Investment committees are the VC partners’ meetings that make or break deal opportunities. They remain largely secretive in an industry that has opened considerably in the last few years. Like all human interactions, ICs are fraught with secret agendas and (sometimes unconscious) cognitive biases, the largest of which is confirmation bias. IC rules and dynamics make or break VC firms’ performance.
In this post and the companion webinar, I uncover hidden truths of VC investment committees and share best practices, including how to create winning investment committee memos, the rules used in the best VC firms to make IC decisions, the psychological barriers you should be aware of, and how to defuse them.
In This Post
- Investment Committees: The Basics
- How To Write World-Class Memos For Investment Committees
- VC Investment Committees: Internal Dynamics
- Recipe for Success or Disaster: Voting Rules in Investment Committees
- Alternative Models: Equal Partnerships And Solo GPs
- How To Break Confirmation Bias Grippling VC Investment Committees
- Conclusion: tl;dr
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Investment Committees: The Basics
VC firms’ investment committees are one of the last bastions of secrecy in an industry that has opened considerably since the veil started lifting at the end of the 1990s. When Harvard professors Paul Gompers and Josh Lerner published their book The Venture Capital Cycle in 1999, little was understood about the asset class. We now live in the opposite situation: so much content is produced by industry players, including VCs themselves, that it’s become necessary to curate the best of the crop.
Yet, for reasons I detail in this post and the companion webinar, VCs are usually shy about providing details about their internal decision-making processes—except for Bessemer Ventures, who shared internal documents I analyze below. The primary reason behind the secrecy is that investment committees are the VC firm’s battlefield, where egos fight for more power and money.
The great challenge at venture partnerships is that the principals must refrain from killing each other.
Michael Moritz (Source: The power law)
Moritz, who’s long been the co-head at Sequoia, was ideally placed to witness and participate in such intestine wars. I’ll get back to these dynamics later in this article.
Why Do IC Meetings Exist?
Among the other transaction-related investment practices, Venture Capital is unique in the abundance of deal flow analysis it requires. When I started my private equity career in LBO financings in the mid-2000s, we typically studied a few dozen opportunities yearly. Those we spent more resources on would take weeks, if not months, to diligence. Spending six to nine months almost full-time to structure and realize an operation was common.
In contrast, early-stage VC firms receive thousands of opportunities yearly, with less manpower to sift the deal flow. VC firms typically have a top-heavy structure, which is why landing a job in Venture Capital is so challenging. The VC deal funnel I show in the webinar shows all the steps in the process and the associated probability of success for startups raising VC funds.
Studies show that a fraction of investment opportunities reach the IC level (the analysis shows 9% of considered opportunities, but how many were received?), and only one in ten are realized. Even top-of-the-crop startups, such as those accelerated at Y Combinator, have a low probability of getting funding. In the article below, I dive into VC’s deal flow screening process.
The investment committee is the gateway opportunities must go through before a VC firm commits more time and money. It’s the Cerberus of the Venture Capital world. Many practices of Venture Capitalists become clear once you understand the role the IC plays in the deal funnel, starting at the top:
- Warm introductions and referral networks help VCs get qualified deal flow, which means more time allocated to promising opportunities
- Pitch decks allow experienced investment professionals to make a go/no-go decision in a few minutes
- Management meetings, where Founders pitch to VCs, are designed for VCs to gather hard data but also interpret signals on the quality of the Founding team—the most significant investment decision criterion at the early stage
- Due diligence, first exploratory and then confirmatory, once the IC sanctioned the spend, serves the purpose of preparing the IC memo and confirming that the “house is in order”
- Term sheets make sure that the VC firm will not spend too much time and resources if the partners can’t agree on basic terms with the Founders
While the last VC bubble compressed the time to make decisions, as new entrants and aggressive players started to deploy capital frantically, the market’s current state allows for a more serene decision-making process.
Investment Committees Matter
Despite the bickering and occasional murderous thoughts, well-run ICs help VCs attain multiple objectives.
Most Venture Capital firms are partnerships with more or less equal voting rights among GPs (a point I dive into below). While deal opportunities are routinely discussed in more informal gatherings—such as the Monday morning meeting—the IC meeting is the forum for deciding resource allocation. Given the sheer volume of deal flow they receive and the many tasks they juggle daily, it is paramount to dedicate time to the most promising investment opportunities.
Money is another parameter. VC firms bear the cost of post-term sheet audits if the transaction is not consumed. The fees they charge LPs barely cover pay and rent, let alone diligence costs for multiple deals falling through. Before they commit to such potential expenses, partners want to ensure they minimize the risk of eventually footing the bill. The IC meeting’s role is to evaluate the chances of success and the opportunity costs associated with the deal team’s request.
It takes time to build the trust to listen to your partners, without taking it personally, and get better.
