The Business of Venture Capital: Insights from Leading Practitioners on the Art of Raising a Fund, Deal Structuring, Value Creation, and Exit Strategies, 2nd Edition

CHAPTER 27 Human Psychology

“It has been said that man is a rational animal. All my life I have been searching for evidence which could support this.”

—Bertrand Russell

Every practitioner should aim to be a student of human behavior. We are primal beings, and we function in ways that cannot be fully explained within the logical construct. A few challenges are likely to occur while making investment decisions, primarily due to randomness of human psychology and emotions.

Let's start with David McRaney's observations in his book You Are Not So Smart. His book points out as many as 48 ways we delude ourselves. But for the sake of brevity, let's focus on the few that are relevant in the context of venture capital investments.

EMOTIONS VERSUS LOGIC

In any investment decisions, practitioners create elaborate logical labyrinths to minimize risk or justify actions; but as human beings, we are equal parts emotion. Or mostly emotions, if you start to scratch beneath the surface. We have a tendency to ignore odds in our favor and often rely on gut feelings. Snap judgments. Love at first sight. You had me at hello. We could go on and on. At work, we do stuff because we like someone. We want to earn points or be liked. Or we want to reciprocate, to feel good about ourselves. Research shows that when it comes to identifying risk, our brains are hardwired to respond from the gut. In his book How We Decide, author Jonah Lehrer points out that “our best decisions are a finely tuned blend ...