222 - Curious Absurdities

One of the curious absurdities in the startup investment space is cognitive biases that assign importance to the volume of previous funding in ways that run directly counter to any rational assessment.

For example, if two startups were to both accomplish the same thing (hypothetically), but one does so while only requiring 1% of the total funding of the other (all else being equal), that massively increases the value of the more efficient startup, yet the default investment methods would attempt to penalize that same startup for doing more with less.

This has led investors to pour funds into the least efficient technologies on the table, and since efficient and effective technologies are often orders of magnitude more efficient and effective, this makes for a very extreme detour in practice. Nvidia has profited substantially from this, as demand for their GPUs would be at least 10 times lower than it is today if vastly more efficient and effective technologies had been properly funded. Many more companies exist exclusively as parasites that feed on those severe inefficiencies.

The assumption that “greater prior investment offers social proof of viability and merit” is a particularly dangerous and self-fulfilling fallacy, as it not only allows but encourages bad actors to game the system, and once in to easily remain there as entrenched parasites. This cognitive bias in reality is sadly no less absurd than Dilbert’s comical Pie Chart example.

Researchers have understood that the “Classical Theory of Rational Humans” is starkly divorced from reality and well-debunked for quite some time now, yet the investment world hasn’t caught up. A “rational investor”, if such a thing existed in reality, would see the two hypothetical startups and realize that the one that accomplished the same thing on 1% of the funding could reliably go much further on the same ticket price for the subsequent investment and that every % of the equity in that company could likely be 100 times more valuable than the same % of equity in the other.

Under competitive market dynamics, particularly zero-sum games of supply and demand, the company that can go much further on the same funding gains an additional nonlinearity to their value, as vastly outcompeting others by such orders of magnitude often drives competitors into obscurity and bankruptcy. The tail of that distribution doesn’t survive for long.

This particular investment domain problem is fortunately nearing the end of its effective lifespan, for much the same reason. Once systems are deployed that assist some investors in making far more rational and scientifically validated decisions, they’ll be able to outcompete others by orders of magnitude, sending those who attempt to continue the status quo directly into bankruptcy. While poetic justice doesn’t govern market decisions, it may certainly take center stage in the near future, as those systems are properly funded, deployed, and utilized to great effect.