The Fourth Edge in Early Stage VC

Behavioral economics has transformed how investors think about decisions. This essay identifies a fourth edge in early-stage venture capital — beyond the traditional advantages of deal flow, analysis, and operational support — that separates the best investors from the rest.

Behavioral economics has seen its mindshare grow significantly in the investing world over the last decade as more and more people have used it as a primary lens for how to think about decision making. In 2000, well after people like Daniel Kahneman and Amos Tversky began making their contributions but before the concepts wrapped inside the field made their way into every corner of the business world, investor Richard Fuller published a paper titled " Behavioral Finance and the Sources of Alpha " that framed the way competitive advantage is gained in investing and identified 3 primary sources of potential market outperformance: Informational — Proprietary access to superior information Analytical — The ability to process information more effectively Behavioral — The ability to take advantage of behavioral biases and mental mistakes by other market participants Since that time, highly regarded investors, analysts, and operators across the spectrum (like Howard Marks, Michael Mauboussin , and Tim Ferriss ) have latched on to the framework and implemented it into their own process. While the three sources of alpha laid out by Fuller are quite comprehensive in the world of S-1s and 10-ks, they fail to fully encompass the way that alpha is created in the much more opaque and jagged early stage venture market. Public Markets vs. Venture Capital For a multitude of reasons, early stage venture capital remains a completely different beast than public market investing. Despite a playing field that is leveling over time (thanks to Angellist and the like), informational edges are still major drivers of long term success as strength of networks play a key role in which investors see which deals. Additionally, the lack of well understood first party operational performance data for startups and industry-wide benchmarks has provided an opportunity for firms like Social Capital (via its Analytics tool) to aggregate and exploit proprietary data in unique ways. And while the venture

By Fred Hoch at TechNexus Venture Collaborative