Syndicators, fund managers, and businesses are all at the mercy of economics. But not all economics are outside forces. Some of them are internal. We’re going through what has been called behavioral economics – the things that drive us internally and shape the way we put our offers together, often in a negative way. We need to examine these forces to ensure we’re not playing victim to them, and make changes for the better – not only for our investors but also for ourselves and for the truth in the market as a whole. To make the world a better place, we need to understand what drives us and how we make decisions. In this video, we are going to go through the last three of the cognitive behavioral elements.
There are nine cognitive behavioral economic forces that work inside our heads. These forces are present in everybody, some to a greater extent than others. The idea is, if we can understand what these are, we can examine ourselves and our processes. When doing an analysis or putting a deal together – whether it’s for a fund, a syndication, or a business – we can ensure that the information we’re compiling is accurate and neutral. We want to avoid driving things based on faulty logic, which is what cognitive behavioral economic forces often lead to.
We’ve already gone through conservatism, confirmation control, representativeness, hindsight, and framing. What we haven’t covered yet are the final three: anchoring, mental accounting, and availability. Let’s go through these individual forces and how we can address them.
Anchoring bias refers to fixating on a specific outcome rather than being flexible. For example, if you think a candy bar should cost 50 cents because that’s what it cost when you were a kid, you’re anchoring to that price. In business, this might manifest as insisting on selling an asset at a specific cap rate or multiple of earnings, even when market conditions don’t support it. Anchoring happens all the time in our communication with investors. People start getting anchored to the numbers we provide, which is why we set things like targeted returns.
We need to address anchoring by openly asking ourselves: Am I getting stuck on any specific number? Is there evidence to the contrary? If the market is telling you a different fair market value, it’s time to pay attention and adjust your numbers accordingly.
Mental accounting is thought of as an improper grouping of wealth. For instance, some business managers might add the value of their company to their profits when budgeting for new items, treating the company’s paper value as if it were cash on hand. Another example is an investor planning an expensive vacation without considering their liabilities, not doing a real grouping of their actual income. To address this, we need to look at line items very specifically and ask if an accountant would agree with how we’ve set up our accounts.
Availability bias is where we place more value on information that’s easily gathered. This often manifests in response to heavy advertising. If you see ads for the same product repeatedly, you might rank it higher than it deserves. This can also affect investors’ perceptions in a 506(c) offering. If investors see your ads frequently, they may naturally rank you higher because you seem to be everywhere. As a sponsor or fund manager, it’s important to base your decisions on more than just the prevalence of advertising or how easily available information is.
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. We’re discussing these biases because they apply to syndicating, putting a fund together, or raising capital for a business. I wear two hats – one as an attorney and one as a syndicator myself. I thought it would be useful to go through the same kind of underwriting details that I have to check myself with, and I’m sure you do too, to make sure we’re not falling victim to these biases which could throw off our numbers.
If we can help you put your syndication or fundraise together, or help raise money for your capital by providing not only the necessary legal documents but also all of the information I have as an experienced syndicator, we would be happy to talk with you. Give us a call today.