Why Your First Impression of a Startup Could Be Losing You Millions!
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The article highlights the way initial valuations, whether high or low, can create a psychological anchor that disproportionately affects future decision-making. In venture capital, where decisions often hinge on imperfect or speculative data, the anchor becomes a powerful reference point. Let’s break down how this bias impacts decision-making and what you can do to avoid its pitfalls.
What is Anchoring Bias?
Saskia van den Ende from Antler kickstarted this conversation in her piece "The elephant in the room: The role of unconscious bias in venture capital decision-making," where she defined anchor bias as:
the tendency to rely too heavily on the first piece of information encountered when making decisions. In the context of VC, this can lead investors to place too much emphasis on initial valuations or projections, rather than considering other factors that may be more important in determining the success of the startup.
From Anchor to Error, an illustration
This graph from The anchoring bias reflects rational use of cognitive resources illustrates how anchoring bias affects decision-making when predictions or estimates are adjusted from an initial anchor point. In Scenario A, if the adjustment from the anchor is less than 100%, the prediction remains biased, failing to reach the correct value. Scenario B shows how the magnitude of the bias increases as the distance between the anchor and the correct value grows. The key takeaway is that insufficient adjustments from initial anchors lead to distorted outcomes, highlighting the importance of making more accurate corrections in predictions.
How Anchoring Bias Can Cost You Big in Venture Capital
1. The Initial Valuation Anchor
Imagine You're Evaluating 2 Startups....
The case of Startup A vs. Startup B is illustrative of how anchoring bias influences decisions. VCs are drawn to the initial high valuation of Startup A and may be overly optimistic about its future potential, while overlooking the operational risks. Conversely, Startup B, despite solid progress and better fundamentals, is overshadowed by its lower initial valuation. This reinforces the danger of letting early valuations dictate perceived growth potential, especially when considering long-term sustainability.
In 1 sentence: Don’t let a flashy seed round cloud your judgment.
The $47 Billion WeWork Mirage
If you’re skeptical about how powerful this bias can be, just look at WeWork's 2019 IPO disaster ( Visual Capitalist ). Early investors anchored their expectations to an eye-watering $47 billion valuation. But when public scrutiny exposed the company’s shaky fundamentals—unrealistic growth plans, corporate governance issues, and huge losses—the bubble burst.
This isn’t just a cautionary tale; it’s a clear example of how anchoring bias can cloud judgment and lead to overvaluations, particularly in the high-growth, hype-driven tech sector.
2. The Perils of Doubling Down on “Winners”
Anchoring bias can lead to "overinvestment in fading opportunities." VCs who anchor on early success may continue to invest, despite clear signals of declining performance. This highlights the importance of not only investing in success but being agile enough to reallocate capital when necessary. The risk of missing emerging opportunities is high when VCs are too focused on reinforcing their initial beliefs about a company’s potential.
In 1 sentence: Anchoring on early success can lead to overinvesting in failing companies while neglecting emerging opportunities that could offer better returns.
Quibi – The $1.75 Billion Streaming Failure
Co-founded by Hollywood veteran Jeffrey Katzenberg and former eBay CEO Meg Whitman, Quibi was a mobile-first video streaming platform with a vision to offer 10-minute episodes.
Before its launch, Quibi raised an astounding $1.75 billion from investors ( Choice Hacking ), including top VC firms like Sequoia Capital and Madrone Capital Partners. The star-studded leadership and aggressive marketing created significant early hype, which became the anchor for how many investors perceived the platform’s potential.
However, by October 2020, just six months later, Quibi shut down after failing to gain traction. Despite clear warning signs like weak user adoption and content struggles, investors continued pouring money into the venture, anchored to its initial valuation and leadership, highlighting the dangers of doubling down on a perceived winner without reevaluating performance.
Instead of diversifying or re-evaluating their investments, many continued to back Quibi, reinforcing the mistake of overinvesting in a fading opportunity. This is a key example of how anchoring on early success, or perceived success, can blind investors to declining performance, causing them to miss better opportunities or waste capital on a failing venture.
