Investing with your gut

Just before heading out on stage at a tech conference, TechCrunch Founder Michael Arrington asked me, “You’ve invested in a lot of great startups, how do you pick your companies?” I responded, “I trust my gut” — he seemed unsatisfied and told me, “You’ve got to come up with something better than that.”

I’ve always admired the tech investors that construct a big overarching thesis to frame their investment philosophy. “Software is eating the world,” “the bottom up economy,” and “investing in thunder lizards,” to name a few.

This type of theme investing is a great strategy for funds, and certainly a worthwhile exercise, but it never really applied to me as an individual angel investor.

For me, the decision to invest in a startup comes after following a process that is heavily weighted towards EQ. This process starts with exploring the idea emotionally and then following the advice that my intuition (gut) sends back. Should it pass this hurdle, I then continue with traditional due diligence, using objective data to validate the entrepreneurs assumptions around the quantifiable aspects of the business.

So how does one explore an idea emotionally?

When evaluating a new product, I take the novel features (not every feature) and exhaustively play out how they might impact the emotions of the consumers that use them. After that, I take the same features and consider how they might evolve over time.

During this creative process, you’ll find that a collection of signals emerge from the exploration. These emotional signals are an accumulation of subconscious experiences that aren’t readily available to our active conscious minds, but rather surface as a level of excitement. If the starting intuition going into the process comes back amplified (e.g. a greater level of excitement), then it warrants proceeding to the objective evaluation of the business.

Let’s take, for example, my notes around Twitter (which lead to my investment in 2008). I was intrigued by a handful of novel features:

Tweeting — Quick public sharing.

Emotional reaction: Typing 140 characters is quicker and easier than starting a blog. The fear and time associated with writing a long post is nonexistent. Updates can be done through text, no computer needed (remember, this was before “apps”). This could be a huge draw for non-technical celebrities.

Following — A new contrarian concept that allowed users follow people they didn’t know. While this seems commonplace today, at the time it flipped the more popular bidirectional friendship model on its head.

Emotional reaction: Building a following base feels like a game or competition. Users will encourage their friends and fans to follow, bringing in additional users. This “game” of bringing in your friends and fans is free marketing for Twitter. Following forces public sharing as default, this gives fans a deeper connection with people they admire but do not know.

Syndication of content —

Emotional reaction: Users are beginning to use the nomenclature “RT” to indicate a “retweet” (this was common practice before the official retweet feature was developed), this ad hoc feature allows users to syndicate messages beyond their social graph, giving a user’s message increased visibility. The real-time nature of Twitter allows news stories to break faster than traditional media (even at the time, my startup, Digg).

In allowing myself to feel these features through the eyes of the users, I can get a sense of the excitement around them. In this case, the starting intuition came back amplified, increasing my excitement to make the investment.

It’s important to note that I’m also a believer in objective data and using it to inform decisions, especially in later rounds of financing. But in the early stage, at the seed of an idea, the bet is largely based on the quality of the team and the emotional connection you feel with the product.

Many fellow investors believe the gut shouldn’t be trusted, and chalk up success using it to just dumb luck. Certainly creative intuition varies from person to person. There is no magic formula here. But I do believe we can think of gut intuition as a creative tool that can be called upon when evaluating ideas with very little data, such as startups that have yet to launch.