“As an early stage VC I quite frequently get exposed to entrepreneurs who have just experienced their first successes (e.g. a first VC funding round, the first €300k in recurring revenues, etc.). Often you can observe a certain sense of success and increase in confidence in an entrepreneur’s behaviour after such success events occur. After all, most companies never become fast growing or VC funded, so being in a class of companies that are on a certain growth curve is in a way a success in itself.”
Guestblog by Jan Andriessen.
I think many entrepreneurs are legitimately proud as a result of this confirmation of their potential. However, in the rollercoaster of negative cash flow that VC funding implies, hyper (personal and revenue) growth is required from the founders. A significant increase in confidence can harm this growth, as in the early stages each ambitious entrepreneur is still extremely far away from achieving her dreams. Every possible commitment to increasing the chances of success needs to be made and overestimating yourself stands in the way.
Below you will find an overview of three psychological biases that are probably both common sense and common knowledge for a lot of people. However straightforward and well-known they are, I cannot help but notice that they tend to become stronger in an entrepreneur’s mind after the first few successes. It is my hope that an applied-to-startups insight in each of these biases will be of help to those who are still to receive their first bit of VC money or to those who just did:
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1) Overconfidence bias
When suffering from the overconfidence bias, one assumes to have an edge over others without being able to explain why. A very straightforward example is an entrepreneur who relaxedly responds to the news that there are three identical competitors emerging in the same geographic area, assuming that his company is better. As investors we of course initially invested in the notion that the company is 100% unique, but the law of the market place is that great market potential attracts new players. Not acknowledging this threat can hurt an entrepreneur in several ways.
I have seen many examples of companies losing tenders because they are failing to explain why their value proposition is actually better than that of competitors. After all, a client isn’t as naturally confident in the overconfidence biasist’s company and instead purely focuses on what the company has to offer in terms of value proposition.
When more persistent over time, the overconfidence bias sometimes leads to the kind of cockiness that keeps a founder from properly seeing his company’s actual competitive position. This, in turn, leads to the eventual demise of the company. I know several cases where a company was already on the downward path of losing product-market fit not even that long after receiving their first round of funding, blinded by the notion of their own amazing yet inexplicable edge. These companies eventually always lost it to those competitors who weren’t just assuming but actually continuously and objectively evaluating whether their product was the best positioned in the market.
2) Optimism bias
In the fictitious American town Lake Wobegon, all the women are strong, all the men good-looking and all the children above average. This is the well-known Lake Wobegon effect and is an example of the optimism bias: we tend to rank ourselves higher compared to others than would be justifiable based on our actual performance.
As it is often not based on results and achievement, it is very dangerous for an entrepreneur to rank the people in his company (his own Lake Wobegon citizens) higher than average without substantial proof. Yet most entrepreneurs seem to think they have the best people.
An obvious example I run into a lot is that entrepreneurs claim to have great sales people, but that these sales people do not actually have great sales productivity numbers. Sales employee performance for a company with product market-fit is straightforward to measure, so this is striking proof that many entrepreneurs suffer from the optimism bias. Beware of this bias, because you might be using a lot of your scarce cash and time on people who aren’t delivering.
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3) Confirmation bias
The confirmation bias describes the phenomenon of mainly focusing on evidence that supports your own view, as well as interpreting ambiguous information in favour of what you already think. It can also mean that you are unconsciously ignoring data that opposes your opinion.
Very often, when they gain some traction or receive their first funding, entrepreneurs become more susceptible to this bias. They get the Mark Zuckerberg Fever and only compare themselves to the greatest entrepreneurs who overcame all the odds. In such a state, founders often dismiss improvement areas as irrelevant blips on the radar as these don’t confirm their view of their company’s greatness.
The confirmation bias opposes common sense. Common sense tells you that optimising the chances of creating a great business is not different from card counting in blackjack. Each significant business decision is a hand. In card counting you want to determine your odds for each hand to decide on your following action. As an entrepreneur you also want to do so for every important decision.
Not taking into account important information, or conveniently misinterpreting important facts, is like expecting to have an advantage over the house in blackjack without counting cards. If you expect to win like this you either believe in fate, or you are plainly naive.
The above biases are very common in each human being. In addition to sometimes noticing it among entrepreneurs, I often notice I suffer from them myself too. However, in my experience they become bigger at the moment when you can afford them the least. Acknowledging this will probably increase the chances of your company’s success and, perhaps most importantly, it will enable you to wholeheartedly say that you did all you could to make your company a success.