The Checklist Manifesto

In the late 1990s, the early go-go years of the internet, a psychologist at Claremont Graduate University, east of Los Angeles, began a study of 51 venture capitalists. Geoff Smart wanted to know how they decided whether to give entrepreneurs money or not. The venture capitalists must yea or nay high-risk, multi-million-dollar investments in unproven start-up companies. The ideas might be little more than scribbles on a sheet of paper or clunky prototypes that barely work – but then again, that’s how Google and Apple started out. You would think venture capitalists’ decisions would centre on whether an entrepreneur’s idea was a good one. But finding a good idea is apparently not all that hard, Smart learnt. Finding an entrepreneur who can execute a good idea is a different matter entirely. You need a person who can take the idea from proposal to reality, work the long hours, build a team, handle the pressures and setbacks, manage technical and people problems alike, and stick with the effort for years on end without getting distracted or going insane.

Such people are rare – and extremely hard to spot. Smart identified half-a-dozen different ways the venture capitalists he studied decided whether they’d found such a person. These were styles of thinking, really. He called one type of investor the “art critic”. He or she assessed entrepreneurs almost at a glance, the way a critic can assess the quality of a painting – intuitively and based on experience. “Sponges” took more time gathering information about their targets, soaking up whatever they could from interviews, on-site visits, references and the like. Then they followed their gut.

Smart certainly isn’t the only one noticing society’s – and industry’s – resistance to change. Recently I’ve met three investors who have taken a page from aviation to incorporate formal checklists into their work. Mohnish Pabrai is managing partner in Pabrai Investment Funds in Irvine, California, and runs a $500m portfolio; Guy Spier is head of Aquamarine Capital Management in Zurich, a $70m fund; the third did not want to be identified or to reveal the size of the fund where he is a director. But it is one of the biggest funds in the world and worth billions.

These three people are value investors, buying shares in under-recognised, undervalued companies. They don’t time the market. They don’t buy according to a computer algorithm. They do intensive research, look for good deals, and invest for the long run. Over the past 15 years, Pabrai has made a new investment or two every quarter, and he’s found that each one requires in-depth investigation of 10 or more prospects. The ideas can bubble up from anywhere but most drop away after cursory examination. Every week or so, however, he spots one that starts his pulse racing. It seems surefire. He can’t believe no one else has caught on to it yet. It could make him tens of millions of dollars if he plays it right. “You go into greed mode,” he said. (Spier called it “cocaine brain”.) And that, Pabrai said, is when serious investors try to become systematic. They focus on dispassionate analysis, on avoiding both irrational exuberance and panic. They pore over the company’s financial reports, investigate its liabilities and risks, examine its management’s track record, weigh up its competitors, consider the future of the market it is in.