How investors *really* make decisions

During my time as an M&A adviser, I began to notice a strange pattern.

Investors would say one thing, but what really influenced their decisions was something completely different.

And I see the same thing happening in startup fundraising.

In fact, it's even more important during early stages than it is at exit.

3 min read

Selling Scaleups to Corporates

During 2017-2019 I worked at BDO, helping founders that had successfully scaled their company and were ready to exit - either to private equity or a big player in their industry.

The investors and acquirers I dealt with were very experienced - and very corporate.

When the time came for management presentations, I'd help my clients (the founders) prepare by asking them difficult questions - the areas I knew would be challenging for them to answer.

The investors would always pick up on the weaknesses and ask probing questions.

This never surprised me.

What did surprise me was an unusually effective type of answer.

Anecdotal Evidence

There was one founder in particular, Dean, who was best at this - and I have him to thank for spotting this pattern.

When he was asked a difficult question, he'd begin his answer with a story. 

I would shuffle uncomfortably in my seat, thinking about which excel file I could put on screen to get to what the investor really wanted to know.

But Dean was a brilliant storyteller.  He drew the investors in with an anecdote, bringing it to life with the names of his staff or an example of a great result they delivered for a client.

The investors nodded along.

Dean would round off the story with a direct answer to the question - which was already obvious by this point, but it helped to emphasise it.

And then he'd refer to a table or a chart that backed it up.

And the investors lapped it up.

What they Ask vs What they Want

What puzzled me was that the investors would always ask for data in their question.

The obvious response would be to dive straight into numbers and analysis.

But this would often lead to more questions.

These investors were trained to pull apart analysis, no matter how solid it was.

But a story was like a blind spot - and they didn't realise it.

It was like a story could not be disputed or argued with.  They believed it, and when showed data that backed it up, they were 100% convinced.

Thinking, Fast and Slow

I began to learn the power of the anecdote, but it was some time before I really understood why stories had such an effect.

And then I heard about Daniel Kahneman and his Nobel prize-winning work on decision-making.

As detailed in his book 'Thinking, Fast and Slow' our brains are wired to think in two very different ways:

System 1 = fast, emotional, gut feel.

System 2 = slow, logical, rational.

We tend to make decisions quickly with System 1 (whether we are aware of it or not) and then seek to validate it with System 2.

Scientific research has proven this many times in many different scenarios.

A Stanford study specifically looked at investment decisions, and it showed that the emotional centres in investors' brains (System 1) lit up before the pre-frontal cortex, which is responsible for complex cognition (System 2).

Fundraising Success

To get the best result in a fundraise you need to know how to target each system effectively, and in the right order.

Investment decisions start with System 1.

It's why VCs skim a pitch deck in 3 minutes and how they can decide so quickly.

If it feels like a good opportunity, the investor then looks for signs that validate their first impression: traction, team, market opportunity etc.

This is why storytelling is so important: it is a System 1 shortcut.

The greatest founders and VCs all know this:

The Bottom Line

If you understand investor psychology you'll be able to create the excitement and desire that pushes a fundraise to a successful close.

This is one of the ways I help founders design their fundraises to get multiple term sheets and close rounds quickly.

If you're raising soon, feel free to get in touch.