Pattern Recognition Is the New Insider Trading
3 ways that investors can get past bias and find deals that are hidden in plain sight
I still cringe when I think of that quote.
I’ll never forget the day that I read the famous quote from John Doerr, Managing Partner of the illustrious VC firm Kleiner Perkins, investors that I both respected and admired tremendously. Until that day.
“If you look at Bezos, or [Netscape founder Marc] Andreessen, [Yahoo co-founder] David Filo, the founders of Google, they all seem to be white, male, nerds who’ve dropped out of Harvard or Stanford and they absolutely have no social life. So when I see that pattern coming in — which was true of Google — it was very easy to decide to invest.”
It was a throat punch. For one of the most successful and celebrated VCs in history to openly state that, investment thesis aside, his decisions come down to targeting privileged young, white men was a repudiation of all entrepreneurs of color and females. The statement reeked of country club exclusivity: This is our club. No outsiders allowed.
Pattern recognition is implicit bias turned practice. It’s the dark art that becomes culture. Simply ask Travis Kalanick and Uber, as internal struggles with their biased culture have become public. Pattern recognition is the equivalent of insider trading. It’s just as prevalent and just as insidious. In the long run, it’s just as bad for investors as it is for entrepreneurs.
So how do you — as a VC, as an investor, or as any decision maker in the innovation process — avoid pattern recognition and its effects? Here are three specific ideas:
1. New Decisioning Models
Venture investors must experiment with new decision models that eliminate the effects of pattern recognition and implicit bias. Among the most promising investment strategies is Village Capital’s peer selected investment model, in which a cohort of entrepreneurs evaluates their peers on investment potential.
Peer selection enables entrepreneurs to evaluate a startup and startup leadership on their own merits (market potential, team strength, founder coachability, go-to-market strategy, traction, execution) by the very peers who are closest to it. No more Demo Days, no more VC panels to determine winners. As a past participant in one of their investment-readiness programs, it is rigorous and thorough and no amount of showmanship (or showwomanship) can conceal the Achilles Heel(s) of your startup faster or more accurately.
2. Expand Your World
Steve Case’s Rise of the Rest campaign has made geographic bias into front page news. Thanks to Steve, it’s now widely known that nearly 80% of venture capital in the United States is locked into just three states (CA, NY and MA). This is inherently prohibitive for entrepreneurs of color, as the US Census Bureau reports that over 55% of African Americans live in the South. Overlay the venture capital map over the Racial Dot Map of the United States, and you’ll see the problem clearly.
3. Use New Distribution Channels
Effective distribution strategy is a key factor in the success of any startup. So it amazes me that venture investors who obsess about the distribution strategies of their portfolio companies don’t apply those same principles to find new portfolio companies.
VCs should further utilize network nodes like the tech hubs within the Google for Entrepreneurs network, and tap into the global web of vibrant tech spaces in cities like Durham, NC; Nashville, TN; Austin, TX; Detroit, MI and many others. These hubs are always eager to share information, and they provide access to a wider pipeline of entrepreneurs off the typical flight path: San Francisco> New York> Boston.
Attend and engage with founders at venture conferences specifically for people of color. Begin with resources like Thomas K.R. Stovall’s Top Conferences for Tech Founders of Color list: Power Moves NoLa, Black Enterprise’s Entrepreneur Summit, Miami’s Black Tech Week, Black Wall Street-Homecoming and an increasingly more diverse SXSW. Resist the urge to avoid SXSW because it’s “overrun with new people,” the purist’s excuse. There are great overlooked entrepreneurs out there but you won’t find the ones you’re missing if you don’t change where and how you’re looking.
Investors: pattern recognition presents a risk to your returns and works against your investment thesis. Fall victim to it, and you’ll be relegated to fighting your way into crowded, overpriced rounds along with every other fund. However, if you’re truly seeking alpha, then invest in underutilized, undervalued assets: founders of color based in markets that offer a lower operating cost basis. Use different decision models, expand your universe of network nodes and utilize new channels to access deals that are hidden in plain sight.