3. Anchoring Bias in Ambitious Exit Strategies
Anchoring bias can significantly distort investors' perspectives when it comes to assessing a company’s potential exit strategies, such as an IPO or acquisition. When early projections set lofty expectations for an exit, investors may become anchored to those initial forecasts, leading to overconfidence in the company’s ability to achieve such an ambitious outcome. This bias can cause investors to overlook operational challenges, market changes, or competitive threats that could derail the company’s path to a successful exit.
For startups, anchoring on ambitious exit strategies can lead founders and investors to make decisions based on unrealistic timelines or inflated valuations, expecting a large payout without fully assessing the risks. When these expectations are not met, the result can be a loss of investor capital, missed growth opportunities, or even the eventual collapse of the company.
Jawbone: How Anchoring to an Overhyped Exit Strategy Led to a $900 Million Collapse
Jawbone, once a pioneer in wearable technology, raised over $900 million in venture capital with ambitious exit plans, potentially through an acquisition or IPO. Investors anchored to early projections of the company's dominance in the fitness and health tech markets.
However, as competition increased and Jawbone failed to deliver on its product promises, it became clear that these exit projections were unrealistic. Investors continued to pour money into the company, anchored to the expectation of a significant exit, but Jawbone eventually shut down, leading to substantial financial losses.
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4. The Danger of Anchoring Bias in Established Companies
Anchoring bias can also affect investors when assessing well-established companies, leading them to rely too heavily on past performance or historical success. This bias often causes investors to overlook emerging risks or shifts in the market that threaten a company’s future viability.
How Kodak Missed the Digital Revolution
A classic example is Kodak, once the global leader in photography. For decades, Kodak’s dominance in film photography anchored investors to the belief that the company would continue to thrive, despite the rapid rise of digital photography. Kodak itself even pioneered early digital camera technology in the 1970s, but its leadership, anchored to its profitable film business, hesitated to fully embrace digital.
Investors, similarly anchored to Kodak’s past success, failed to recognize the seismic market shift toward digital and continued to value the company based on outdated assumptions. By the time Kodak attempted to catch up, it was too late, and the company eventually filed for bankruptcy in 2012. Anchoring on Kodak’s past glory prevented investors from seeing the true risks of digital disruption, highlighting the dangers of relying on historical performance rather than staying attuned to market changes.
VC Winter: How Anchoring Bias Can Freeze Your Investment Strategy
As we navigate the "VC Winter"—a period marked by scarcer capital and more conservative valuations—anchoring bias is playing an increasingly critical role in how both founders and investors approach this new reality.
Anchoring on Previous High Valuations
During the boom that preceded this downturn, many startups were riding high on inflated valuations driven by optimistic growth projections. These lofty numbers became anchors for both investors and founders, serving as benchmarks for future valuations. Now, as market conditions shift, startups are finding it difficult to adjust.
The Impact on Startups
For founders, these inflated valuations have become a psychological anchor. Many are hesitant to accept lower offers, believing their companies are still worth what they were during the peak. This reluctance can lead to missed opportunities for much-needed capital and extended fundraising periods—ultimately putting the startup’s survival at risk.
The Impact on Investors
VCs are not immune to this bias. Those who invested at peak valuations may hesitate to write down their portfolio companies’ value, holding on to the belief that the market will rebound sooner than expected. This can lead to overcommitment to struggling companies or a reluctance to invest in new opportunities at today’s more realistic valuations.
Anchoring on Past Investment Criteria
In boom times, many VCs focused on high-growth potential and riskier bets, favoring rapid scalability over sustainable business models. These criteria, often driven by the initial success of high-growth startups, became the anchor for future investment decisions. Founders, accustomed to easy and fast fundraising during those years, are now anchored to the expectation that capital will flow just as freely. However, the current environment demands more thorough due diligence and a slower pace for securing funding, a reality many are struggling to accept.
