kahneman, Thinking and Venture Capital

Kahneman, Thinking and Venture Capital


Over the past few weeks I've been re-reading Daniel Kahneman's Thinking, Fast and Slow. Kahneman's book is an outstanding source of intelligent advice about business decision-making. Here I zero in on three quotes that I've been sharing with our team and our founders.

  • “Intuition adds value... but only after a disciplined collection of objective information and disciplined scoring of separate traits.” (p. 231)

Kahneman does not deride intuition; he points out what should be brilliantly obvious, namely that intuition will do better when informed by facts. He specifically shows the virtues of having algorithms, even schematic and simple ones.

The venture capital business over-indexes for intuition, often conflated with "pattern recognition". At Amasia, we are quite algorithmic in our triaging process. When you're backing a 5 or 10 or 50 person company, there's no shortage of intuition required, but we have evolved our own custom algorithm, specific to our #GetGlobal focus, in figuring out which investment opportunities merit that intuitive leap.

This logic applies to VC-stage companies as well. Entrepreneurial intuition is the engine behind the modern business world, and I have written elsewhere about not draining away intuition and the evils of being over-coached. But the best teams apply intuition to an edifice built out of facts and analyses (i.e. to the results of an algorithm).

Intuition divorced from the facts is a leap into the abyss -- versus a leap onto a tightrope, which, while still scary and risky, is a path towards the goal.

  • “A well-run organization will reward planners for precise execution and penalize them for failing to anticipate difficulties, and for failing to allow for difficulties that they could not have anticipated— the unknown unknowns.” (p. 252)

In a small company, it is often the case that the failure to achieve (admittedly ambitious) goals is not penalized. It's incredibly hard building a company, and there is a natural reluctance to administer the stick when it's difficult enough to find and retain good employees. The problem is that if you don't establish a baseline culture of consequences early, it becomes very hard to change later -- and this is a massive drag on effectiveness.

The other issue is not having enough of a cushion -- of money, of time, of mental space -- for unforeseen developments. Life in an early-stage company is a relentless sequence of unforeseen developments ("a new competitor showed up"; "the best sales guy quit"; "the decision maker left the company"; "the new feature is buggy"; "we spent more cash on XYZ than could have been imagined").

In other words: it can be foreseen that there will be unforeseen developments. It is worth building a cushion into any plan to reflect that fact.

  • “When forecasting the outcomes of risky projects, executives too easily fall victim to the planning fallacy. In its grip, they make decisions based on delusional optimism rather than on a rational weighting of gains, losses, and probabilities.” (p. 252)

This final quote is one that applies in equal measure to both VCs and founders. We do what we do as investors, and founders do what they do as founders, in part *because* of delusional optimism -- who'd want to start or invest in a business given the likely trauma that lies ahead?! Yet there is a balance, and part of our job is to strike that balance. 

The usual manifestation of the planning fallacy in early-stage businesses is what I think of as the incredible shrinking forecast. This is absolutely pervasive, even in very good companies that are likely winners. You have a plan -- and then that plan gets adjusted to a re-forecast every quarter...

Having invested in much later stage companies as well, I can say that it's a lot easier to engage in "rational weighting" when a company is further along. But we could all be doing much, much better in applying a rational lens to decision making, no matter the stage.


Impact Investing -- Three Lessons

Impact Investing -- Three Lessons