PsychTech

How often do you think you make decisions on a daily basis? It’s likely more often than we think. Where you want to go for lunch, what movie you want to see, whether you should get the complementary Parmesan cheese added to your soup or entree at Olive Garden. All of these are harmless decisions that require very minimal negotiating. But what happens if you’re in a situation where negotiating is a must, such as negotiating the price of the car you like or a bump in salary? For negotiations that involve a quantifiable amount, it’s a different story.

When it comes to negotiating, whether it be salary or the nice car at the dealership, it’s commonly said that you should never give the first number. Other times, it’s said that you should give the first number to set the range. In either scenario, when the first number is given, it sets the stage for a cognitive bias known as the anchoring effect. This causes people to rely too heavily on the first piece of information that’s given. Once that detail is acknowledged, all discussions tend to center around it. This is most evident in situations where people don’t have the right amount of context or knowledge around that piece of information (e.g., not knowing the average price for the car you like or how much your current role is actually paying). Like most other cognitive biases, the anchoring effect occurs across almost all kinds of situations.

For early-stage startup founders, or even people thinking of starting a company, looking at certain metrics can take you down the wrong path. If you’re researching the Total Addressable Market and you see that the number is eye-popping, it doesn’t mean you’ve found a potential market. Not at all. Being tempted by a metric like this is a prime example of being hooked in by the anchoring effect – seeing this piece of information dictating your future thoughts around whether you have a viable market for your product or service. That’s why you research the Serviceable Available Market and Serviceable Obtainable Market to get a better idea.

From the investing side, it’s easy to fall in love with a startup if you hear that the team worked at a Big Tech company or the startup is backed by a big-name VC firm. Although those things have merit and can be used as possible screeners when looking for companies to put capital in, it doesn’t guarantee that the startup will make it out alive. That’s why due diligence is so important and a critical part of how VC firms make their returns. Basically those who don’t get tied down by a tempting statistic or fact are those who survive longer.

Next time you’re negotiating or deciding between two options, always keep everything in mind. Never base your choice on the first piece of information you hear – that’s only one piece of the puzzle. Research how much that car is worth or how much your role is really worth. Conducting proper due diligence can pretty much cure this, whether it’s an everyday occurence or something big like deciding whether to invest in a company or not. As long as you’re aware of the anchoring effect, you’re one step closer to making a much smarter bet.

We’ve all been both a victim and a perpetrator of this. Parents use reverse psychology to get their kids to eat their veggies. Kids would use it to get out of being yelled at for that one bad test grade. The slogan behind Lay’s chips is based on this idea. Why does it work so well, even when we know what’s happening?

The idea behind reverse psychology lies in the concept known as Reactance Bias. If a parent tells their child to eat their veggies, and the child doesn’t enjoy eating veggies, that child is going to resist doing so, at least initially. To the child, it seems like the freedom to not eat those veggies is being taken away from them by their parents since they no longer have a choice. Here, the parents’ stance is that eating veggies is essential, whereas the child’s stance is that eating veggies is the worst thing in the world. When it comes down to it, when someone feels pressured to do something they don’t want to do, it can cause them to become more firm in their stance – hence why the child resists eating those veggies.

This is why reverse psychology exists. Rather than restricting a person’s freedom to do something or not, you enable them to choose the option you want them to in order to get what you want. This can often be performed without either party realizing it.

This can be seen in the startup world as well. When a venture-backed founder meets with their board, everyone is sure to agree on some things, but there may be certain items on the agenda where disagreements are sure to arise. This is especially true on items that require a vote, such as issuing new shares, bringing in a new board member, or discussing a potential exit. If the founder sees things one way, and the board another, how do they all come to a conclusion? Of course talking it out and compromising may happen, but if one party is firm in their stance, what do you do?

The worst thing a founder or board member can do is to take the opposite stance just for the fun of it. It’s important when it comes to big decisions not to lose objectivity when someone is forcing you to do something. If you don’t like someone, don’t take the opposite view of them just to spite them. You may end up only hurting yourself or worse, the company. Like with all other cognitive biases, keeping your head clear of emotion or irrational behaviors is the key to preventing Reactance Bias from occurring.