David Frankel – Founder Collective (Source: 20VC)
There are two more reasons to hold IC meetings despite the time they mobilize—several opportunities are typically presented during each meeting, and partners must go through all of the material in advance.
The first reason is that ICs allow for sharing expertise, networks, and points of view on the opportunity presented. Since Venture Capital is mostly about interpreting signals, having several people around the table with different perspectives helps. As I showed in another article, diverse VC teams perform better.
The other reason why ICs matter is more subtle yet significant. They are an effective tool to fight off confirmation bias. A pernicious effect of working on an investment opportunity is that Investors bond with the startup’s Founders. While building trust is helpful because VCs will sit on the startup’s Board for years to come, there is a risk of losing objectivity and becoming biased supporters of the startup, disregarding obvious perils or putting them aside by focusing only on positive aspects.
Basing the discussion on data—insofar as possible in VC—forces the deal team to question their judgment. In the webinar, I play an extract of a 20VC episode with Founder Collective’s David Frankel, who eloquently makes this point.
Investment Committees debate the merits of every opportunity based on the Investment Committee Memo or IC Memo. In the next section, I dive into the best practices to write effective IC memos.
How To Write World-Class Memos For Investment Committees
Although VC firms’ IC memos have circulated online for a few years, they remain difficult to understand and emulate for the untrained eye. In the webinar, I review a couple of memos from top firms such as Bessemer Venture Partners (BVP) and Sequoia. My objective is to help professionals relatively new to VC avoid a typical mistake. Most recent VC professionals focus too much on the risks instead of imagining mitigants, i.e., reasons to feel comfortable about the risks identified—which will be tested in the next growth phase.
The IC Memo’s objective is not to underplay the risks in a bid to push for the deal during the IC; or, on the contrary, overplay them to cover your butt if the venture goes south. The art of the IC memo lies in the section called Risks & Mitigants. Experienced VCs know how to provide data demonstrating why they are comfortable with the potential risks they identified.
They do so in a variety of ways, highlighted in the webinar:
- Ask experts for their opinions
- Use analogies from other industries
- Build sensitivity scenarios
For instance, Sequoia gets comfortable about the lack of visibility on YouTube’s exit by taking analogies from photo-sharing apps. For their part, BVP gets behind a pricey round for LinkedIn by demonstrating that the structure protects their downside risk.
On top of the examples you can watch in the webinar, I recorded short videos showcasing some IC memos from elite VC firms.
#1 – Twitch
I focus on how the deal team reports deal dynamics, how they fight intuition with data, their take on the team, and how they get comfortable with the main risk: market size.
#2 – YouTube
I focus on how elite VC firms think about value-add before the investment is made, how they try to reduce uncertainties around the company’s growth (here: monetization), and how the staging investment technique works.
#3 – Shopify (Part 1)
I illustrate two of the seven secret evaluation criteria VCs use to evaluate investment opportunities: internal standing and mental models. I also discuss the growth vs. profits trends in Venture Capital, which are detailed in my article: How Venture Capitalists Evaluate Unit Economics. While the VC market has put profitability forward since the 2022 market correction, the temptation is always present in upcycles to focus on growth.
#4 – Shopify (Part 2)
I talk about VCs’ methods to interpret signals during the exploratory due diligence phase. I also further analyze the deal structure, discuss the problem with cost asymmetry in Venture Capital, and explain how Investors try to reduce it.
VC Investment Committees: Internal Dynamics
I always illustrate the internal workings of investment committees with the intense jury deliberations portrayed in the 1957 Sidney Lumet classic, “Twelve Angry Men.” In the film, twelve jurors are tasked with deciding a verdict, with each member bringing their perspectives, biases, and convictions to the table.
Similarly, the VC IC is a crucible where diverse viewpoints and investment theses are debated fervently. Each member serves as a juror of sorts, weighing the venture’s potential. IC members must navigate personal convictions, collective reasoning, and the pressures of looming cognitive biases to arrive at a decision that could shape their firm’s success or failure.
Consensus vs. Conviction-Driven Firms
The decision-making ethos of Venture Capital firms can be broadly categorized into two paradigms: consensus-driven and conviction-driven.
As the term suggests, consensus-driven firms seek unanimity or near-unanimity in their decisions, aspiring towards collective agreement and shared confidence in every deal they pursue. While fostering a sense of mutual responsibility, this approach may also dilute individual accountability and lead to more conservative investment choices.
Conviction-driven partnerships want to know that the deal “sponsor” is willing to have his or her head on the chopping block advocating for this opportunity.
Mark Suster – Upfront Ventures (Source: INC.COM)
Conviction-driven firms, in contrast, are spearheaded by Venture Capitalists who are willing to push for a deal they believe in, even in the face of skepticism. This model empowers passionate advocates to champion non-obvious opportunities, potentially capturing transformative ideas that consensus might overlook.
