Evaluating startups

: addressing herd behavior and other biases in venture capital due diligence

Abstract

This paper examines the impact of cognitive biases on the effectiveness of Venture Capital (VC) Due Diligence (DD). In a threefold approach, theoretical background is combined with Expert interviews and a survey, resulting in a comprehensive understanding of biases in investment decisions. The study focuses on investigating herd behavior, which can affect the independent opinion formation and thoroughness of VC DD. Research demonstrates that relying on other investors' DD and following industry trends can lead to suboptimal investment decisions. The qualitative interviews with Venture Capitalists (VCs) highlight the prevalence and impact of this bias and thus emphasize the need for preventive measures in VC fund structures. Developing practical strategies to mitigate the effects of herd behavior is a crucial contribution of this work. For example, structured DD protocols, a Collaborative Evaluation Framework, or a Capital Commitment Incentive were derived from Expert interviews. These initiatives are intended to protect VCs and their decision-makers from the urge of herd instinct by providing VCs with more internal control mechanisms. It is concluded that recognizing and addressing cognitive biases is crucial for fostering a more diverse and innovative investment environment.

Date of Award	25 Jan 2024
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Peter V. Rajsingh (Supervisor)