It takes time to make a decision. Lots of time—118 to be exact, according to some VCs, write Ilya Strebulaev and Alex Dang.
Here’s how people think great things happen in Silicon Valley: A bright-eyed startup founder sketches a groundbreaking idea on a napkin. The napkin is picked up by a savvy venture capitalist. The VC glances at the sketch, gets excited, and wires millions of dollars to the young entrepreneur. And a unicorn—that is, a company that will reach the $1 billion level in value—is born.
[time-brightcove not-tgx=”true”]This narrative of high stakes, fast decisions, and a risky gamble is alluringly cinematic. It’s also a myth. And for anyone who wants to be a successful founder or investor, it’s a dangerous one.
During our 10-plus years of research on VCs, we peeled back the layers of Silicon Valley’s mythology. We found a complex set of principles and mechanisms marked by rigorous review, careful management of risks, and a hard-nosed readiness to say no. This is not the Silicon Valley that you see in movies, but it’s the one that truly drives the wheel of innovation forward.
Venture investors spend, on average, 118 hours scrutinizing facts and stats before they invest in a startup. Their decisions are based not on a gut reaction to a napkin but on extensive analysis of details and discussion of multi-page memos. Perhaps surprisingly, VCs are not risk seekers. Rather, they see themselves as “risk reduction engineers.”
The myth that successful people make important decisions by shooting from the hip is dangerous for all of us. It goads us to take unwise risks without thinking things through. In contrast, the goal of the venture mindset is to understand and minimize risks, not to ignore them. Finding and funding truly innovative ideas is a highly disciplined process.
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It takes time to make a decision. Lots of time—118 to be exact. That may already seem a big commitment. But 118 is only the average. Brian Jacobs, co-founder of the Emergence Capital VC firm and co-teacher of the Stanford VC class with one of us, estimates that his firm spends 400 hours on due diligence before making an investment. These long hours of due diligence are typically condensed into a single, concise document called an investment memorandum, or simply “the memo.” The investment memo explains the logic of the investment in a well-structured way. It forces the decision makers to bring rigorous discipline to their analysis of key risks.
But memos are tools, not goalposts. They are concise. They weigh pros and cons, benefits and costs of the decision. They pressure-test the ideas. They identify major risks, assumptions, and unknowns. They are witnesses, not eager advocates. They are a starting point to spark debate. More importantly, they often lead to a “no” decision. With “no” being a very common outcome.
Rejecting ideas is as important as accepting them. In fact, VCs reject about 100 ideas for every one they decide to fund. That’s hardly a sign of reckless abandon or gut-driven optimism. Rather, it is a feature of a well-structured filtering process.
The investment memo is almost the exact opposite of a sales pitch. The purpose of a pitch is to sell an idea, to smooth the corners, to convince the audience; the purpose of an investment memo is to recognize unknowns, to identify weak spots early on, and to stimulate a frank discussion within the entire partnership. Making a high-stakes decision? Consider asking yourself: what are the reasons not to pursue the idea? We should not just put together a list of pros and cons when we face a tough choice, but also share it with other people in whose wisdom we trust. This is one path to better decisions.
Consider, for example, the investment memo written by Bessemer partner Jeremy Levine in December 2006, describing a proposed investment in LinkedIn. The tone of the memo is fact-based and not rosy. Levine identifies major risks of the investment and paints various scenarios, from a complete disaster (in which everything falls apart) to a super-bright scenario (in which LinkedIn becomes a dominant global business social network). The purpose is clearly to inform and stir discussion among the partners. The memo is impressive in its honest and detail-specific assessment of an opportunity; certainly, it is not an attempt to convince the reader to rubberstamp the idea.
Investment memos serve another often-underappreciated purpose: they facilitate retrospective analysis. If the investment goes sour, scrutinizing the memo helps everyone figure out what they missed, thereby uncovering flaws in review patterns and improving future decisions. Similarly, if a rejected opportunity becomes a super success story, investors will pore over all the memo’s details to identify why they missed their golden chance. A well-documented record beats memory every time.
Words in the memo matter. The original investment memo written in February 2009 by Andrew Braccia, the investor at Accel leading the investment in the gaming startup Tiny Speck, said, “Tiny Speck is still primarily a team bet. They have failed with one another, succeeded with one another, and everything in between.” Soon the idea behind the Tiny Speck failed. However, as the memo clearly stated, the bet was on the team and not the idea per se. Accel decided to support the same team with their new idea which turned to become Slack, the famous corporate communication tool.
Contrary to popular myth, the tendency to ignore risks is more common in corporate cultures than among VCs. Sadly, within many corporations, optimism about a favored idea is overrated and genuine discussions are rare. To get a corporate project approved, the sponsors have to pretend to be extremely optimistic. Even though everyone in the room knows that the optimism may be unfounded, everyone goes along with the idea, especially if the CEO sounds enthusiastic. In such situations, a system that requires writing and analyzing an investment memo can be very helpful as it forces people to identify and examine risks and alternative strategies.
Many outside the VC world have seen the benefit of VC-type memos. Amazon introduced a similar practice of preparing structured, six-page documents to guide their decision-making processes. Amazon memos have to address key questions surrounding the new product idea. How will it make customers’ lives significantly better? Why does this problem need to be solved right now? How will success be measured? What is the most contentious aspect of the product? What are the major risks and how does the team plan to address them?
Marc Andreessen, a famous VC investor, surprised many Stanford students when he described his VC firm’s business in this way: “Our day job is crushing entrepreneurs’ hopes and dreams. We have focused very, very hard on being very good at saying no.” The venture mindset leads decision makers to reject most ideas quickly to save time for the extensive due diligence that the best ideas require. It takes a prepared mind to accept.
We are the sum of our decisions: personal, business, political, financial. Our most important decisions—quitting a job, relocating to a new country, committing to a long-term project, or investing in a startup—require a lot of time and attention. Relying on 30-second elevator pitches, cowboy-style decision making, and leaping into risks based on intuition will lead to bad decisions. When you can’t afford to make a bad decision, remember the 118-hour rule that the world’s best investors follow.
