Ask yourself, “Is there really any difference between an Investor and a Gambler?” They both participate in high risk activities that require a sum of money for entry and could result in great winnings or losses. Venture Capitalism is inherently high risk due to the early stage at which they invest. Though gambling and investing is similar on the surface, one of the defining differences is clarified by Peter Lynch: “An investment is simply a gamble in which you've managed to tilt the odds in your favor.”
An investor’s goal should be to find companies and take appropriate actions that place the odds of success in their favor. This is easier said than done in the fast paced world of early stage investing. Venture capitalist can be placed under a lot of pressure from investors, managers, and colleagues to win big. If a venture capitalist doesn’t have a code to abide by, they will most likely make mistakes and create unnecessary risk. Whether a venture capitalist is gambler or an investor is based on how well they can follow their strategy. To avoid becoming a gambler, an investor must understand the probabilities paradox, the importance of consistency, have intellectual conflict, and have the ability to control fears.
The Probabilities Paradox
It is fitting that we are based in Las Vegas, which is known as the gambling capital of America. Casinos understand probabilities more than anyone. “What casino owners, experienced gamblers, and the best traders understand, that the typical trader finds difficult to grasp is: even probable outcomes can produce consistent results, if you can get the odds in your favor and there is a large enough sample size.” (Trading in the Zone, Douglas) Basically, you can receive a consistent result, even if the outcome is based on chance. Casinos create this consistency by requiring players to follow the rules of play. These rules are created to place the odds in favor of the house.
Likewise, in venture capital we can follow this same model. All venture capital firms should establish a set of rules or a strategy that they themselves and the companies they evaluate must follow in order to advance into an investment. The only purpose of these rules should be to increase the odds in favor of the company and the VC firm. These rules, over a large enough sample size, will generate consistent results. Examples of these rules include a well-defined due diligence process and a specific minimum and maximum dollar amount allowed per investment.
Of course, none of this matters without consistency in following the rules. A good ethos to live by is to not make anyone an exception to the rules. Once an investor does this, they become a gambler. For example, if a VC firm does not follow their established due diligence program in the same way for each company they are investigating, they will expose themselves to increased risk and the odds will no longer be on their side. The same is true for exceeding their investment dollar range for a deal that seems too good to not take a bigger stake in the company. It can be really attractive to overspend on a ‘home-run’, but when you stray from your firm’s strategy, you become a gambler. The goal shouldn’t be to get a home-run. The goal should be to let the odds do the work you over your entire portfolio. Do not make anyone the exception to the rules!
Have Intellectual Conflict
A key for being consistent is to be objective. This doesn’t mean that your whole team is going to agree when a company pitches and an investment decision must be made. This is due to the inherent diversity of experience and beliefs in each investor. They can still be objective, as long as they base their opinions and evaluations on fact, instead of feelings or prejudice. Having diversity in a firm can be a huge asset to a VC Firm if utilized effectively.
This diversity will almost always mean that decisions will not be unanimous. Chamath Palihapitiya, Founder of VC Firm, Social Capital, has stated that his firm’s best investments came when everyone didn’t agree. He now strives for this dynamic in every team. He calls this dynamic “intellectual conflict”. He believes that It is important with early stage investing to live in a world of ambiguity. A firm’s returns will start to dwindle when there is not enough diversity and too much consensus. A firm can have intellectual conflict by inviting diversity and applying objectivity, thus exposing themselves to greater breadth of opportunities.
Fear is the arch nemesis of consistency in investing. The most common fears that investors combat is the fear of being wrong, the fear of losing money, the fear of missing out, and the fear of leaving money on the table. Each one of these is extremely common and will cause any investor to stray from their guidelines and become a gambler. An investor will never be able place the odds in their favor if they give heed to their fears. Here are some examples of these fears influencing an investor’s actions:
Fear of Being Wrong: Performing too much Due Diligence.
-This can make the company disinterested in receiving you as one of their investors and can cause you to lose the deal.
Fear of Losing Money: Not investing in a high enough number of companies.
-Every company carries risk when investing. Out of fear of losing money, an investor might not invest in a large enough number of companies. If this happens, the odds that an investor tries to gain are less likely to make an effect on a firm’s portfolio.
Fear of Missing Out: Investing without doing proper due diligence.
-Something I have recognized in all of my decision making is that I almost always make a mistake when I am pushing or rushing a decision. Don’t place unnecessary risk in your portfolio by making a company an exception to the rules. Play the long game and let the odds given to you by your guidelines do the work.
Fear of Leaving Money on the Table: Investing too much money.
-Establish clear boundaries on your investment amounts per company per round. The capital that a firm has is limited. This capital must be divided in order to distribute risk. Look for companies that would be compatible with your investment boundaries.
An investor should constantly evaluate themselves and guide themselves back to their team’s rules in order to find consistent success.
An investor can have success with gambler’s mentality, but the results are based on chance. The results are less in control of the investor. They just are hoping to get lucky. A smart investment firm can have consistent results, by consistently placing the odds in their favor. Basically, don’t be the gambler, be the casino. In addition, surround yourself with diversity and do not let your fears influence your actions. All of these things will lead to consistent returns in your portfolio.
About the Author
Justin Tran is a Mechanical Engineering student at the University of Nevada, Las Vegas. Justin is also the VP of the UNLV Formula SAE Electric team. Previously, Justin served a two-year, church mission, where he spent most of his time in leadership and training roles. Most recently, Justin founded Preserve a Mission, an online email to book service for return missionaries, which he exited last year. He has also been working for K2 Energy Solutions, a leading lithium battery company, as a mechanical engineering intern.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of RVF or UNLV. In addition, thoughts and opinions are subject to change and this article is intended to provide an opinion of the author at the time of writing this article. All data and information is for informational purposes only.