In 1995, a man by the name of McArthur Wheeler thought of a brilliant idea: he was going to rob a bank. When he pulled up to the bank, he showed up with a gun and no mask and demanded the money. He then escaped, thinking he was going to get away with this plan. He was caught hours later. When he asked how they were able to identify him, they simply pointed to the fact that he wasn’t wearing a mask. Obviously, Wheeler was aware of that. What he wasn’t aware of was that he had thought that the lemon juice he had covered his face with would make him invisible to the cameras. Read that sentence again – this is not a joke. Because he had seen that lemon juice could be used as invisible ink, his thought process was that this could chemically transfer over to his face and make him invisible. Imagine the reaction from the officers who interrogated him.

Now had Mr. Wheeler actually done his research – and paid attention in chemistry class – he would have known that him covering his face in lemon juice was completely trivial. And yet, we see this concept all the time – we’re all guilty of it from time to time. This concept, known as the Dunning-Kruger Effect, occurs when people think their cognitive ability is greater than what it really is. This explains why the arrogant person you know talks about a topic they think they know more than anyone else.

What causes this effect? For the most part, it’s really a lack of self-awareness and metacognition – the ability for you to analyze your own thoughts. People who start learning something and think they know enough to proclaim themselves as ‘experts’ are really the ones who are blinded by this effect. The paradox behind this is that you don’t become aware of how little you know something until you’ve learned enough about it. When you have low self-awareness and you combine that with having a lower cognitive ability in a certain area, it leads you to believe you know more about something than you really do. The thing to note here is that this isn’t limited to just a certain group of people – almost everyone from every industry can become a victim.

When you start out as an investor of say stocks, and you buy a few shares of a stock that suddenly skyrockets in share price, you either tend to think beginner’s luck or you really know what you’re doing. For those in the latter mindset, that’s a dangerous game. Your ego starts to swell and you think you know more than you really do. You buy all kinds of stocks at all kinds of prices and then what the market shows you its true face, you’re left with a lot of questions and not a lot of money. It explains why people who have been in their sector for a long time don’t really get overconfident – they know what they don’t know and their confidence matches more realistic levels.

As a founder or venture capitalist, you have to really be aware of the Dunning-Kruger Effect. When you first start a company, it helps to always be paranoid. Knowing that market trends could change, who your competitors are, and whether you have a real product-market fit are all key indicators of whether a founder should know whether to pivot or continue to right the ship. Those who can’t see a clear vision and picture of what they’re trying to do are usually the ones who end up going bust. The same can be applied to VCs too. It’s why conducting due diligence is one of the most critical tasks and those who do it well last longer than other firms. Knowing your metrics, your sector, and the market will allow you to appropriately keep your ego in check when deciding who to invest in or what market to start a company in.

Chances are that you’ve been in a situation where you thought you knew more than you actually did. It’s not a bad thing initially, but improving your self-awareness and analyzing your thoughts as you go will help reduce your chances of being that person who knows more than they think. Whether you’re a startup founder, an investor, or anyone else, the message here is simple: never think you know more than you think.

The great thing about society is that even though every one of us differs in one way or another, we still have certain psychological tendencies we fall for. These cognitive biases tend to rule our everyday thinking whether we know it or not. It doesn’t matter what industry you work in or what your background is like – we all share these tendencies. One such tendency is known as the ‘Sunk Cost Fallacy’.

Picture yourself buying a ticket for a movie you’ve been eager to see. You checked out the ratings and they’re decent, not spectacular. Then, you get to your seat and the movie begins. However, you realize about 30 minutes in that the movie is terrible and that you can’t stand being there any longer. But then you remember that you paid for the ticket and you can’t get a refund for it. The rational decision here would be to cut your losses and get out of the movie theater before you waste another second. Humans aren’t always rational though, so you decide to watch the whole movie and complain all the way home.

This perfectly describes the concept behind the Sunk Cost Fallacy. There’s a cost that has already been deducted and that cost can’t be recovered. Even though this investment turned out terribly, you wait out and hope that the movie improves over time, which rarely happens. Now replace this with other scenarios and you’ll understand why this is such a universal occurrence – eating the entire plate of food at a restaurant when you’re already full or continuing to date someone you’re not compatible with. People don’t usually know when to cut their losses; they base their current choices on past mistakes.

