The psychology of investing in startups

Venture capital is a psychological game, and your ability to keep a clear head under pressure will determine whether you become a successful investor or just another statistic in the failure rate.

High uncertainty

Venture investing means a systematic approach to dealing with uncertainty. When an investor backs a startup, they are effectively backing a hypothesis rather than a stable business. Will the team be able to find a product-market fit, scale the model, and withstand competition? This is unknown. In the early stages, basic metrics are often absent or limited.

This creates specific psychological pressure. On the one hand, there is a desire to find a breakthrough project and reap substantial profits. On the other hand, there is the realisation that most such hypotheses will not come to fruition. The result is an internal conflict between greed and the fear of loss. This conflict frequently leads to irrational decisions.

A professional approach involves transforming uncertainty into a probability system. Rather than asking whether a startup will succeed, an investor considers the probability of success and the upside potential. This is a fundamentally different way of thinking. For instance, even if there is only a 10% chance of success and the potential return is 20x, such an investment may still be rational.

The key skill is accepting that mistakes are inevitable. In the venture capital business, it is impossible to have a 100% success rate. If an investor tries to avoid all risks, they automatically miss out on the best opportunities. Therefore, psychological resilience is based not on certainty but on the ability to work with uncertainty without becoming overwhelmed emotionally.

Long-term investment horizon

Venture capital investments operate on a wholly different principle from public markets. There are no daily price quotes, nor is there the option to quickly secure a profit or loss. The investment horizon is typically 5–10 years, sometimes longer.

This means that investors are forced to live with delayed results. During the first few years after the investment, it may seem as though nothing is happening. The startup is developing, but this does not result in liquidity. This can be mentally challenging, as the brain expects regular confirmation that decisions were correct.

It is precisely during this period that the greatest risk of doubt arises. The investor begins to re-evaluate their decisions, compare them with alternatives, and regret 'missed opportunities'. This can lead directly to FOMO and chaotic actions.

Experienced investors address this issue from the outset, adopting a long-term mindset. Each investment is viewed as part of the portfolio as a whole, rather than as a separate bet that must 'pay off quickly'.

A practical approach is to document the investment hypothesis, including why the decision was made, expectations regarding future performance and the risks considered. This enables investors to revisit the original rationale and avoid being driven by emotions one or two years after putting money in.

Low liquidity

This is one of the key factors that shape the mindset of a venture investor. Unlike shares, a stake in a startup cannot be sold quickly. In effect, the investor’s capital is tied until the company is sold or goes public.

This creates two significant psychological pressures. The first is a lack of control. When the market falls, one can reduce one's position in public investments. In the venture capital business, this option does not exist. The second is opportunity cost. Investors see other options but cannot reallocate capital.

Under such conditions, the risk of making emotional decisions at the outset increases. People subconsciously try 'not to make a mistake' because they realise they will not be able to rectify the situation quickly. This often leads to either decision paralysis or impulsive investments.

A rational approach involves managing liquidity at the portfolio level. Only the portion of capital that will not be needed in the short to medium term is invested. This reduces pressure and allows for more considered decision-making.

It is also important to understand that low liquidity creates the opportunity for high returns. It limits competition from short-term investors and enables investors to support startups through difficult periods.

How FOMO affects investment decisions

Investing without due diligence

FOMO frequently manifests as cutting back on due diligence or ignoring it altogether. When a deal looks 'hot', the investor starts acting faster than common sense would dictate. The logic is simple: if you don't seize the moment, the opportunity will disappear.

In this state, analysis is replaced by trust. Rather than assessing the business model, market and team, investors focus on signals such as a well-known fund involvement, recommendations from acquaintances, or the general buzz surrounding the startup.

However, venture capital is not a game of authority. Even top-tier funds make mistakes, but their model assumes that a few successful deals will offset the losses. A private investor making 5–10 investments does not have that margin for error.

To avoid problems, you need to maintain a minimum standard of analysis that isn’t compromised, even under time pressure. For example:

• Market assessment (TAM, growth dynamics).
• Team analysis.
• Understanding unit economics.
• Competitor analysis.

If there are no answers to these questions, the investment should be declined.

Overvalued startups

FOMO directly influences valuation formation. When demand for a deal exceeds supply, the price starts to reflect market sentiment rather than objective metrics. This creates a situation in which investors pay an 'access premium'. They are willing to invest at a higher valuation simply to be part of the deal. While this may seem justified in the short term, eventually, it significantly reduces returns.

