VCs Also Succumb to Cognitive Biases

I was just reading Fred Wilson’s post Mocked And Misunderstood

When people ask me, “how do you know which companies and services are going to be the biggest successes?”, I usually tell them to look for the companies and services that are mocked and misunderstood. For some reason, that correlates highly with the biggest breakout successes.

Fred Wilson is obviously a very smart guy, but that doesn’t make him impervious to cognitive biases. The above article shows a few of them. Let’s start.

1) Survivor bias. Gandhi Nicholas Klein said: “First they ignore you, then they laugh at you, then they fight you, then you win.” Wilson is skipping the companies that are ignored. Twitter was mocked because it was already standing out. Nobody mocked Twttr back when it started. That’s when you wanted to invest in it. Mocked and misunderstood implies that a company has a ton of media attention.

2) Hindsight bias. Think about companies that are mocked and misunderstood. Misunderstood is a loaded word. Do Webvan or Pets.com make that list? They were mocked, but were they misunderstood? Misunderstood implies a time sequence. At first you mocked the company, but then you thought “oh, maybe I misunderstood something.” Or it means that those who mock the company are not the same as those who misunderstanding. In any case, you can only realize that something *was* misunderstood at the time, not that it is misunderstood right now.

3) Availability bias. Can you think of successful companies that were not mocked or misunderstood? Of course, but it takes more effort. Why? Because the vast majority of companies are not mocked or misunderstood. On the other hand, unsuccessful companies that were mocked and misunderstood are no more, and you have forgotten them.

You can try this experiment: list all the startups that launched in 2007. Pick a sufficiently large random set (say 100). Find all relevant press articles for that year. How many “mocked and misunderstood” companies went on to be successful compared to companies with an equal amount of coverage that were not mocked or misunderstood?

Fred Wilson, I strongly recommend that you read Daniel Kahneman’s Thinking, Fast and Slow. Every investor should read this.

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3 thoughts on “VCs Also Succumb to Cognitive Biases

  1. there was a flaw in my post. i should have qualified it for companies that have had some initial success traction. but the post is done. it will have to stand on its own now.thanks for the recommendation on Thinking Fast and Slow.it was one of the top suggestions I got on this post from last week (sorry posterous won’t take my link)

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