In the financial world, especially in venture funding, the Sunk Cost Fallacy can mean the death of a firm. When an investment initially seems like it might be a home run, but the startup begins to go south, the irrational thing to do is to put more money behind it. This is known as “throwing good money after bad” and usually results in a worse return than cutting your losses. It’s one of the worst things you can do as an investor, almost like a cardinal sin. To fix this, you need to be disciplined, unbiased, and you may need the perspectives of several others so you don’t get in your own way. Don’t base these decisions on past mistakes and cut out the investments that aren’t working.

As a startup SCF can be similar to not knowing when to pivot. If you’re working on what you think is a great solution for a problem, but the market thinks otherwise, you need to stop what you’re doing and immediately think about your next steps. A lot of the times, founders become emotionally rather than financially invested and that’s what can hold them back. By being objective and simply looking at the signs, the decision usually becomes more clear. Knowing when to pivot is just as critical to a startup as the product itself since time is your most valuable asset, though it’s usually not on your side.

Sunk Cost Fallacy is harder to overcome than it seems. It wouldn’t be a common cognitive bias if it wasn’t. By taking emotions out of the decision-making process and focusing on the objective side of things, it does get a little easier. Just because you’ve already invested in something that didn’t pan out doesn’t mean you show throw more into it. Don’t let past mistakes influence your current choices. So next time you go to a terrible movie or can’t finish your plate, just leave it and call it a day.

“What Nike did for exercise, what Whole Foods did for organic foods, we want to do for sleep.” ~ Philip Krim, CEO of Casper

Overview

As a part of the direct-to-consumer model family that’s been disrupting nearly every industry, Casper, to put it simply, delivers comfortable mattresses directly to the end user. In addition to mattresses, they also sell other sleep products online, such as pillows, bed frames, bedding accessories, and other gifts. Launched in 2014 by founders Philip Krim (now CEO), Neil Parikh, T. Luke Sherwin, Jeff Chapin, and Gabriel Flateman, Casper later filed their S-1 in January 2020 and went public on February 6 of 2020 after raising close to $340 million all the way through a Series D round.

Stats

Here are some stats that best represent Casper’s growth:

• Gross margin has risen from 42.8% in 2016 to 47.9% in the last 4 quarters
• Returns made up 15.4% of gross sales in 2017, 18.4% in 2018, and 20.4% in the first three quarters of 2019
• 48 stores opened with plans to get to 200; it generates $1600 in revenue per square foot
• Grew 12% in revenue 2018 from $229 million to $259 million
• There is only a 16% repurchase rate and a 14% first-year repurchase rate – this means only 2% of customers end up purchasing from Casper after a year has passed

Differentiators

The good thing about Casper is that it currently holds the majority of the market share when it comes to D2C ecommerce. The reason Casper has been able to position itself as well as it has is because of both the lack of innovation with the more traditional retailers and manufacturers (Mattress Firm, Tempur-Pedic, etc) and that it was an early player in the ecommerce movement (although they are opening up more and more physical stores). In addition to this, Casper has been able to go past just selling mattresses and into other categories of sleep, which has allowed it to expand its revenue streams. By being in a market where repurchases on mattresses are extremely low, having multiple other products helps vastly.

Funding / S1 Info

Basic Fundraising / IPO Timeline:

• January 2014 – Raised $1.85 million in its first round of funding
• April 2014 – Casper officially launches
• August 2014 – $13.1 million in series A raised
• June 2015 – $55 million in Series B raised
• June 2017 – $170 million in Series C raised
• Early 2019 – $100 million in Series D raised; valued at $1.1 billion
• January 2020 – Casper files S-1 with SEC with intent to go public
• February 6, 2020 – IPOs at $12/share with market value of $476 million

Reasons to Worry

Casper is a great example of a market leader in a bad industry. In an industry where repurchases of the same product don’t happen for several years at a time, it can be tough to generate a significant amount of revenue over a long period of time. Even though Casper does diversify when it comes to its products and partnerships, it seems like that may be the best way to sustain its current position. Another thing to point out is that Casper continues to the trend of being a big-name brand that isn’t profitable but has decided to become public anyway. The market, like it’s done with previous companies in this position, has brought the sleep company back to earth – Casper started with a $1.1 billion market valuation before the IPO, and after the end of the first day, the stock went from $14.50 a share to around $13.50. The valuation also went down to less than $500 million, more than half of what it was originally valued at before ringing the bell.

