Malcolm Gladwell once said, “Truly successful decision making relies on the balance between deliberate and instinctive thinking”.

It’s typical human nature to make fast, instinctive decisions whenever we can. However, it is essential to take a step back and plan the decision rationally, especially when it has a long-term effect. In the book – Thinking Fast and Slow, Daniel Kahneman touches on a vital subject that discusses how humans make decisions, how our brain works in many situations, and how our choices are often affected by our cognitive bias.

Every investment decision a VC takes has lasting impacts; they need to be deliberative and rational rather than fast, instinctive or driven by the experience. In this article, we discuss how VC’s make their investment decision.

How does thinking impact a VC’s investment decision?

Humans are evolutionarily programmed to dodge tough decisions. When we encounter tricky situations, we subconsciously opt for a more straightforward solution or intuition to avoid the need to think deeply and deliberately about the issue as it needs effort.

For example, if we are asked to answer 24 times 17, it takes us some time and effort to arrive at the solution (408) unless we rely on a calculator. But the second time when someone throws the same problem, our response is instantaneous as our brain has stored the result.

Let us take an example to understand how this is relevant to the VC world.

A startup X has reached out to your VC to raise funds, and you are one of the VC panel members. The startup’s pitch went well, the product has the right market fit with an exciting business model, but you are not fully convinced with the founders and team.

As we know, the VC community is closely knit. VCs consult each other for information and feedback on startups before making funding decisions. Let’s say you spoke to another VC firm that has dealt with Startup X in the past and discreetly enquired about their business model and the founding team.

Our brain is perpetually tricked into looking at things in a way someone portrays them to us. There is a likelihood of the opinion shared by the fellow VC having an impact on your decision.

Making a complex investment decision need both intuitive and deliberate thinking – focus on their numbers, financial projections, go to market approach and more. A view of both the long-term benefits and the area for improvements.

Now let’s move on to the next phase of this article, where we will discuss how delusional optimism can lead VCs to take wrong investment decisions.

Planning Fallacy vs Rational Decision Making

Kahneman has discussed how planning fallacy works: it’s a situation where we disregard information about how likely we are to succeed and go by our instincts which can be misleading.

Let’s look at Kahneman’s thoughts from a VCs perspective.

When VCs are looking to invest, they fall victim to the planning fallacy. They tend to make decisions based on delusional optimism (optimistic bias), which causes them to believe that they are likely to succeed.

Often VCs invest in experienced startup founders, who have a few successful exits. This is a case of the halo effect – an extremely positive perception the serial entrepreneur carries. They tend to believe that these founders have succeeded in the past to succeed in the future. However, past success does not necessarily guarantee future success.

VCs must be diligent while making investment decisions irrespective of the funding stage or the past success of founders of a startup. Looking at all the projects, big and small, from a rational lens helps dodge significant uncertainties. Instincts, when aligned with rationality, help strike a balance.

We tend to become over-optimistic at times and inch towards decisions that our brain thinks is right even when it has seen strong evidence that it is not. VCs must pay attention to such cues and ensure that their decisions are considered and not just based on instincts.

We hope this article helped you understand how intuitive and deliberate thinking impacts investment decisions. Share your thoughts on this article in the comments section below.