The higher the entry price, the harder it is to achieve a high multiple. Even if the startup grows fivefold and the investor enters at the peak valuation, their actual profit will be limited.

Experienced investors strictly control their entry price. They are prepared to walk away from a deal if the valuation does not justify the risk.

Entering overheated funding rounds

In such situations, deals close rapidly, often within a few days or even hours. Investors have limited time to decide and must act based on limited information. This creates the perfect environment for mistakes. Firstly, the depth of analysis is reduced. Secondly, the terms of the deal deteriorate, with fewer protective mechanisms, a higher valuation and a weaker position for the minority investor.

Another risk is the 'last-in' effect. When a funding round is almost closed, investors feel it’s their last chance to get involved. In such a state, rationality takes a back seat.

Professional investors follow a clear rule: never invest under time pressure. If a deal does not allow for fundamental analysis, that is a warning sign in itself. They also understand that missing an opportunity is not a loss. In the venture capital business, there are always more deals than available capital, so discipline is more important than speed.

How to stay calm during portfolio drawdowns

Understanding venture capital market statistics

Drawdowns are a normal occurrence in the venture capital business. If a portfolio appears to be underperforming temporarily, this reflects the market's organic nature.

The classic venture portfolio model is as follows: 50–70% of startups either fail or fail to return the invested capital; a further 20–30% deliver moderate returns; and only 1–2 investments generate most of the profit. This implies that the portfolio typically looks weak, with a significant change occurring only during the exit stage.

The problem arises when an investor assesses the portfolio over a short period. For example, one year after investing. At this stage, most companies have not yet scaled up, while some are already showing signs of difficulty. Visually, this looks like failure, although in reality, it is a normal phase of development.

It makes more sense to assess the portfolio using the expected return model than its current condition. Investors need to be fully aware that any losses can be compensated for if even one investment generates a 10–20x return.

Portfolio diversification

Not only does diversification reduce risk, but it also helps to stabilise an investor’s state of mind. If a portfolio consists of just one or two startups, negative news is perceived as critical. However, if there are 10–20 investments, the impact of a single setback is significantly reduced.

The essence of diversification is spreading risk. Rather than attempting to pick a single ideal startup, the investor builds a portfolio in which the probability of success increases as the number of investments grows.

This mitigates the impact of systemic risks. For instance, a downturn in one sector would not affect the entire portfolio.

Focus on a long-term strategy

One of the key mistakes is evaluating long-term investments based on short-term results. In the venture capital business, this almost always leads to false conclusions. Startups develop non-linearly: nothing noticeable may happen for a long time, and then growth surges sharply.

An investor with a short-term focus may begin to doubt the soundness of their decisions. They may lose confidence in the team, change strategy, or even attempt to exit the investment on unfavourable terms.

Experienced players operate differently. They establish their investment thesis at the outset: why this startup has potential, what the growth drivers are and what the risks are. They then periodically revisit this thesis to check whether the underlying logic has changed.

If the answer is 'no', short-term fluctuations are ignored. If the answer is 'yes', the decision is reviewed.

This approach helps to avoid chaotic actions. The investor stops reacting to noise and focuses on signals. Consequently, stress levels decrease, and decision quality improves.

Limit emotional decisions

Drawdowns, startup failures and news of other investors’ successes all create a powerful psychological backdrop. The aim is not to eliminate emotions, but rather to ensure that they do not influence decisions.

One practical approach is to formalise the decision-making process. For example:

• Do not make investment decisions within 24–48 hours of experiencing strong emotions.
• Do not change the portfolio without reviewing the investment thesis.
• Record the reasons behind each decision.

Another effective approach is to use checklists. When there is a clear list of criteria, decisions are made based on structure rather than gut feeling.

It is also important to distinguish between controllable and uncontrollable factors. While an investor cannot influence the market or the macroeconomy, they can control the size of the investment, the portfolio structure, and the quality of the analysis. Focusing on these aspects can help reduce anxiety.

Drawdowns are a normal part of venture capital investing

Drawdowns in the venture capital business are not a problem to be solved, but rather a mechanism that must be accepted. They are a direct consequence of a model in which a few successful deals generate most of the profit. From a mathematical perspective, venture capital operates on the principle of asymmetry.

• The maximum loss is limited to the capital invested (-1x).
• Potential returns, however, are unlimited (10x, 50x, 100x).

It is precisely this asymmetry that makes drawdowns inevitable. To access significant upside potential, investors must accept a high failure rate. Furthermore, the absence of drawdowns may indicate a concern. This suggests that the portfolio has been constructed too conservatively and that the investor is avoiding risk. In such a case, they are unlikely to achieve significant returns.