Conclusion

Like many of the other companies in this position, I remain skeptical about the future of Casper from a performance standpoint. It’s extremely difficult to sell mattresses, so relying on other products and partnerships with other retailers is going to be a heavy focus. The good thing is that Casper is just innovative enough to leap ahead of the traditional retailers and manufacturers and carve out its own path. However, the lack of profitability is something that the public investors don’t like and hence it’s lackluster IPO. It will be interesting to see how Casper performs one year from today, but based on current standings and the market they play in, it will be difficult to keep up their pace.

In almost everything I do, I’ve found that giving something and adding value is often more rewarding then getting something. Whether it’s spontaneously giving my team donuts (which actually wasn’t my idea) as a sign of appreciation or giving time to my family when I can, I find it to be a very satisfying way of living. I’ve tried to apply this thinking in my past and hope to continue doing so in the future.

In the VC world, adding value is pretty much the most important thing you can do. Outside of providing capital to founders of promising startups, it’s everything else you can give that sets you apart from other investors. This article here shows that VCs see things like helping obtain additional financing, strategic planning, and recruiting the best management as some of the top services they can add to portfolio companies. Of course, there are other ways to be seen as a value-add VC and not just someone who cuts the check.

For some of the investors who have been in the industry for a while, there are three things they can give that provide the greatest value: experience, expertise, and time. Seasoned investors are known for being able to “recognize patterns” after dealing with numerous startups and learning from experience. They’re able to see the big picture that founders and CEOs don’t see because they’re so focused on righting their ships. This kind of experience is absolutely valuable to companies because it can lead to quicker growth with fewer mistakes being made. Having expertise in the same sector that a portfolio company is in is also a great value add because they’re able to spot market trends in ways that founders may not. Finally, when an investor gives their time to the founder, it shows that they’re all in with them. It has to feel great to a founder when they know that their investor, who happens to be extremely busy, is using their time to provide help, guidance, and advice to the founder when they could be doing so many other things.

Another way of looking at this is through the idea of Intellectual Capital and Relationship Capital, as this article states. Essentially, in addition to financial capital, most of what an investor can provide falls into one of two buckets: 1) Intellectual Capital, where experience, expertise, and guidance play a role, and 2) Relationship Capital, where founders can rely on the investors’ deep network. Investors usually know other investors or industry leaders who may be willing to help out the startup in terms of securing additional financing or hiring a great person with experience as part of the executive team. This is a great way to look at it as well since it clears up what an investor could best be doing to help out portfolio companies.

Lastly, there’s the concept of being on the board of an invested startup. In addition to the previously mentioned methods of adding value, having a seat on the board is a privilege and one of the greatest positions an investor can have. Mike Volpi’s article on the art of board membership lays this out quite well. It all comes down to your relationship with the founder, the network you can provide founders and CEOs, being available for them, and more. Being an individual that they can rely on in good times and bad, from strategy decisions and recruiting to everything in between, is absolutely valuable in helping the company grow while continuing to have the shareholders’ best interests in mind.

Really what this comes down to is how investors can find ways to contribute to the greater good. It doesn’t matter how grand the gesture or how impactful the action – if you are an investor and you’ve found a way to be there for a CEO, you’ve done a great job in adding value. It has to be one of the most rewarding aspects of being an investor, and something I look forward to doing myself.

One of the goals I set for myself this year was to become better at learning how to learn. There is an enormous amount of information that people come across on a daily basis, and we only remember a small percentage of that. Of that percentage that we remember, we can only recall yet an even smaller percentage. It’s unfortunately a highly inefficient process, which is one of the reasons I decided to tackle this goal.

I’ve always seen learning as more of a framework and not as a chore or something that you stop doing once you throw your graduation cap in the air. Whether it’s a skill needed to boost your professional life or learning an instrument, learning something helps keep me fresh and cognizant of the fact there is so much out there in the world and that we should strive to take advantage of the opportunities given to us to change the way we think about things. Because of this thinking, I realized that the only way to get better at anything I put my focus on is to figure out how to learn smarter and not harder.