The Challenge of Cognitive Biases
Venture Capital operates at the frontier of innovation, where disruptive ideas naturally meet skepticism, and decisions are made in the shadow of uncertainty. Without hard data, Investment Committees rely on interpreting signals, making Venture Capital a hotbed for cognitive biases such as Fear Of Missing Out (FOMO), Fear Of Looking Stupid (FOLS), and confirmation bias.
I wrote over two dozen articles on the various biases that VC is fraught with. The article below, which focuses on the main ones in the startup evaluation process, is a good place to start.
These biases can cloud judgment, influencing decisions in subtle yet profound ways and leading to errors of omission, which I call “the “VC’s capital sin.” The IC’s task is to recognize these biases and mitigate their influence, ensuring that skepticism does not stifle potentially groundbreaking ideas, and excitement does not lead to overzealous investments.
The Impact of Internal Politics: No Retribution And No Reciprocity
Internal politics within Venture Capital firms can significantly influence decision-making. Policies of “no retribution” and “no reciprocity”, discussed by Upfront Ventures Mark Suster in the post referenced earlier, should be instituted to cultivate a culture where investment committees can operate without fearing internal consequences.
A no retribution policy ensures that dissenting against a deal does not lead to punitive repercussions, encouraging open debate and honest feedback. The no reciprocity rule is equally crucial; it prevents the establishment of quid pro quo arrangements, which can result in compromised investment quality.
These rules are essential for maintaining the integrity of the decision-making process, allowing Venture Capitalists to make decisions based on conviction and the merits of the investment, rather than internal politics or personal agendas.
I went through the abyss on my own, and I came through on the other side. I learned the value of the abyss. It has huge value.
Doug Leone – SEquoia (source: 20VC)
Sequoia’s approach to internal dynamics, as illustrated by its commitment to assisting struggling partners, aligns well with the policies discussed earlier. Doug Leone, who co-led the elite VC firm for two decades, highlighted the importance of tailored support in navigating the “abyss”—a metaphor for the challenging periods in a Venture Capitalist’s career.
Sequoia’s culture of nurturing rather than penalizing allows for growth through difficulty, encouraging partners to conduct rigorous due diligence and elevate their standards without fearing internal fallout. It fosters an environment where partners can be candid about their struggles, seek guidance, and ultimately emerge as successful Investors.
Recipe for Success or Disaster: Voting Rules in Investment Committees
The voting rules adopted by Investment Committees critically shape decision-making processes. Elite Venture Capital firms meticulously craft these rules, understanding their profound impact on investment outcomes. How partners vote influences the firm’s strategic direction and embodies its risk appetite.
Three Types of Voting Rules
The simple majority voting system, characterized by its straightforwardness, requires more than half the votes for a proposal to pass. This system’s primary advantage lies in its promotion of democratic decision-making and its ability to expedite the decision process, thereby avoiding protracted debates. However, it risks marginalizing minority viewpoints, which could be crucial for a comprehensive analysis. Additionally, it may lead to a groupthink scenario, potentially overlooking diverse perspectives and risks.
The supermajority voting system demands a higher threshold for approval, often set at two-thirds or three-quarters of the votes. This system ensures a broader consensus and thoroughness in decision-making, effectively mitigating the risks of impulsive decisions. Nevertheless, it can slow the decision-making process and potentially lead to deadlocks, especially in diverse committees with varying opinions. It also promotes the internal wheeling and dealing mentioned before.
The no-vote system eliminates formal voting altogether. The IC becomes a forum to discuss the potential pros and cons of the investment opportunity, but the decision is ultimately delegated to the lead partner on the deal. This system enables Venture Capital firms to pursue non-obvious opportunities that might not receive widespread support. However, partners who decide to invest in the face of potential negative feedback from other IC members might find their internal standing compromised if the investment does not perform as expected.
How To Optimize VC Investment Committees Voting Rules
Little research has been done on VC IC voting rules. I was able to find a 2023 paper investigating the rationale behind different voting rules used in VC ICs during various stages of investment. The researchers surveyed some of the 55 largest U.S. VC firms, analyzing their stated reasons for their choice of voting rules and examining these responses through conventional models of information aggregation in committees.
Single partner championing allows early-stage VC firms to catch outliers, while conventional majority or unanimity rules is more frequent for late-stage investments.
MAlenko, Nanda, Rhodes-Kropf, & Sundaresan (Source: Harvard business school working paper, 2023)
Key findings indicate that many VC firms surveyed use the “champions rule”—where one partner can engage the firm—primarily for early-stage investments to catch outliers. These potential high-impact startups may not show immediate promise but have high returns. The paper’s authors also found that majority or unanimity rules are preferred for later-stage investments.
The research supports the idea that for early-stage ventures, where the distribution of investment returns is significantly heavy-tailed, the champions rule can increase the likelihood of selecting high-return investments compared to a majority rule, which may reduce the chances by up to 70%.
