COGNITIVE BIAS

If you’re skeptical about how powerful this bias can be, just look at WeWork’s 2019 IPO disaster (Visual Capitalist). Early investors anchored their expectations to an eye-watering $47 billion valuation. But when public scrutiny exposed the company’s shaky fundamentals—unrealistic growth plans, corporate governance issues, and huge losses—the bubble burst.

This isn’t just a cautionary tale; it’s a clear example of how anchoring bias can cloud judgment and lead to overvaluations, particularly in the high-growth, hype-driven tech sector.

Anchoring bias can lead to „overinvestment in fading opportunities.“ VCs who anchor on early success may continue to invest, despite clear signals of declining performance. This highlights the importance of not only investing in success but being agile enough to reallocate capital when necessary. The risk of missing emerging opportunities is high when VCs are too focused on reinforcing their initial beliefs about a company’s potential.

In 1 sentence: Anchoring on early success can lead to overinvesting in failing companies while neglecting emerging opportunities that could offer better returns.

Co-founded by Hollywood veteran Jeffrey Katzenberg and former eBay CEO Meg Whitman, Quibi was a mobile-first video streaming platform with a vision to offer 10-minute episodes.

Before its launch, Quibi raised an astounding $1.75 billion from investors (Choice Hacking), including top VC firms like Sequoia Capital and Madrone Capital Partners. The star-studded leadership and aggressive marketing created significant early hype, which became the anchor for how many investors perceived the platform’s potential.

However, by October 2020, just six months later, Quibi shut down after failing to gain traction. Despite clear warning signs like weak user adoption and content struggles, investors continued pouring money into the venture, anchored to its initial valuation and leadership, highlighting the dangers of doubling down on a perceived winner without reevaluating performance.

Instead of diversifying or re-evaluating their investments, many continued to back Quibi, reinforcing the mistake of overinvesting in a fading opportunity. This is a key example of how anchoring on early success, or perceived success, can blind investors to declining performance, causing them to miss better opportunities or waste capital on a failing venture.

Anchoring bias can significantly distort investors‘ perspectives when it comes to assessing a company’s potential exit strategies, such as an IPO or acquisition.

When early projections set lofty expectations for an exit, investors may become anchored to those initial forecasts, leading to overconfidence in the company’s ability to achieve such an ambitious outcome. This bias can cause investors to overlook operational challenges, market changes, or competitive threats that could derail the company’s path to a successful exit.

For startups, anchoring on ambitious exit strategies can lead founders and investors to make decisions based on unrealistic timelines or inflated valuations, expecting a large payout without fully assessing the risks. When these expectations are not met, the result can be a loss of investor capital, missed growth opportunities, or even the eventual collapse of the company.

Jawbone, once a pioneer in wearable technology, raised over $900 million in venture capital with ambitious exit plans, potentially through an acquisition or IPO. Investors anchored to early projections of the company’s dominance in the fitness and health tech markets.

However, as competition increased and Jawbone failed to deliver on its product promises, it became clear that these exit projections were unrealistic. Investors continued to pour money into the company, anchored to the expectation of a significant exit, but Jawbone eventually shut down, leading to substantial financial losses.

A classic example is Kodak, once the global leader in photography. For decades, Kodak’s dominance in film photography anchored investors to the belief that the company would continue to thrive, despite the rapid rise of digital photography.

Kodak itself even pioneered early digital camera technology in the 1970s, but its leadership, anchored to its profitable film business, hesitated to fully embrace digital.

Investors, similarly anchored to Kodak’s past success, failed to recognize the seismic market shift toward digital and continued to value the company based on outdated assumptions. By the time Kodak attempted to catch up, it was too late, and the company eventually filed for bankruptcy in 2012.

Anchoring on Kodak’s past glory prevented investors from seeing the true risks of digital disruption, highlighting the dangers of relying on historical performance rather than staying attuned to market changes.

During the boom that preceded this downturn, many startups were riding high on inflated valuations driven by optimistic growth projections. These lofty numbers became anchors for both investors and founders, serving as benchmarks for future valuations. Now, as market conditions shift, startups are finding it difficult to adjust.

For founders, these inflated valuations have become a psychological anchor. Many are hesitant to accept lower offers, believing their companies are still worth what they were during the peak. This reluctance can lead to missed opportunities for much-needed capital and extended fundraising periods—ultimately putting the startup’s survival at risk.

VCs are not immune to this bias. Those who invested at peak valuations may hesitate to write down their portfolio companies’ value, holding on to the belief that the market will rebound sooner than expected. This can lead to overcommitment to struggling companies or a reluctance to invest in new opportunities at today’s more realistic valuations.

In boom times, many VCs focused on high-growth potential and riskier bets, favoring rapid scalability over sustainable business models. These criteria, often driven by the initial success of high-growth startups, became the anchor for future investment decisions.

Founders, accustomed to easy and fast fundraising during those years, are now anchored to the expectation that capital will flow just as freely. However, the current environment demands more thorough due diligence and a slower pace for securing funding, a reality many are struggling to accept.

Before the downturn, valuation multiples, particularly for tech startups, were based on aggressive growth assumptions and lofty revenue forecasts, often without profitability.

These multiples became the norm, creating an anchor for how both VCs and startups viewed company valuations. Now, as the market tightens, those multiples are no longer realistic, yet some investors and founders remain attached to them, hindering the ability to adjust to more conservative valuations.

In the abundant times, startups anticipated quicker exits, whether through acquisition or IPO, based on a fast-moving market and a willingness from investors to fund rapid growth. However, during this VC winter, those exit timelines are extending as market conditions slow down. Many founders and investors, anchored to shorter timelines, may misjudge how long it will take to achieve a successful exit.

While it’s common to follow the lead investor’s terms, you should still perform thorough due diligence on each potential investment. Relying solely on the lead’s research can expose your firm to risks that might not align with your goals or risk tolerance. Make sure you independently assess the startup’s financial health, market potential, and leadership team.

Lead investors can fall victim to anchoring bias—fixating on early valuations or overhyping a startup. While you may follow their lead in rounds, challenge assumptions and don’t be afraid to raise concerns if new data suggests a different reality. Trust your own analysis and be mindful of how anchoring can influence your decisions.

As a minority investor, it’s crucial to have a voice, even if your stake is smaller. Negotiate for access to information and the ability to contribute to strategic decisions. Your input may not dictate terms, but having visibility and influence can help protect your investment and provide insight into how the lead investor operates.

Don’t become overly reliant on a single lead investor’s network or expertise. Diversify your portfolio by exploring deals with other lead investors or sectors. This mitigates the risk of exposure to one firm’s bias or strategy and gives your firm greater flexibility and independence in deal-making.

Ensure that the lead investor’s vision and exit strategy align with your firm’s objectives. Some lead investors may focus on aggressive growth and fast exits, while others may have a longer-term approach. Clear alignment will help ensure that you aren’t pushed into timelines or decisions that don’t suit your firm’s strategy.

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