Psychological errors made by venture capitalists

The herd effect

This happens when an investor adopts others’ actions rather than performing independent research. A startup is considered a tested opportunity if it has well-known investors on board or is the focus of ongoing market discussion.

In practice, this looks like an investor seeing that a funding round is closing quickly and concluding that the deal is good. However, the speed at which a funding round closes is an indicator of demand, not the strength of the business.

The main risk is the loss of independent thinking. Investors stop asking critical questions:

• Is the business model clear?
• Does it have a real competitive advantage?
• Is the risk assessment appropriate?

The result is a portfolio based on other people's decisions rather than logic. A professional approach involves using market signals as supplementary information only, rather than as the basis for a decision. If an investment does not match your analysis, it is better to pass it up, regardless of who else is participating in the round.

Confirmation bias

This is the tendency to seek information that confirms an already-made decision, while ignoring information that contradicts it. In the venture capital industry, this can be particularly dangerous, as data is often ambiguous.

Once an investor has emotionally committed to the deal, they begin to subconsciously pick out only the positive signals, such as a strong team, a large market and rapid growth. At the same time, risks or shortcomings are either underestimated or completely ignored. This creates a distorted picture of reality. Investors believe they have conducted a thorough analysis when, in fact, they have merely confirmed their opinion.

To avoid this trap, one must consciously explore counterarguments. One practical method is to ask: 'Why might this startup fail?' If there is no clear answer, this suggests that the analysis was superficial.

Overestimating one's own expertise

After making a few successful investments, it is easy to get the feeling that you have figured out the market. This is a classic example of overestimating one’s own expertise. In reality, in the venture capital business, the success of one or two deals does not equate to a systematic understanding. This mistake can manifest itself in several ways:

• Increasing the size of investment cheques without sufficient justification.
• Ignoring the basic rules of analysis.
• Overconfidence in one’s ability to identify successful startups.

The problem is that the VC business is characterised by a high degree of randomness. In addition to careful analysis, outside variables may also contribute to a profitable investment. When investors begin to overestimate their abilities, they shift from a systematic approach to an intuitive one. This sharply increases the risk of significant losses.

The 'catch-up investor' syndrome

This syndrome arises following losses or missed opportunities. The investor begins to feel that they have fallen behind the market and tries to catch up quickly. In practice, this leads to aggressive and ill-considered decisions:

• Investing in high-risk startups without analysis.
• Increasing one’s stake in deals.
• Participating in overheated funding rounds.

Psychologically, this is an attempt to recoup losses, and it is a mistake that is not only typical in venture capital but in finance as a whole. The main risk is the accumulation of errors. One unsuccessful investment can lead to another, causing the portfolio to deteriorate.

Tools for managing an investor’s emotions

Investment strategy and guidelines

An investment strategy provides a stable foundation. It determines what to invest in, the terms and the amounts. The key elements of the strategy are:

• Investment stages (pre-seed, seed, etc.).
• Investment size.
• The number of investments in the portfolio and the criteria used to select startups.

This helps to avoid decisions being made on an ad hoc basis. For instance, if the strategy only allows investment at the seed stage, the investor will not participate in overheated later rounds, even if they appear attractive. It is also important to have exit or follow-on investment rules to reduce uncertainty and ensure consistency.

Pre-investment checklist

A typical checklist includes:

• Market: Is it large enough, and is it growing?
• Product: Does it solve a real problem?
• Team: Do they have the necessary experience and expertise?
• Business model: Is the monetisation strategy clear?
• Competition: Is there differentiation?
• Risks: What could go wrong?

If there is no clear answer to at least one of these key questions, the investment should be reconsidered.

How do seasoned VCs handle FOMO?

Rather than trying to eliminate it, which is impossible, experienced investors change their attitude towards FOMO. For them, FOMO is a signal to pause and double-check their decision rather than act more quickly.

The first step is to slow the process down. If a deal triggers strong emotions, further analysis is automatically required. In such cases, speed is the enemy of quality.

Secondly, stick to clear selection criteria. Regardless of how much market interest there is in a deal, it is ignored if it does not fit the strategy.

Thirdly, accept missed opportunities. This is one of the most difficult yet critically important skills. In venture capital, there will always be more good deals than there is available capital. Missing out on an investment is normal.

Fourthly, focus on the process, not the outcome. Rather than assessing whether they ‘got the startup right’, an investor should focus on whether the decision was made correctly. This enables long-term stability.