046 - Investment Paradox

Much of technological progress today requires investors. There are thresholds that simply can't be met by the volunteered time and out-of-pocket expense of bootstrapping startups, at least within any practical time frame.

However, this is a problem where the Complexity versus Cognitive Bias Trade-off hits hard. Let's examine what that is:

  1. Investors have a limited supply of time, and high demand for that time.

  2. Interaction with potential investors is most often a zero-feedback environment.

  3. Due Diligence (DD) for trending (mediocre) technology is far easier and simpler than DD for new technology.

  4. Investors often anchor to arbitrary figures, based on averages or "rules of thumb".

The supply and demand imbalance causes saturation and spam for investors in practice, and the zero-feedback element creates a strong negative feedback loop over that spam.

Both elements further strongly encourage forgoing the time and effort of DD in new technology, in favor of the mediocre.

Lastly, by saturating heuristics with mediocre investments likely to fail, the averages and rules of thumb necessary to statistically avoid bankruptcy are often heavily skewed to offer unreasonable terms for companies with new technology. These terms are self-defeating, as any startup sufficiently unwise to accept them is statistically also sufficiently unwise to stay in business, further reinforcing the negative feedback loop.

These 4 problems in particular compound upon one another, producing the trends we now see in spaces like "Generative AI", where investments of over $100m in trashbot companies are becoming fairly common, but investments in any new technology are avoided.

The net result is very counterintuitive, that 1% gains for mediocre technology are favored over 10,000%+ gains from new technology. In this market, cognitive bias rules with an iron fist.

All of these problems are opportunities proportionate to their severity, but it takes skill and courage to step out of the status quo.

#ai #startup #innovation #investment #bias

In the spirit of making this more scientifically quantifiable, I decided to distill points 1-3 into a one-sentence litmus test and send the resulting question to 30+ VCs and investors, in the interest of establishing statistical significance.

My educated guess is that 80% fall prey to the combination of 1 and 2, with either no response or a canned response, correlated to network connection strength. Then, another 80% of the remainder will likely fall prey to 3, leaving only 4% by the time the focus shifts to number 4.

I'd love for this to be proven wrong and pessimistic, but I suspect reality may be more grim than such an iterative 80/20 split.