Among Angel Investors, Intuition Trumps Analysis
4 min read · Jan 2025
Huang and Pearce (2015)
“[angels are] significantly less likely to invest if the business viability data were positive but the [personal] assessment of the entrepreneur was negative.”
Summary
This mixed-method study examines how angel investors make their investment decisions. Unlike other investment contexts, the authors find that angels rely more on intuition than formal analysis when evaluating opportunities. Notably, this decision-making process appears to pay off the most for experienced angels.
Method
This paper conducts three studies. Study 1 uses interviews with experienced angel investors to learn about their decision-making process. Study 2 uses an experiment to generalize findings from the interviews. In the experiment, 135 experienced angels were presented with business plans and asked whether they would invest in each business. Business plans were randomized on the strengths of the business plan (strong vs. weak) and subjective founder evaluations (whether the founder elicited generally favourable versus unfavourable evaluations from a previous set of angels.) Study 3 was a quantitative study using observational data that assessed how well angels could predict “homerun” investments (measured either as a successful acquisition, and IPO, or a return 10 times as large as the investment). 90 angels were shown pitch presentations and asked to rate the entrepreneur and the investment. Their results were compared to future business performance.
Key Findings
Angels tend to rely on founder’s personal characteristics when making decisions.
Angels convey that ‘gut feeling’ plays a big role in successful investment decisions, which reinforces the idea that their informal assessments and intuition are better than formal analysis in selecting investments.
Angels are more likely to invest in strong business plans when the founder elicits favourable personal evaluations.
Strong business plans with unfavourable-rated founders were funded at a lower rate than those with favourably-rated founders.
Angels seem capable of identifying home run investment on the basis of founder characteristics alone.
But founder characteristics are not associated with other metrics like venture survival, growth, or future financing.
Likewise, the strength of the investment does not predict venture survival, growth, or future financing, nor does it predict homerun investments.
Takeaways
This paper shows that angel investors use a mix of formal analysis and intuition in making investment decisions. This aligns with previous literature on the topic. Angels, because they are typically accountable only to themselves, rely on heuristics and intuition to decide where to allocate capital knowing that many of their investment decisions will not pay off. Still, their heuristics generally do pay off— by conducting these mixed, informal analyses they can process a lot of ideas and find successful home runs.
Relying on intuition and experience, however, generates exclusion. Since data shows that men receive the most capital, experience will teach angels to think that men are more likely to be successful than women, for instance. In turn, this makes women and diverse founders seem more risky. Knowing the importance of intuition raises the question of what types of interventions can address unconscious biases in these processes.
One possible path for improving angel investment decisions involves balancing intuition and formal analysis. While intuition, shaped by experience and affective evaluations of entrepreneurs' qualities like trustworthiness and passion, plays a key role in navigating early-stage investment uncertainty, it can be supported by formal analyses to provide additional confidence.
Angel investors actively seek out decisions involving unknowable risks, believing these offer the greatest potential for extraordinary returns. Another approach for promoting change may be to emphasize the success of women and diverse founders, as this could shift investors’ views on what constitutes a "risky investment" versus a "sure bet."
References
Huang, Laura, and Jone L. Pearce. 2015. “Managing the Unknowable: The Effectiveness of Early-Stage Investor Gut Feel in Entrepreneurial Investment Decisions.” Administrative Science Quarterly 60(4): 634–70.
About WIN-VC Canada:
New Power Labs is the research lead of the Women and Nonbinary (W) Impact (I) Network (N) for Venture Capital (VC), a national collaborative of organizations working to provide services, programming, events, and dedicated resources to women and non-binary entrepreneurs and gender lens investors across Canada who are working towards becoming investment ready and increasing the pool of investors driven to invest in these ventures.
This research is part of WIN-VC Canada, supported by the Government of Canada. WIN-VC acknowledges the support of Innovation, Science and Economic Development (ISED). ISED has awarded funding for WIN-VC that will make the venture capital environment more inclusive for women by transforming traditional investment processes, processes and knowledge into respectful and meaningful approaches that value equity and impact with a focus on diverse women and non-binary entrepreneurs and SMEs including Black communities, Indigenous peoples, racialized populations, persons with a disability, 2SLGBTQ2+ and new Canadians.
