Forging A Bias-Free Path to Investment

Venture capital firms are tasked with forecasting and investing in an inherently uncertain future. The daunting unknowns in early-stage startups can push VCs to focus solely on risk, rather than return potential. While it’s important to account for risk, it can become a mental trap, preventing VCs from finding unicorns.

Relying on investment memos and votes can also be dangerous, as they are susceptible to bias and depend upon the quality and persuasiveness of the writer — which can lead to fewer investments in minorities who do not match the typical founder profile. Another common bias is the notion that established VCs are more intelligent, and their knowledge or experiences can justify an investment decision. These are just a few of the cognitive biases that consistently prevent well-intentioned people from thinking rationally.

The disadvantage of these innate biases led SVLC to adopt a data-driven and mindful approach to investment decisions. We use the Decision Analysis Framework to determine our investment decisions. Decision Analysis is a disciplined process for evaluating important decisions that was developed through a collaboration between the Stanford School of Engineering and Harvard Business School. It’s widely used by companies such as Bristol Myer Squibb, Ford, Pillsbury, Honeywell and Southern Railway.

Our colleagues at Ulu Ventures adapted the framework for venture capital, galvanizing the movement.

By calculating a bottoms-up total addressable market, exit value and success probabilities, we’re able to determine the probability-weighted multiple on invested capital (PWMOIC). We also assign a number to each uncertainty and judgment we make, to help eliminate unconscious biases and make responsible choices with our capital. Once we calculate the intangible values, we have a final PWMOIC result. No matter the industry or vertical, all companies must pass a minimum threshold for us to invest and form a long-standing partnership with them.

The Decision Analysis practice enables us to frame our intuition, minimize bias, focus on what matters and streamline the diligence process. This method distinguishes SVLC from most other firms, as it is immensely transparent and collaborative with founders. We pull back the curtain on our decision-making and share our model with founders, so they understand what it takes for a startup to be worth the investment risk.

This process requires entrepreneurs to think outside the box and long-term. We challenge them, asking, “Now that you have acquired customers, what else could you do?” These open-ended questions often uncover business directions and opportunities, and give us a deep understanding of potential pathways.

The Decision Analysis model is also a perk for our portfolio companies. Our framework can identify the main markets that drive revenue, and which business drivers are most sensitive to market fluctuations. Some of our founders, like Oyster CEO Vilash Poovala, continue to use the model to explore decisions and quantify judgments.

We are immensely thankful for the framework, and we wholeheartedly believe that it’s integral to bringing greater equity, objectivity and capital returns to the VC sphere. Much of our success can be attributed to our due diligence process, and we hope to see more VC firms and investors joining us in confronting uncertainty and biases head-on.