Fundamental Attribution Error in Angel Investing

Just for my own edification, I want to shine a light on one small
aspect of the psychology of angel investing. Specifically, I want to
address what I consider a very ripe area of research: fundamental
attribution error in angel investing.

I observe that when angel investors follow lead investors (see the
previous blog) there are many opportunities for them to make
fundamental attribution errors. By that I mean they attribute useful,
positive personality traits to others because they observe some
apparent external condition (wealth or success).

The easiest false logic is "He is rich, so he must know how to make
money."

More subtle are assumptions like …

He is articulate …

He is skeptical…

He is cynical …

He is passionate …

He is intelligent…

… so he must make good investment decisions."

He could be a member of what we call 'the lucky sperm club' (i.e.
inherited wealth). Many times the truth is more subtle. Barry
Switzer observed, "Some people are born on third base and go through
life thinking they hit a triple." Maybe he was born on second and
barely made it to third.

My point about fundamental attribution error is that other angels
assume that the lead angel has to be capable of 'hitting a triple' or
even a home run!  The reality could be the lead angel is a very
middling talent who at some point in his life was just plain lucky.
Alternatively, he may be very intelligent and very successful in his
business but not have the experience, skill, or time to do a good job
as a lead angel.

There is another source of uncertainty that exists when a syndicate is
coming together. Guys (who may be viewed as keystone investors) can
express genuine interest in investing during the early stage but elect to take a pass when the final call goes out for checks. So you thought you were in a deal with one group of people and you may find that you are in a deal with a slightly different set of investors.   That small changes may significantly affect your comfort level.  It may also effect the start-up's probability of survival.

Even if you are comfortable with the group that you invest with. How
superficial is the basis of that comfort? I think it is accurate to
say that relationships between most angels can be better characterized
as business associates rather than as close friends. (a ripe area of
research).

Many if not most of the interactions between angel investors can also
be characterized as infrequent and occurring in public venues (another
ripe area of research).

As a result of these two situations, most angels have very sketchy
information on the careers and capabilities of other angels. In
point of fact, the actual information they have may be significantly
less than is presented by any prospective employee on their resume.

So just exactly how much halo effect is attributed to a fellow angel
(to twist Mark Twain's words)… "just because he is a member of a club
to which I belong"?

Angel Investors: 'Birds of a feather flocking together'

I recently replied to a research survey on angel investing that got me thinking.  The survey was focused on teasing apart the issue of trust that angels investor had in the entrepreneur and how it affected their decision to invest.

It occurred to me that perhaps a very important underlying factor affecting the angel's (and VC's) reason to invest was being missed.  It may not primarily be the investors' comfort with the entrepreneur but his comfort with his fellow investors, particularly the lead angel, that influences the decision to invest.

Let me give you an example.  In one case, I invested in a deal not because of the entrepreneur but because I knew two investors that I really trusted were in the deal.  In fact, I have not met the president of the start-up company.  But I trusted that the lead angel would work to protect his own and my interest and would do what he could to make it a success.

This type of 'logic' (and I do use the word loosely) is more common than the case where each potential investor taking the time to get to know the entrepreneur, much less his business plan.

Can entrepreneurship be taught?

I am not sure if you can teach a person to be an entrepreneur or not.  The process of starting a company is more an art than it is a science.  Like all forms of art, it requires one to practice the craft.  As any teacher of art knows, all one can do is help a novice avoid obvious mistakes and suggest techniques or conventions that have produced favorable results in the past.  With that as background, I want to share with you a sentiment that has finally been crystallizing into an observation for me. 

My sense is that Entrepreneur Education is too frequently about analysis and not about execution.  It tends to be "thinking" and not "doing."  Not only does that not give the students a favor for what being an entrepreneur is like, it can be a real deterrent.  What helped bring this into focus was a quote I recently read from my favorite French philosopher, Henri Frederic Amiel.  He observed ..."Analysis kills spontaneity.  The grain once ground into flour springs and germinates no more."

Imagine that you, as a student, have a "seed" of a good idea.  Could it get analyzed to death by "wiser more experienced business professionals" during an analysis activity or a business plan competition?  I am not too worried about this, because I most of us who interact with college students try to be positive and upbeat, but I am trying to make a different point. -->

We are rewarding the students for telling good, bullet-proof stories rather than for doing something!  We should not be surprised if we produce a bunch of accomplished bull-shitters and possibly a bunch of future liars. 

Now imagine that the rules were that you had to make progress toward launching a new business.  So you are judged in class and in collegiate competitions on what you have done not what you have thought.  

I have a few ideas on how this might be approached but I will defer to the talented bunch of educators to whom I have lobbed this rock.  I have talked about this pitfall as "Analyzing vs doing" but I could have called it the "spectator vs the athlete."    

Hoping that we encourage a few of them to "get into the arena," I close with another of my favorite quotes.  This one from Theodore Roosevelt: 

"It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly; who errs and comes short again and again; because there is not effort without error and shortcomings; but who does actually strive to do the deed; who knows the great enthusiasm, the great devotion, who spends himself in a worthy cause, who at the best knows in the end the triumph of high achievement and who at the worst, if he fails, at least he fails while daring greatly. So that his place shall never be with those cold and timid souls who know neither victory nor defeat."