by Luni Libes & Nobel Laureate Daniel Kahneman
Editor’s Note: This Advisor-X is presented in two parts. The first part is from the pen of Luni Libes, a 25+ year serial entrepreneur, a founder of six startups; and an Entrepreneur in Residence and instructor at Presidio Graduate School; and the University of Washington’s CoMotion. Luni is the author of The Next Step, a series of books and classes guiding entrepreneurs from idea to reality. He is also a blogger and an incessant answerer to entrepreneurs’ questions on Quora.
The second advisor provides validation of Yellow Flag Investing. He is Nobel Laureate, Daniel Kahneman.
In the public markets, “Yellow Flag Investing” goes by a different name: ‘multi-factor filtering’. The concept: Identify the common behavior traits or characteristics of underperforming companies and exclude those that have those traits – BEFORE you get emotionally attached. Objectivity is key.
Kahneman believes that evidence of voluntary transparency should be the first criteria investors look for, as it is possibly the most highly correlated criteria to potential success.
A few times per year I attend conferences full of fellow fund managers, managers of family offices, and big impact investors. The rest of the year I share investment opportunities multiple times per week with other investors.
From all these conversations, I’ve come to realize the power and benefits of running a business accelerator rather than a traditional venture capital fund.
From 10,000 feet away, we do the same job. We invest in young companies, providing capital to grow. But from 10 feet away the approaches are vastly different. And those differences boil down to what we do with flawed companies. A common, polite terms for flaws is “yellow flags”, so lets’ stick with that.
At an accelerator we expect yellow flags. We seek them out, and when we find them, we consider how hard they will be to fix.
At a fund (or family or individual), when you see a yellow flag, you pass, as there will be another company in the deal flow shortly.
We all agree most startups have yellow flags. This is why so few companies get funding. So if yellow flags are the norm, why is the norm from investors to say no, rather than to say “let me help you deal with that issue?”
That’s what we do at accelerators. I posit that’s why around 80% of accelerator graduates tend to still be in business five years later, vs. the general statistic of 50% gone after three years.
If nothing else, it makes us a lot less surprised when an unforeseen yellow flag appears a year after investing, as accelerators who invest in their startups expect to continue helping our graduates for years, as it takes years to succeed.In this mindset, we get to say “yes” to a lot more startups, rather than defaulting to “no.” And that makes for a much more satisfying life.
Optimism is the engine of capitalism. Yet overconfidence is both a blessing and a curse. The people who make great things, if you look back, were overconfident and optimistic — overconfident optimists. They took big risks because they underestimated how big the risks were. They trusted their intuition even when they were wrong.
Kahneman proposes four simple strategies for better decision making that can be applied to both finance and life.
1. Don’t Trust People, Trust Algorithms
Whether it’s predicting parole violators and bail jumpers or who will succeed as a research analyst, algorithms tend to be preferable to independent human judgment.
“Algorithms beat individuals about half the time. And they match individuals about half time,” Kahneman says. “There are very few examples of people outperforming algorithms in making predictive judgments. So when there’s the possibility of using an algorithm, people should use it. We have the idea that it is very complicated to design an algorithm. An algorithm is a rule. You can just construct rules.”
And when we can’t use an algorithm, we should train people to simulate one.
“Train people in a way of thinking and in a way of approaching problems that will impose uniformity,” he said.
2. Take the Broad View
Don’t view each problem in isolation.
“The single best advice we have in framing is broad framing,” he said. “See the decision as a member of a class of decisions that you’ll probably have to take.”
3. Test for Regret
“Regret is probably the greatest enemy of good decision making in personal finance,” Kahneman said.
For example, the more potential for regret, the more likely personal finance clients are to churn their accounts, sell at the wrong time, and buy when prices are high. High-net-worth individuals are especially risk-averse, he said.
4. Seek Out Good Advice
Part of getting a wide-ranging perspective is to cultivate curiosity and to seek out guidance.
So who is the ideal adviser? A person who likes you and doesn’t care about your feelings. [24×7]