The ignorance of ignorance
So much has been said about the Dunning-Kruger effect and its applications in every aspect of life. It almost feels like all of us writing about it are stuck on Mount Stupid ourselves, unable to move on. But for the sake of this article, let’s ignore all the meta stuff and go right into where Dunning-Kruger could apply in investing, in both founders and VCs.
A quick recap on the Dunning-Kruger phenomenon, if I may - it’s essentially a cognitive bias where people with limited ability in a specific area tend to overestimate their knowledge or skill and appear overconfident, whereas the ones who actually know their stuff underestimate themselves at every step of the way.
The Mount Stupid hall of fame
In the world of investing and entrepreneurship, this confirmation bias can often be disastrous. Because, as humans, we’re constantly looking to prove our own self-made hypothesis, a few initial successful investments or success as a founder in one industry often leads to overconfidence in one’s abilities. Conversely, more knowledgeable investors and founders may severely underestimate their expertise, adopting overly cautious strategies while missing out on some great opportunities.
We’ve seen this play out so well recently in India. Rahul Yadav (co-founder of Kult, Broker Network, and housing.com) became a household name recently for all the wrong reasons. I think his story is a phenomenal example of the Dunning-Kruger effect in action from both sides - founders and VCs. Housing raised $120M from Softbank, and was genuinely solving a huge customer pain point. But the founder's fights with investors, massive layoffs, and chaos at the company led to his being ousted from the company. He then went on to raise about 100 Cr for his next venture - Broker network. Still not entirely crazy, as the man had relevant experience with housing and brokers and could be the right guy to build something out in that space. However, this one also imploded due to financial misconduct and alleged misuse of funds, leading to Investors writing it off.
What followed next is, in my opinion, a prime example of overconfidence blurring the actual picture. Rahul, after his alleged misconduct at 2 startups, went on to raise another $20M for a beauty brand, Kult. This is a very common mistake founders make, wherein they assume expertise in one sector would easily translate into success and expertise in another. Rahul had no background in the beauty industry and was mostly just riding the BPC wave. Investors, too, ignored the red flags and felt confident backing a ‘third-time founder’. Everyone knows what happened next to Kult; vendors, and influencers were unpaid, they hadn't paid income tax for their employees, and a whole web of lies was exposed, leaving investor money dangling again.
I do want to say here that everything looks straightforward in retrospect. The idea here is not to bash anyone, but more so to raise awareness on how our own brains often trick us into believing things that aren’t true.
I might be a victim of the Dunning-Kruger effect while writing this, and Kult may, over the years, become a huge ethical beauty brand. But that’s why it's important to think in frameworks more than anything else. Our investment team often applies aggregation theory and cognitive flexibility theory to reason and articulate our genuine feelings about companies and founders. We also have weekly huddles wherein we question each other on any assumptions or potential flags we’re seeing in any companies that we discuss.
The other side of Dunning-Kruger nobody talks about
While this is one aspect of the Dunning-Kruger effect in play, there’s another lesser-discussed theory that Dunning himself discovered: the effect does not seem to apply as easily to women and racial and ethnic minorities.
In one study, Dunning and Ehrlinger found that women performed equally to men on a science quiz - yet women underestimated their performance because they believed they had less scientific reasoning ability than men. Women tend to be the biggest targets of impostor syndrome and might not fit very well into the standard Dunning-Kruger chart, and a similar notion applies to racial and ethnic minorities. As long as you’re not white or a man or a lethal combination of both, you’re much likely to fall into an opposite circular rut of never feeling confident enough!
Learning to trust your voice
I have a personal attachment to this theory, given that I recently became a part of the VC world and didn’t know too much. However, because I came from a tech background, I did know a thing or two about tech companies, and especially AI. But anytime I had opinions on a company or a technology or knew something from previous experience, I would just keep it in my head instead of speaking it out.
Why?
Of course, I was underconfident and feared I might be wrong, but more importantly,
I thought I was in my Mount Stupid phase
So actually, in certain cases, people end up overengineering for the curve, thinking they’re on Mt Stupid when they actually mostly aren’t. This makes sense because these are the people who don’t know how to ever be overconfident - they underestimate almost everything they do and are often driven by societal conditioning and biases.
It’s interesting to me because there’s an analogy here that was very helpful for me - you can’t hit your slope of enlightenment or plateau of sustainability until you hit your Mount Stupid. And it’s okay to hit your Mount Stupid - it’s okay to make a lot of mistakes as you learn because that’s how you move ahead.
One small chart and so many learnings! I think there are many key takeaways from this one -
Try to recognise when you might be biased for/against something and use frameworks, tools to help you mitigate those biases.
Try to recognise when you might be over-engineering for the curve and when it’s your imposter syndrome talking.
Lastly, make a ton of mistakes, learn from them, and then enjoy the green pastures at the plateau of sustainability.
