What is instinct? That was the question I put to legendary venture capitalist Alan Patricof 10 or so years ago when I teamed up with him to launch a Japan-based VC company. As an industry newcomer, I was keen to learn all I could from Patricof.
“What’s the secret of success in VC?” I asked him. “What do you need to make good investment decisions?”
His answer was short and simple: instinct.
I then went on to ask him what instinct was. He did not reply, so I had to try and work that one out for myself.
So what is instinct?
• A vague sixth sense?
“I just know this will work.”
• Judgment based on the sum of your experiences?
“I’ve seen enough to know how this will go.”
• A serendipitous feeling of attraction?
“This CEO has what it takes. I can feel it in my gut.”
All of the above are good, but in the end, I decided to define instinct as “everything that’s not covered by intellect or emotions.”
Instinct and decision-making
When we make decisions (including about VC investing), we rely on some combination of three things: intellect, emotion, and gut instinct.
Most of us are probably too willing to trust the first two—intellect and emotion—and not willing enough to trust the third—instinct.
Personally, I’m the opposite. I’m a little skeptical about my intellect and emotions and more inclined to respect my gut—even if I can’t explain why.
Why am I suspicious of intellect?
When VC professionals make investment decisions, they run various what-if scenarios. Since some of our assumptions are, by necessity, based on imperfect data with quite a few unknowns, the most intellectually rigorous methodology can lead us to conclusions that are quite wrong.
My takeaway? The intellectual approach is less reliable than we think. Don’t over-rely on the intellectual approach.
Why am I suspicious of emotions?
When selecting a business to invest in, it’s obviously good to feel positive about it. Emotions like excitement, enjoyment, and optimism can be harnessed in a positive way to help overcome the challenges that startups inevitably face as they grow.
At the same time, you need to guard against getting carried away by your emotions. Just think of all the money that over-excited investors threw at internet companies in the late 1990s when their feelings took over.
Which brings us to instinct. What role does instinct play in investing?
Trusting your instinct means being prepared to walk away from a deal if it makes you feel uncomfortable.
Equally, it means having the courage to put money into a deal for no more reason than that something “just clicks” or “feels right.”
Perhaps the best thing I can do is to give you an example from my own experience.
One of the most successful investments that my firm GLOBIS Capital Partners ever made was in GREE, a Japanese social networking service. We multiplied our investment by 97 times!
When we invested in 2005, GREE was a modest outfit based in an apartment with only a handful of employees—just like most seed-stage ventures. It went public in December 2008 (a major news event, since it was just three months after the collapse of Lehman Brothers) and by 2010, Forbes was listing the founder Yoshikazu Tanaka as the world’s second-youngest self-made billionaire, after Facebook’s Mark Zuckerberg.
Nonetheless, when we invested, GREE’s eventual success was far from a sure thing.
• In the social networking space, GREE was just a follower. In 2005, Mixi (a sort of Japanese proto-Facebook) was the pioneer and dominant player. GREE was No. 2 (which is nowhere in the winner-takes-all world of the internet). We had an intellectual reason not to invest.
• I could not find anything exciting about GREE’s business. I felt neither very positive nor negative about the company. My emotions didn’t pull me strongly either way.
• Nonetheless something “just clicked” when I met the founder. When he talked about his passion for the Internet, his career, and his struggles as an entrepreneur, I felt drawn to him.
If I had to rationalize after the fact, factors that contributed to my decision included the following:
1) As a college student, the founder had interned at one of our portfolio companies.
2) He had gone from working in a Japanese blue-chip company to launching a startup in an apartment.
3) I liked his paradoxical combination of passion and calm.
This mixture of coincidences and personal taste played a part in nudging me into one of the most successful investments of my career.
In a further irony, GREE really took off when Tanaka switched his business model away from social networking to social gaming.
It just goes to show how right Alan Patricof was: instinct is what counts when making VC investments—even if you have a hard time defining it.
Whatever field you’re in, I urge you to move beyond intellect and emotion and act more upon instinct.
I’m not quite sure why, but my gut tells me that it will work out.