Investment Biases

By Juan Manuel Giner, Managing Partner of Alaya Capital.

Five years ago, 100% of my stomach was removed after discovering that I had a mutated gene (CDH1 gene) that predestined me, with an 80% probability, to have stomach cancer. Although I was already in the VC Industry (on the entrepreneurial side), this MILESTONE confirmed my decision to get involved in an activity that could transform people’s lives through innovation and knowledge. Not only for my three children (who may eventually go through the same thing) but also for everyone living in our Latin American region. This innovation not only applies to health issues but also to other important areas such as: how we educate ourselves, how we shop, how and where we live, how we move, and how we work.

From then on, I have had a certain predisposition towards health-related projects, especially those linked to human genetics. This is nothing more than a bias, in my case, a conscious one. But the vast majority of our biases are unconscious, so it is essential that those of us who work in Venture Capital work to avoid them or, at least, try to minimize them. As GPs, we manage third-party funds, and our decisions should be as far away as possible from any factor that does not contribute to maximizing the financial return and choosing the best projects (“meritocracy”).

At Alaya Capital, we are four Managing Partners. Obviously, the four of us did not go through a surgery like mine, reducing somewhat the possibility of us (and/or the Investment Committee) approving an investment because of a bias of this type.

But some biases are not as evident or conscious. If all four of us were graduates of the same university, we would positively value projects founded by entrepreneurs from that same university. The same would happen with entrepreneurs of the same gender, from our place of birth or residence, projects linked to activities of our affections, or some extraordinary situation we have experienced.

Studies conclude that investors tend to evaluate entrepreneurs who resemble us more positively (“mirror-tocracy” o “affinity bias”), not only socially or demographically, but also in personality.

Another one that I commonly bring to the conscious plane is Contrast Bias. It occurs during demo days when we have already seen several projects, and fatigue begins to show. Perhaps we begin to evaluate the pitches by comparison instead of analyzing them individually. We may subjectively value a presentation that is not outstanding as acceptable because the previous ones were below average or did not produce a “wow effect”.

I would also like to share with you three additional biases (there are many!) that I also frequently notice and Noa Matz mentions in several articles:

Halo effect: the perception of a person’s unique characteristic is transferred to how you perceive other aspects of that person. This often happens to us, for example, when an entrepreneur mentions that they were a volunteer in an NGO that challenges us personally. We attribute to them other skills as a leader or other capabilities that they do not necessarily have.

FOMO: one of the most frequent biases before December 2021. The “fear of missing out” on a deal. It can be a great motivation for the fund team, stimulating our agility, achieving greater focus, and stripping us of unnecessary bureaucracy. Still, at the same time, it may generate “unusual pressure”, and we may make hasty decisions.

Gender bias: perhaps the bias we talk about most in the industry. Although we are still far from having parity (in entrepreneurs and investors), it is no longer totally unconscious. It is already being discussed, and concrete initiatives exist to reduce the gap. If you are interested in the subject, I leave you this clarifying TED talk by Dana Kanze “Why do women entrepreneurs get less funding?

The lack of diversity in the composition of a VC fund team, combined with the fact that we can minimize the impact of our biases, can result in poorly diversified (or rather homogeneous) portfolios with a consequential effect on the fund’s performance. Discussing potential biases with our team and partners can be a great first step in minimizing them.

The fact that most of the biases are unconscious, it seems to us that this is an issue that we should externalize, discuss, analyze and write about. :)

See you next time, Juan.

* ‘I Like How You Think’: Similarity as an Interaction Bias in the Investor–Entrepreneur Dyad Charles Y. Murnieks,J. Michael Haynie,Robert E. Wiltbank,Troy Harting

** Tech aspires to be a meritocracy but its only a “mirror-tocracy” – American Banker