BHIDA – Analyzing your investment decisions

Conducting a Brutally Honest Investment Decision Analysis (BHIDA) will help you beter understand your start-up investment decisions, uncover biases, and identify your personal investment preferences. Use a system mindset focused on decisions rather than outcomes.

An investment journey

I started early-stage startup investing in earnest two years ago. After a few direct investments I turned to AngelList to explore a broader range of opportunities. Together with a good friend, I signed up to a selection of syndicates and diligently logged and evaluated every single deal that came our way.

Two years in and we have just crossed the 750 deals mark, of which 300 in the last 6 months. A plethora of ambitious decks, optimistic deal memos, highly talented founders and teams, equally talented and successful co-investors, and a wealth of innovative and exciting novel business ideas resulted in a steadily growing number of investments.

As always, a disclaimer first: none of the below should be taken in any way as investment or legal advice of any sorts. I’m but a humble individual investor, sharing my personal views and thoughts, nothing more. 

Taking stock

Time to take stock. As Elizabeth Yin from Hustle Fund put it in an absolutely excellent blog post, your initial investments will likely be horrible, because you won’t know what you’re doing. And that’s completely fine. You need to start somewhere. You can read every investing, start-up, strategy book there is, but the only way to find out if you can swim is to get in the water.

However, that means it is crucially important to go back over your investments and to understand what drove your decisions to invest. Understanding your own decisions, biases and preferences is key to improving them.

Time for a Brutally Honest Investment Decision Analysis (BHIDA).

System mindset

In his book Loonshots, Safi Bahcall describes the concept of a system mindset. In contrast to an outcome mindset, where you focus on what caused the outcome, a system mindset analyzes the process by which you arrived at a decision.

System mindset means carefully examining the quality of decisions, not just the quality of outcomes. A failed outcome, for example, does not necessarily mean the decision or decision process behind it was bad.

Loonshots by Safi Bahcall

This concept is so important and the confusing bad decisions with bad outcomes (and good decisions with good outcomes) is so ubiquitous in society that it warrants its own post. Start-up investments however provide a perfect use case for applying it for a couple of reasons.

Applying a system mindset to your start-up investments

Firstly, you’re making decisions often based on very little information. In public market or later stage investing you typically have a wealth of data and information. Early-stage investment decisions however are often made based on a handful of factors:

  • How impressive is the founder?
  • How novel and defensible is the idea?
  • Is now the right time?
  • How big and competitive is the market?
  • Is there any initial traction or indication of product market fit?
  • What is their unfair advantage?

Secondly, you don’t have outcomes yet! Start-up investing is a game of patience. You should not expect to see any return on your investment for several years. if at all. And this applies especially for your successful outcomes. Failures happen early. A company increasing 50x in value doesn’t happen overnight. Yes, you could look at mark-ups in subsequent funding rounds, but even those take time to come through. Personally I also place limited value on them until a much later stage.

So you have ample opportunity to evaluate your decisions, without interference from outcomes.

Photo by Joël de Vriend on Unsplash

Be honest

In order for this exercise to be useful, you need to abide by one main rule:

  • Be brutally honest with yourself

There is absolutely no point doing this if you’re not going to be honest. All you will be doing in that case is kidding yourself and feeding your biases. The point is to learn from your past decisions, not to justify them. Without learning your future decisions won’t improve.

You might not be too impressed with yourself when realizing what the honest reason behind an investment decision was. And you might be even less impressed realizing there are structural biases to your approach. Acknowledging them is the first step however. Only then can the next step be to decide where to accept and keep them, try to attenuate them, or look to eradicate them.

Just because you have a bias or certain heuristic to your approach, doesn’t mean this is a bad thing per se. Again, we are dealing with limited information at this early stage. This is not a hard science.

My BHIDA

So what did I find when conducting my own BHIDA?

  • I place a lot of importance on the founder. Especially prior experience in the start-up world, and in particular ones that are a repeat founder
  • I am sensitive to who the co-investors are
  • A strong preference for clear, concise decks and convincing deal memos
  • I am affected by FOMO
  • I suffer from confirmation bias, and might be prone to making a decision first and then justifying it
  • My moods influence my likelihood to invest
  • I prefer earlier stage over later stage
  • And can be sensitive to valuation, whilst allowing myself to override that if I really like an idea
  • I do not place as much value on traction
  • And although I love to see signs of initial product market fit, I have invested in ideas without any hint thereof yet
  • I invest because I find something interesting, rather than for purely financial reasons
  • I value less, higher quality information over more, random or unsubstantiated information
  • A preference for big, ambitious, high risk ideas over incremental ideas
  • I set a higher bar for start-ups in areas that I (think I) know something about than ones in areas I don’t
  • Yet prefer to invest in areas of personal interest
  • And although I consider market size and whether an idea is truly venture scale, I should pay more attention to this

Analyzing your BHIDA

The above contains a range from clearly less desirable aspects (subject to FOMO, influenced by mood) to ones that are perfectly valid (importance of founder).

Some highlight a preference (earlier stage, risky ideas), which is perfectly fine. Whereas others are important to be more weary off (confirmation bias).

The sensitivity to who the co-investors are is one that’s both positive and negative. You should make your own investment decision and not be afraid to go against consensus. At the same time, having a strong, logical co-investor involved provides some comfort and validation. As well as an element of humbleness, a recognition of the fact that you might not have the same potential for access, insight and experience that others might have.

Combining these different insights and realizations leads to being able to form a picture of what my ideal investment opportunity looks like, as well as to an awareness of traps to avoid. I know now that I like 1) very early stage ideas, 2) from impressive founders, 3) with strong co-investors, 4) which ideally have some indication of traction / product market fit (but I’m willing to overlook it), 5) at a valuation which feels fair (without it providing a veto), 6) in an area that is of personal interest and that I’m keen to follow as it progresses.

BHIDA over time

In line with Elizabeth Yin’s comment, I look back on some of my very earliest investments and grimace. Wondering what I was thinking. It is however key again to realize that decisions at that point were made on very little comparative information. Something might have sounded good, but there was no comparison to make. No opportunity cost.

Two years in, and there are far more comparison points. Opportunities are no longer analyzed purely on their own merit, but also in relation to others. An idea that in the beginning might have sounded incredibly novel, since then might have seen several virtual identical, or better versions.

This again highlights the importance of getting started. Because no matter when you start, there will always be a beginning. (Insert thoughtful face here).

At the same time, it’s important to realize that even two years in, this is still a beginning. In five years time, you will likely look back on your first two years in the same way you’re currently looking back on your first few months. It is ever evolving and, if done right, ever improving. And accordingly your BHIDA will change over time as well. So this is definitely not a one time exercise.

To reiterate: Decisions NOT Outcomes

As mentioned, it is still too early to see what the actual outcomes are. Those grimace inducing initial investments might turn out to have the best outcomes ever. And those well-considered later decisions might turn out to be duds. That doesn’t take away that the decision making process involved might have been far superior for them. Focus on a system mindset, not an outcome mindset.

One word of warning. With an increased knowledge and experience comes a risk of overconfidence. As always, it’s important to know what you actually know and what you can know. Start-up investing is inherently steeped in uncertainty, that’s part of what makes it fun and exciting. Just because you’ve spent more time doing it doesn’t automatically mean you have all the answers. However, knowing how you arrive at your decisions means at least that you can stand fully behind them.

Links

I’ve written some posts about further resources, such as blogs, podcasts, and newsletters. Hopefully you’ll find them useful. If you have any suggestions for additional resources to be added, I’d love to hear about them in the comments.