The emotional side of investment

Posted in: Business and society, Entrepreneurs, Research4Good

What role does “likability” play in the allocation of funding by development banks, and how can entrepreneurs use this to their advantage? Dr Richard Fairchild spent several years working in collaboration with European Bank for Reconstruction and Development (EBRD) to develop a model explaining why development banks choose their investment partners. In this piece, he explains their findings, and their significance for entrepreneurs in developing nations.

In these times of increased economic scrutiny, the call to base investment decisions around an ethical framework has become more pronounced. Economic development must be considered alongside environmental and social factors.

To this end, the European Bank for Reconstruction and Development (EBRD) works with entrepreneurs in developing countries to build their markets around a set of values. They invest in businesses that will help them establish an ethical framework in the economy – those that have a social impact, or advance sustainability.

This model helps explain several key factors behind these decisions, by examining why some investment pitches succeed and others fail, and what incentives all the participants have to work together.

Most of us believe that our financial institutions run as objective, systematic machines; driven by statistics and prizing efficiency, economy and performance. We could be forgiven for thinking that algorithms and data drive most decisions, and that the opinions of the people involved play little part. This new research challenges these assumptions. The findings suggest that human relations are in fact an essential component of the EBRD’s processes.

How the process works

As entrepreneurs often don’t have the resources or expertise to pitch for investment directly from EBRD, and in order for EBRD to develop local institutional management capacity and thereby be able to scale its financing activities, EBRD will often invest in local private equity or venture capital fund managers as the “middle man” between EBRD and entrepreneurs. Not only do such managers pitch for funds from EBRD so as to be able to finance the entrepreneurs, but they act as partners by supporting and guiding the business with their expertise. As a result, the entrepreneur’s vision, or plan, reaches the Bank through the filter of a third party.

During the pitch, the Bank grades the fund managers’ pitch based around a number of economic factors, tallying up the scores to determine whether they proceed for further assessment and receive the requested funds.

If the Bank chooses to finance the business, it will provide a range of value creation benefits such as integrating environment, social and governance standards, providing wider industry perspective to the manager and entrepreneur, but will also function as a “political umbrella”, to protect their investment in the area.

Complex relationships

This process may seem straightforward, but in reality it’s anything but. For the investment relationship to work, all players have to cooperate in order to create value, and this dynamic is already complex, as there are three players involved. As a result, most other financial modelling is unsuitable as it’s based on a theory of a two player relationship.

In addition, there is a fine line between help and potential interference in the role of the private equity/venture capital fund manager. If the Bank chooses to invest they must be certain that the relationship dynamics will succeed.

The human element

This model draws on behavioural economics to form its conclusions. While traditional economics views market forces and financial behaviour through a scientific, rational lens, this theory incorporates the human element. It assumes that even economic interactions will be affected by the emotions or possible irrationality of the people involved.

In this instance the model showed that a development bank made its decision within two broad parameters:

  1. The economic ability of the PE/VC team.
  2. The behavioural characteristics of the PE/VC team.

The second factor is surprising. It showed that the personal characteristics and attitude of the team had a significant effect on their success in pitching. Passion and empathy has as great an impact as economic ability. In essence – likability gives you a significant advantage.

While we may reasonably expect the bank to take a purely dispassionate, factual approach to such big financial decisions, the likability of the team is a legitimate consideration within this three player relationship. The Bank must be certain that the PE/VC team will be in a position to both successfully work with the entrepreneur to build their business, but also with the bank itself, in each case over a long time horizon.


The next stage is to expand the research, to try and build this piece of work into a real world process. However, it already has a number of significant implications. From the Bank’s viewpoint, it helps them analyse their behaviour and make better decisions on their pitches. From the private equity/venture capitalist perspective, it will help them build their pitches more successfully. For the local entrepreneur, it might help them rethink their choice of fund manager, hopefully leading to the growth of socially and environmentally beneficial projects in developing countries.

Based on ‘A Development Bank’s Choice of Private Equity Partner: A Behavioural Game Theoretic Approach’, by Dr Richard Fairchild and Ian Crawford of the University of Bath’s School of Management, and Adil El-Fakir of Sheffield Business School, Sheffield Hallam University. With assistance from Troy A. Weeks and Maria Musatova, European Bank for Reconstruction and Development.

Posted in: Business and society, Entrepreneurs, Research4Good


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