Thinking Fast and Slow in Seed-Stage Funding

Contributor: Cole Diamond

Editors Note: Cole Diamond is a member of the Dorm Room Fund Investment Team in New York City. He is a graduate of Columbia Engineering, where he majored in Computer Science and minored in Economics. A hackNY Fellow (class of 2011), Cole is passionate about technological entrepreneurship. This fall, Cole will be heading to Seattle to work as a Program Manager at Microsoft. 

All is fair in love and war.

When it comes to seed-stage investments, we at the Dorm Room Fund strive to make the process fair, too. But what does “fair” mean, exactly? And how can founders communicate the value of their product so that VC’s can make fair decisions? In my short time here at the Dorm Room Fund, I have had the opportunity to step inside the shoes of a VC first-hand. The perspective has given me insight into how founders might increase their success in raising capital.

Evaluating a company’s potential objectively can be tough. Really, really tough. There is no cut-and-dry way to fairly assess a company without enormous amounts of research and time. But time and resources are often limited, so investors — like all people — are prone to take shortcuts. Yet, when we think too quickly and rely on heuristics to guide our decisions, we leave ourselves vulnerable to bias. Whether we realize it or not, we are all predisposed to subconscious biases whenever we make decisions. In fact, the very belief that one is immune to bias is a bias in-and-of-itself called the blind spot bias!

When it comes to investing, the Dorm Room Fund  strives to make the process as fair as possible,  but investors are naturally prone to the same time constraints and biases as all humans. How then, can you as a founder best communicate the value of your product so that VCs can make the most fair decisions under these natural constraints? In my short time here at the Dorm Room Fund, I have had the opportunity to step inside the shoes of a VC first-hand. The perspective has given me insight into how founders might increase their success in raising capital.

Since joining Dorm Room Fund NYC, I’ve been really interested in the concept of bias and how we, as an investment team, can take steps to avoid it when evaluating companies. So, I consulted an expert, Daniel Kahneman, to learn more about bias in decision-making. The father of decision theory, Kahneman was handsomely rewarded for his ground-breaking work with a Nobel Prize in Economics. He recently detailed his career findings for the lay-person in his book, Thinking Fast and Slow.

In Thinking Fast and Slow, Kahnmen states that there are two major systems which motivate our actions. The first system, which Kahneman simply refers to as System I, relies on heuristics and intuition, while the second system, System II, is more methodical and systematic. For example, System II will be used to answer questions like 45×25, whereas System I helps us decide what outfits to wear. Most of the time, System I will prove extremely useful in answering questions which System II might take eons longer to resolve. Nonetheless, System I is flawed since it is prone to bias.

So, how can a founder use this understanding of cognitive bias in decision making to optimize their chances for success in raising capital? The answer is simple – be proactive. While investor time and resources are often limited, there are proactive steps you can take to help them best understand your startup’s value.

Here are some effective behaviors which I have observed:

1. Send regular updates leading up to the pitch and after;
2. Occasionally forward interesting industry articles with a note on how it relates to what you’re doing;
3. Frame the pitch itself on the points you want the VC to consider and make sure to take on the challenging points head on.

I, myself, have struggled with conveying value to prospective investors.  Having spent months and months building out my start-up, www.stakd.com, I was eager to bring Stakd to market. So there I was, a 20-year-old kid with no previous entrepreneurship experience whatsoever, ready to take on the world. But, it seemed as though VC’s did not share my vision. After all, who would trust a college-student with 50k? Even though companies like Google and Facebook were started in Dorm Rooms, I felt like no VC truly empathized with my plight and was willing to hear my vision. If only Dorm Room Fund were around at the time…

Now that I find myself at the other end of the table, I understand that a Dorm Room Fund partner must do his or her best to honor the industriousness of the founder(s) by reciprocating in kind. Essential to the service the Dorm Room Fund provides to entrepreneurs is empathy. Without an ability to relate, it is impossible to serve the needs of founders – who at the end of the day – are our real clients. Investors owe these entrepreneurs the hard work that comes with careful and thoughtful research, both to minimize bias and maximize the fairness of the process. That said, time will always be limited and by taking proactive steps to communicate important information and updates to investors, you as a founder can help investors make the best decisions possible for your start-up.

To read more posts by Cole Diamond, please visit his blog.