Anchoring on Valuation Multiples
Before the downturn, valuation multiples, particularly for tech startups, were based on aggressive growth assumptions and lofty revenue forecasts, often without profitability. These multiples became the norm, creating an anchor for how both VCs and startups viewed company valuations. Now, as the market tightens, those multiples are no longer realistic, yet some investors and founders remain attached to them, hindering the ability to adjust to more conservative valuations.
Anchoring on Exit Timelines
In the abundant times, startups anticipated quicker exits, whether through acquisition or IPO, based on a fast-moving market and a willingness from investors to fund rapid growth. However, during this VC winter, those exit timelines are extending as market conditions slow down. Many founders and investors, anchored to shorter timelines, may misjudge how long it will take to achieve a successful exit.
How to Follow a Lead Investor While Maintaining Independent Decisions?
Conduct Your Own Due Diligence
While it’s common to follow the lead investor's terms, you should still perform thorough due diligence on each potential investment. Relying solely on the lead's research can expose your firm to risks that might not align with your goals or risk tolerance. Make sure you independently assess the startup’s financial health, market potential, and leadership team.
Avoid Blindly Following Anchoring Bias
Lead investors can fall victim to anchoring bias—fixating on early valuations or overhyping a startup. While you may follow their lead in rounds, challenge assumptions and don’t be afraid to raise concerns if new data suggests a different reality. Trust your own analysis and be mindful of how anchoring can influence your decisions.
Negotiate Strategic Influence
As a minority investor, it’s crucial to have a voice, even if your stake is smaller. Negotiate for access to information and the ability to contribute to strategic decisions. Your input may not dictate terms, but having visibility and influence can help protect your investment and provide insight into how the lead investor operates.
Diversify Beyond the Lead Investor
Don’t become overly reliant on a single lead investor’s network or expertise. Diversify your portfolio by exploring deals with other lead investors or sectors. This mitigates the risk of exposure to one firm’s bias or strategy and gives your firm greater flexibility and independence in deal-making.
Align with the Lead’s Long-Term Vision
Ensure that the lead investor’s vision and exit strategy align with your firm’s objectives. Some lead investors may focus on aggressive growth and fast exits, while others may have a longer-term approach. Clear alignment will help ensure that you aren’t pushed into timelines or decisions that don’t suit your firm’s strategy.
Overcoming Anchoring Bias: How ACE Alternatives and Tactyc by Carta Are Revolutionizing Data-Driven Decision Making
Anchoring bias is a subtle but powerful cognitive force that can significantly shape our decision-making in ways we might not even realize. Whether in investing, negotiations, or daily life, being anchored to an initial piece of information can lead to skewed judgments and less-than-optimal outcomes. However, by recognizing this bias and adopting strategies to counteract it, we can make more rational, informed decisions, ultimately driving better results.
ACE Alternatives recognizes this and has partnered with Tactyc to empower fund managers with advanced tools and real-time insights.
Matias Collan , CEO of ACE Alternatives, Matias Collan, shares:
“Our collaboration with Tactyc marks a pivotal movement in fund management. Together, we're equipping fund managers with the power to fully leverage data-driven processes, thereby boosting efficiency and refining decision-making throughout the fund's lifecycle."
Anubhav Srivastava CEO of Tactyc emphasizes the partnership's impact:
Joining forces with ACE Alternatives enhances fund managers' capabilities with real-time data and market insights, lifting portfolio forecasting, planning, and management to unprecedented levels. We're not only introducing cutting-edge technology but also fostering stronger, more informed decision-making to improve fund performance.
Source: Rolf Dobelli, “The Art of Thinking Clearly” (2013)
About ACE Alternatives
ACE Alternatives, a leader in managed services for the Alternative Assets sector, specializes in venture capital, private equity, fund of funds, private real estate, and more. Leveraging tech-driven processes and extensive industry experience, ACE offers tailored solutions for fund administration, compliance and regulatory, tax and accounting, investor onboarding and ESG needs.
Our vision is to redefine fund management standards with data-driven processes, combining advanced technology with deep industry knowledge. We are committed to demystifying complex fund operations, promoting transparency, and achieving sustained growth across the fund lifecycle.
Media Contact: Rhea Colaso ??