Barbara Oakley, an engineering professor at Oakland University and McMaster University, published a book on how to excel at learning new concepts. Although her book A Mind for Numbers focuses on how to learn tough new concepts in math and science, the principles and ideas she explains so thoroughly can be applied to any subject. It really opened my eyes into the way I was learning before and how a few tweaks can help me learn significantly more efficiently. I enjoyed it so much that I went ahead and took her course on Coursera – one of the most popular courses to date on the MOOC platform.

I’m not going to spoil the book or the course, but I will say that they have altered the way I look at learning. Even though I said previously that I see learning as a framework, it was only after going through Professor Oakley’s work that I truly gained a much better perspective on learning in general. From the different types of thinking and battling procrastination to understanding how to chunk concepts together while enhancing your memory through recall, this is undoubtedly one of the goals I’ve undergone that will benefit me over the course of my life.

How does this apply to startups or VC? Well in both, you have so much to learn in such a small amount of time. Not learning the right information or not learning at a high and efficient rate can be the difference between you being a market leader and you being forced to watch others be a market leader. When building a startup, there are numerous things you have to learn that come from doing things yourself. That helps when you need to store things in your long-term memory for later use. As for VCs, learning how to learn comes in handy when performing due diligence on companies, whether it’s investigating the market or understanding a new piece of technology. Even learning how to do cap tables involves certain learning strategies that make it easier to perform these kinds of quick financial calculations.

If there’s one goal a lot of people should aim towards, it would have to be improving the way they learn. By doing that, you become better at picking up unfamiliar concepts at a much faster rate, which leads to bigger and better rewards much more quickly. This is something that will take time to learn, but the payoff is absolutely worth more than its weight in gold. Or information.

If you went up to any Venture Capitalist and asked what the bloodline of a VC firm is, almost all of them will almost immediately respond with “Deal Flow”. Your ability to generate and maintain a pipeline of startups that look promising from an investment perspective is actually what will make or break you as a venture capitalist. While you’re creating this pipeline, there’s another important piece of the puzzle investors need to make a decision on whether to invest: due diligence.

The ability to gather as much data on the startup of interest is a necessary minimum for any VC. What really matters on top of that is identifying the metrics and angles that define startups, along with having an intuition around the key items you can’t measure, like the team or the culture. All of this can only come from experience and from actually being on the front lines and looking for startups worthy of being sourced. During my brief experience of sourcing startups, I’ve been able to refine my due diligence process (both from experience and from reading articles like the ones below). There’s still a lot to learn here and the work is almost never over, but having a framework in place helps me make the most use of not only my time, but the founders’ as well.

Of course, all of this depends on factors such as what stage you’re investing in, the sector, and your investment thesis. For now, my framework is based on Pre-Seed / Seed stage companies with a sector-agnostic approach. Below is how I normally begin the due diligence process once I’ve found a promising startup:

Initial Diligence

After reaching out to the founder and asking to meet to learn more about their company, I usually jot down some notes to get a better understanding of the company’s overview, team background, website, and funding history. This gives me a good sense of the company’s health and standing so that when I meet with the founder, I can immediately take all of that info I’ve looked into and hit the ground running. The last thing I’d want to do is ask the founder questions that could have easily been looked up. Their time is just as valuable and shouldn’t be wasted.

First Founder Meeting

When I first meet with the founder, I try to establish some sort of connection right away. Usually these meetings can be difficult to maneuver in my experience unless you show you can relate to the founder in one way or another. After the nerves die down, I tend to ask questions around things like the origin of the idea for their startup, what the problem is that their solution can solve, funding requirements, and other things around the product and what people currently do that warrants them to use their product or service instead. One key thing I’ve noticed is that if users currently use a spreadsheet to accomplish something, there’s a good chance that there’s a need for software to address it instead. This meeting also helps me gauge what kind of personality the founder has and if I think they’re capable of scaling the startup down the road. Asking about the team is important, as it’s an indicator of a major strength or weakness of the company. At the end, I usually request to see their investor deck and if they have it, they’ll send it over for me to review.