Alternative Models: Equal Partnerships And Solo GPs
Equal partnerships and solo GP models represent alternative approaches to the traditional IC, each with unique mechanisms for decision-making and interest alignment.
Equal Partnerships
Equal partnerships are designed to align partners’ interests and avoid the pitfalls of internal politics. In this model, each partner has an equal stake in the firm’s success and equal voting power on investment decisions.
This structure eliminates the potential for backroom dealings where partners might trade favors on deal approvals. It also discourages partners from blocking deals to secure more allocation to their own projects. By having an equal partnership, each partner’s success is tied to the firm’s collective success, fostering a culture of collaboration and mutual support.
This approach can help ensure that investments are made based on their merits, rather than individual partners’ clout or self-interest.
A lot of firms are set up hierarchically, which leads to competition and negotiation on carry splits, and politics. We thought teamwork would be better served if we took the hierarchy off the table.
Bill Gurley – Benchmark Capital (Source: Techcrunch)
The most famous equal partnership is Benchmark. Each partner shares equally in the management fee and the carry, which has profound implications for the firm’s dynamics.
This equality ensures that when a new partner is brought into the fold, they are a full team member from day one. Benchmark’s absence of hierarchical structures prevents internal competition for fund allocations and discourages the politics that can arise in firms where economic shares differ among partners.
One rare feature of such partnership is that carry interest, the profit-sharing scheme rewarding overperformance, is equally distributed among partners. As highlighted in the webinar below, this is far from the case in most VC firms.
Go Further: How Much Do Venture Capitalists Make?
This model engenders a collaborative environment, free from the temptation to engage in quid pro quo dealmaking. As Gurley notes in a Techcrunch interview, it also creates a powerful peer pressure to contribute equitably to the firm’s success, as everyone shares in the returns of each investment.
Solo GPs
Solo General Partners (GPs) are the antithesis of traditional Venture Capital firms by centralizing decision-making authority within a single individual. AngelList’s data shows they are among the best investors by markup rate, indicating their strong performance.
In recent years, solo GPs have raised funds exceeding $100M and led rounds in notable unicorns, challenging traditional VC firms. This shift reflects a broader trend towards individualized, agile investment strategies that leverage personal branding and Founder experience.
Solo capitalists raise larger funds and write larger checks than super angels – i.e. $50M+ funds, and are able to invest $5M+ in rounds.
NIKHIL BASU TRIVEDI – Footwork (Source: website)
These “solo capitalists,” a Nikhil Basu Trivedi coined to describe solo GPs who invest alone and compete to lead Seed, Series A, and later stage rounds against traditional venture capital firms, operate with agility, often being able to make quick investment decisions without the need for committee consensus. They typically build their investment approach around their personal brand, and because of their streamlined structure, they can offer founder-friendly terms and adapt quickly to market changes.
Solo GPs leverage their networks, often comprised of other founders and operators, to add value beyond capital. As these individuals raise larger funds and establish a track record of successful investments, they increasingly compete with larger Venture Capital firms for lead roles in funding rounds, highlighting a shift towards a more nimble and responsive investment model in the Venture Capital landscape.
How To Break Confirmation Bias Grippling VC Investment Committees
Confirmation bias is the tendency to favor information confirming existing beliefs or hypotheses, leading to suboptimal decision-making. It can cause ICs to overlook critical data, undervalue contrarian insights, and follow the herd instinct, potentially missing out on groundbreaking investments.
In the webinar, I detail several methods to combat confirmation bias, which I call “VC’s poison pill.” These methods include:
- Awareness: Analyze your biases when evaluating an investment opportunity
- Adopt skepticism: Question assumptions and encourage debate to challenge the status quo
- Conduct thorough due diligence: Evaluate investments independently, without over-relying on others’ analyses, which I call “proxy due diligence”
- Suspend immediate judgments: Postpone intuition-based decisions until after a comprehensive data review
- Manage FOMO: Be vigilant against the “Fear Of Missing Out,” which can cloud judgment with urgency
- Cultivate diverse perspectives: Ensure the IC comprises individuals with varied backgrounds to bring a breadth of thought to discussions
Watch the webinar for more details with real-life illustrations such as Theranos. (Members: click here).
Conclusion: tl;dr
Venture Capital Investment Committees are the backbone of strategic decision-making in Venture Capital. In this article, I delve into the foundational reasons for their existence and their critical role, navigating a journey through crafting world-class memos for ICs, dissecting the nuances of internal dynamics, and pondering the strategies for optimizing voting rules. The crux of effective IC operation lies in mitigating cognitive biases and internal politics, ensuring decisions are made on the merit of the opportunity rather than the sway of preconceived notions or backdoor negotiations. Embracing these insights can lead to more successful investment outcomes.
