Dangers of the Halo Effect

Why is it that founders who begin to raise capital tend to look at trying to get the attention of VC firms who have had one or two big home runs under their belt? Why is it that Venture Capitalists who see a startup led by someone who worked at a big tech company begin to salivate? What about when you meet someone attractive and think they also display other positive qualities without you having known that person? These questions all point to one answer: the Halo Effect.

This form of cognitive bias occurs when a positive impression of one quality in a person tends to radiate towards other qualities of theirs. If you see someone who seems nice and charming, for example, you may also think they’re intelligent and funny among other things. The opposite also tends to be true – if you see someone who might be less attractive, you might also think they’re impolite, rude, or possess several other negative qualities (this is known as the horn effect). These concepts are something that we can’t normally control, and is thus something we need to keep ourselves aware of when meeting people.

The Halo Effect can be seen in nearly every facet of everyday life. In school, studies have shown that teachers tend to have higher expectations of intelligent students in the classroom because they’re viewed more favorably. When you watch a commercial that has your favorite athlete or celebrity, you tend to transfer some of their well known qualities over to the product or service they’re selling. When you’re at work, it’s not uncommon to see certain people be promoted or get a raise based on their likability rather than for being able to deliver results consistently or work longer hours than others.

Startup founders and Venture Capitalists are no exception. In fact, it’s been shown that founders with company alma maters such as Google, Facebook, and other big tech companies tend to have a higher pre-money valuation for their startups than those who have a background outside of big tech. This is likely due to the fact that VCs think that if a founder has prior experience in an innovative and global tech company, they can likely translate that to their own startup and thus become more successful in a shorter amount of time. Now this isn’t true the majority of the time, but it does provide some sort of shortcut that allows VCs to filter through which teams can make a startup successful and which teams can’t.

On the flip side, founders who are keeping a list of VCs in mind for when the time comes to raise capital certainly have a list of firms to watch for. Imagine how many startups knock on the doors of Andreessen Horowitz, Union Square Ventures, and some of the other well known firms. Their big investments that have paid off many times over have resulted in a large amount of inbound deal flow and even a network effect where they have the luxury to have companies pitch to them rather than the other way around. It’s how firms like Accel Partners and Greylock partners are able to benefit from investing in Facebook.

Just because a founder or VC firm had a successful exit or investment pay off many times over doesn’t mean it can be replicated again. It simply improves the chances of doing so. That is the danger with the Halo Effect in the startup world – associating a single event or outcome to other things that may not guarantee the same outcome later on. If you’re a founder of a startup, you still have to identify the appropriate VC firms that can best help your company grow and scale, even if that means not going for one of the more well known firms. For VCs, it’s still critical to perform due diligence, identify credible references, and assess risks and rewards without putting on rose-colored glasses. Being aware of this can greatly help reduce bias associated with the Halo Effect.