Post-Meet Diligence

After meeting with the founder, I review the pitch deck if they sent it over. This provides a ton of valuable info that lets me see not only the overview of the company, but also the broader overall market, competitors, financing needs, and more. I also take this time to perform further diligence on things like the pros and cons of investing in the company including risk analysis, market trends, competition, and so on. That way, when it comes time to meeting with my Principal and the rest of the team, I’m able to comfortably pitch these startups and explain my thought process behind why we should pass on, postpone, or invest in the company.

At the end, I put together a short deal summary that allows me to gain a simpler but overall view of the company I’ve sourced. This includes things like a description, amount of capital they’re looking for, why we should invest, risks, and what the fund can do to help add value to the company. If the team I pitch to is interested in the company, there will be further due diligence on my end around the market, the business model, and other factors to make it easier to determine whether the startup is a viable candidate for investment.

Having done this for several companies now has allowed me to gain a better appreciation for what it really takes to become an Associate at a VC firm. The amount of work, research, and time put in to identify, source, and weed out potential companies looking for investments has made me more appreciative of all parties involved and what it really takes to succeed in an industry like this. Only through continuous tweaking and improvements in how I perform due diligence on companies will I be able to truly provide value to both firms and companies alike.

Back in the era of the caveman, life was basically eat or be eaten. Nothing else mattered – no waking up and driving to work, no taxes, no boring baby showers to go to. Early humans had one of three roles: the hunter, the gatherer, or the prey. It was soon understood that in order to survive as a species, they would have to rely on one another and stick to groups. They eventually began to collectively share the same beliefs, behaviors, and morals that allowed them to thrive in an uncertain time period.

Fast forward to today, and things are just as different as they are the same. If you peek inside a high school, you can see different kinds of groups in the halls and in the cafeteria. Each group has a fundamental value, belief, or other commonality that roots the members together. Whether that’s done naturally or to fit in may vary among each group but the concept is the same nonetheless – the tendency to conform is all around us.

Conforming to a group often means shifting your attitudes or beliefs or behaviors to fit into the group. Conformity can be both a good and bad thing. With the cavemen, the ability to sync on fundamental values, like survival, producing offspring, and avoiding predators allowed conformity to benefit everyone. On the other hand, conformity may not always be the best hand to play. As teenagers know best, peer pressure is alive and well and often times they will agree to something they don’t want to do just to fit in – a type of conformity known as Compliance. By doing this, they conform in order to avoid standing out and potentially become a target of ridicule.

Conformity often happens in startups as well. If a founder often touts about how great their company is and how well they’re doing, the employees often end up drinking the Kool-Aid because they happen to be part of the same tribe. If an employee objectively looks at the startup and understands the market they’re in, the competitors, and risks and sees things to be worried about, they will still conform even the company isn’t as strong as they think they are. If the executive team is meeting with the CEO and he or she says something that the team may not agree with, there’s a good chance the team will simply appease the head honcho to avoid conflict or disagreement (they probably shouldn’t be on the executive team then). This kind of groupthink, even if the members are consciously against it, can be the death of a startup.

That’s why most VC firms have some sort of process in place against this from the bottom up. An Associate may find what they think is a diamond in the rough and report it to their managing Principal. If the Principal is on board, it may go to a committee and then up to the GPs who cut the checks. By letting the system operate like this, the GPs not only have the final say, but can look for holes that the Partners and Associates might have overlooked. The danger here then lies in the possibility that the GP doesn’t feel as strongly as others on a startup and passes on them. The Partners / Associates have no choice but to follow along. Firms that incorporate some sort of “unanimous vote” system usually can either make or break the system.

Where it gets sticky is when VC firms realize that a big firm is investing in a particular startup. “Oh, if they’re investing in this startup, we’ve got to get in on it too.” The Halo Effect that these other firms seem to be blinded by can be quite strong if GPs don’t take the rational route and think these things through.

All in all, cavemen may not differ so much from high school kids or VC firms. We’re all human, and deep down we all have a need to be accepted somewhere even if we don’t see it that way. Whether you’re in the US where an individualistic sense of living rules or somewhere in Asia where collectivist thoughts tend to govern everyday life, conformity is simply a hidden layer in our lives that we must be aware of at all times.