Is Gut Feel a good reason to invest in a start-up?

Is Gut Feel a good reason to invest in a start-up?

Most investments in start-ups should never be made, at least not with the use of numbers. But they are funded. Laura Huang believes that investors use their instincts to handle this risk.

The chances that investors have, if they decide to start their start-ups, are long enough for any poker player to hold their own cards. “Most investors know that when they write a $ 50,000 check, they have a 98 percent chance of never seeing that money again,” says Laura Huang, Associate Professor of Business Administration at the Unity of Organizational Behavior. from the Harvard Business School.

Yet, investors often take risks with great success when they embark on a revolutionary entrepreneurial adventure. What brings you to it? Huang finds that investors often provide a surprising explanation: their instincts.

“If they just relied on Pro-Con lists or the company’s hard numbers in their current state, probably none of these investments would be made,” says Huang. “Good is the factor that enables them to invest, even if that seems too risky.”

Unlike most situations where a key decision based on intuition is perceived as negative, venture capitalists and angel investors often praise the wisdom of their middlemen. “They are very proud of how they make their decisions,” says Huang. When she asked an investor how he had chosen to invest, he rubbed his stomach repeatedly and said, “I’ll do it.”

A mix of both

As Gang Huang describes in the recent study “The role of the investor in managing complexity and extreme risk,” which was recently published in the Academy of Management Journal, Gut believes it is difficult to invest.

Behavioral psychologists generally share decision-making in two ways. Type 1 is characterized by impulsive, instinctive, emotional reactions, often fast and without much analysis. Type 2, on the other hand, is more analytical and conscious, and uses superior cognitive processing.

Although we are likely to attribute ideas to Type 1 thinking, Huang found that what investors meant by words was actually a combination of Type 1 and Type 2 decisions was kind of a decision, it’s a lot more complicated than we are usually think, “she says.

Huang came to this conclusion after interviews and observations by more than 100 angel investors over the past decade. She also did dozens of interviews with the entrepreneurs she financed; attended presentation and board meetings to see if her explanations were in line with her actions; and tracked the performance of the companies they invested in.

As she described in an earlier article in Administrative Science Quarterly, the decisions attributed to intuition were surprisingly effective. Although less successful overall, successful companies have performed much better. “In terms of baseball, investors who had relied on their instincts had a lower strike average, but more homeruns,” said Huang. In this paper she tries to understand what investors really do when making decisions with their instincts.

She has scrutinized all the interviews to see what investors are really looking for and found that two different types of investors have emerged. The first, which Huang calls “checklist investors”, initially focuses on quantitative information, including financial data, markets and intellectual property. Once convinced that a company has reviewed all of these fields, the prospective investor makes the jump into the investment based on a more intuitive relationship with entrepreneurs.

The second type of investor Huang calls “syncopated investors” reverses this process by focusing first on his affective relationship with entrepreneurs, on whether a young company has the courage and the passion to be successful. When it removes this bar, they check their instincts with a quantitative analysis.

What kind of investor are you?

No approach is necessarily better, Huang said. Both are more ways to manage and rationalize risks for investors.

Investors in the checklist handle uncertainty by looking for elements they can control. “It’s such a risky process and they want to be guided by their expertise,” she says. Syncopated investors control the risks, giving the impression of making the choice. “They feel like it’s a fun activity they do with the entrepreneur.”

For investors, knowing the nature of the default approach can help them understand their decisions and assure them that there is a method behind their investment decisions.

Entrepreneurs understand how investors make their decisions so that they can present their case most effectively. But it’s not about playing the system, Huang says, startups need to make sure they have both quantitative analysis to support their idea and “soft” factors that investors can address.

Depending on the signals they receive from investors, they can focus on one thing or another. “If you have an investor who is very careful with checklists, you want to show your IP and product prototype very quickly and then, if they feel comfortable, develop that chemistry,” says Huang. For a syncopated investor, entrepreneurs can focus on producing a report before they look at the numbers.

Also keep in mind that an investment decision is only the beginning of a hopefully long relationship between investor and contractor. Understanding how an investor makes decisions from the beginning can help an entrepreneur decide if he will work in the long term.

“It can be very painful to have a bad investor,” says Huang. “Understanding how someone invests can affect how he behaves and gives advice.”

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