Why some deals get funded, while others do not, can be a mystery. But consider this point: Transactions that are successful in attracting capital often do so because they meet the affinity standards of their backers. Tech money tends to respond to internet-related firms. Real-estate wealth supports property deals. And those who like bling seem to back bling.
There is a behavioral principle here: cognitive fluency. Or the ease with which our brains process information. Those making investment decisions — whether institutions or individuals — may revert to what they consider to be simple and familiar.
A recent Harvard Business Review article points out that early-stage investors seldom use financial-analysis techniques to evaluate deals. In “How Venture Capitalists Make Decisions,” the authors argue that the primary focus is on the capabilities and character of startup founders. Affinity is a reliable lens through which risk takers can evaluate these personal qualities.
Another essential reason investors may be more easily persuaded by affinity deals is the prospect of easier due-diligence evaluation. Founders and entrepreneurs can stumble at representing their transactions with full clarity or industry context, at least initially. Backers do not have to tread through a morass of new industry metrics for seemingly good deals.
The problem of course is that trend-worthy opportunities tend to boil over, targeting the same investor names. There is now a flood of artificial-intelligence transactions in the market. One way to overcome that challenge is to follow a “blue ocean” capital-raising strategy. Go where others are not.
New pools of capital are erupting almost volcano-like in some geographies. Sponsors behind US-based real-estate deals can now search for capital in Taipei or Tbilisi. Tech-related entrepreneurs in Brazil can think of Silicon Valley as a concept, not a location, exploring backer relationships in Singapore or Stockholm.
Those looking for capital often fall into a rut because they do not take time to explore the full global universe of affinity backers. It is excruciating both to develop a business and uncover the financial resources to propel that evolution. Never mind trying to do so on a worldwide playing field. Still, the first step to discovering that unexpected gold vein may be understanding the vast potential “over there.” ■
Learn more at the Harvard Business Review
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Image: Panning can help to locate a primary gold vein. Credit: Robert Gubbins at Adobe Stock.
