Biases in Venture Investing: Why Top-Tier and Average Investors Don’t Face the Same Odds

Addressing Egos, Cognitive Bias and Assessing Your Playing Field

There is a fundamental bias worked into investors’ psyche when screening prospective investments, an unforgiving “Real Access” bias. As investors, our self-perceived reputation, wealth or skills often determine our appreciation of how the market views us and our access to it. The truth of the matter is most investors overestimate their abilities and attractiveness to entrepreneurs.

What does this mean in practice? Well, if you’re not putting in the effort to be a top tier investor you might be playing a rigged game. And you might not know it.

The distribution of returns and exit values in ventures follows a power law. And this is what the investment universe would look like for most investors:

J12 Ventures — Illustration of the Real Access Bias in Venture Capital for investors not considered top-tier. The graph represents the level of access to deals for an average investor in a typical startup ecosystem following a power law distribution of performances. The blue, arrowed, line represents the perceived level of access of an investor subject to bias. The red line illustrates the actual level of access. The red area, or Blind Spot, illustrates the deals consistently out of reach for an investor subject to bias.

If all 4 success factors mentioned here don’t apply to you then you’re most probably not a top tier investor (…yet). You will probably never hear of the best investment opportunities until after the fact because they will have been addressed to a select few, highly reputable professionals and close friends. De facto you will be assessing a subset of the total market when screening and making investment decisions, which effectively leaves you out of the very best deals and has a direct impact on your overall return prospects. Investing is increasingly competitive and the barriers to entry high. In order to make your own odds, to be invited at the table, you need to put in the necessary elbow grease and realistically self-assess your playing field.

Overcoming Selection Bias, Picking and Getting Picked

While it is easy enough to view and comparatively rank investment opportunities within reach, it is much more difficult to do so over the entire market unless you have a wide sourcing strategy and adequate resources for screening and analysis. In the absence of many hard facts, comparative ranking of startups is one of the main tools at the disposal of venture capital and early-stage investors when assessing a prospect, effectively ruling out a vast majority of deals assessed.

After applying proper analysis, conducting due diligence and implementing proprietary strategies, one simple truth remains: the very best startups pick the very best investors, not the other way around.

So what does the investment universe look like for a top tier investor? As you can see below, odds have drastically improved and tend to explain why top tier investors consistently outperform the market.

J12 Ventures — Illustration of the Free Playing Field in Venture Capital for investors considered top-tier. The graph represents the level of access to deals for a top tier investor in a typical startup ecosystem following a power law distribution of performances. The blue area represents the deals for which only top-tier investors compete.

If you want to dig deeper into how this numerically impacts your portfolio, have a look at our analysis and simulated dataset.

Questions? Ideas? Comments? Give us a shout @ j12ventures.com.