​How the Sunk Cost Bias Affects Venture Capitalists and How Startup Founders Can Benefit from It

Venture capitalists are human too, which means they make mistakes and are susceptible to emotions. Today, I want to talk about how the sunk cost bias affects VCs and how founders can use this to their advantage. I hope this post helps you understand why maintaining good personal relationships with venture investors is so important.

As a reminder, this cognitive bias occurs when someone has already invested significant effort or resources into a project and finds it hard to abandon it.

This effect is most pronounced when a startup has already received substantial investment but the business results are ​l​agging behind. Very often, investors in this situation are happy to “delude themselves” that with a little more effort from the founder, the startup will reach a point where it can raise the next round and get on a high-growth trajectory. As a result, current investors provide small bridge rounds that give the startup an additional 3–6 months to achieve results. Sometimes there may be several of these rounds in a row. To encourage a VC to support you during a difficult period, founders should provide regular updates on the business and manage investor expectations. This gives VCs a sense that they better understand what’s happening in the startup and strengthens their belief in the founder.

Another example of the sunk cost bias appears when you have been negotiating with an investor for a long time, signed a term sheet, the fund has invested in due diligence, and suddenly a fact emerges (not a red flag) that slightly reduces the attractiveness of the investment opportunity. In this case, the fund is unlikely to back out of the deal and will likely try to renegotiate. For the same reason, once a term sheet is signed, the fund usually avoids canceling it, even though formally it is not ​b​inding to close the deal. This bias is especially strong in the fund employee​ who manage​s the deal​. ​They have already invested significant effort in making it happen, convincing colleagues, and coordinating external parties. In fact, this person can become your most loyal ally because they have put their reputation on the line internally to advance your deal. Help them sell your deal to their colleagues inside the fund.

A subtler manifestation of the sunk cost bias occurs when you have closed an unsuccessful previous startup and are launching a new one. If you maintained good relationships, kept investors informed, and made maximum effort to make the previous business work, investors are more likely to invest at the very early stage in your next venture. Here we see a combination of the sunk cost bias with the “familiarity bias.” Investors feel they already know the founders well, which makes them more willing to overlook early-stage risks.

In short, investing is a long-term game. Maintain good relationships so you can later reap the benefits.

If you want to better understand how venture capitalists make decisions, follow ​Denis Kalyshkin and Ask VC​ on LinkedIn. I regularly run my “Venture Analyst” course there, answer questions, and analyze venture deals. ​