A key aspect of the governance of a VC firm is its decision-making process. In this article, we share the key components of VC decision-making and discuss trade-offs between different decision designs.
Components of VC Decision-Making
Investment Committee Size (# of people on the IC)
In early-stage Venture Capital, the size of the Investment Committee ranges from one to four people. The main trade-off when it comes to IC size is in objectiveness versus individual investor talent. The larger the IC, the more objective each decision will be, but individual talents will be “diluted” by a larger group. Depending on the voting mechanism, it may be important for the size to be either even or odd.
IC Members
It is standard practice for IC members to be internal (part of the investment team). But in some cases, there may also be external parties (LPs, VPs, Advisors) who are voting members or observers. These external members can also rotate over time. The involvement of external members is a double-edge sword: Adding an external observer or technical advisor to a DeepTech IC can add great value, but giving a vote to an LP may completely shift the power dynamics of decision-making.
VC Decision-Making Voting Mechanisms
In a VC firm, there are two different ways of arriving at a decision:
1. By Majority – The downside of majority-based mechanisms is the increased chance of doing a wrong deal.
2. Unanimously – The disadvantages of unanimous decision-making are twofold: Early-stage ventures often require contrarian views, which are incompatible with unanimous thinking. In addition, this type of mechanism could incentivize team members to do “politics” to win deals, putting team dynamics at risk.
Special Rules to Voting
1. Superpowers / Stronger Votes – In some cases, certain IC members can have special voting powers. For instance, if the votes are even, one member could have the last word. In other cases, the vote of a member could weigh more (for example double) than all the others. These type of powers or rights are a good proxy of how the team is organized and what the power dynamics are. The key thing to bear in mind is that in very unequal contexts, people are incentivized to leave.
2. Veto powers – Similarly to above, some members of the team can also have a veto power, which can sometimes lead to a Mexican standoff.
3. Silver Bullets – In some cases, every IC member is granted a “silver bullet”, which is the possibility of doing an investment even if the rest of the IC is against it. Usually, the number of bullets is limited and is max 1-3 per fund, depending on team size. This rule enables ICs to integrate the objectiveness of unanimous decisions while granting individuals to do contrarian deals in exceptional cases.
4. Scoring Systems – In some contexts, firms prefer to make decisions based on scores rather than “votes”. In this system, every IC member gives a vote to the deal (or to separate aspects of the deal), that is then made if the score is above a certain threshold. Scoring system can also be used as “guidelines” rather than actual voting systems and the design of the scoring method can vary dramatically from firm to firm.
Three Examples of Voting Mechanisms
Example 1: Two GPs and Two Rotating LPs with a unanimous system
In this system, there are a few problems. First of all, IC members rotate, making it difficult to build trust between them. Decisions will be subject to some degree of randomness, depending on the members, as well as to constantly different preference and risk and return appetites.
At the same time, this structure prevents GPs from making independent decisions since they need to convince two other external members. Those members are both LPs, meaning that GPs will have an incentive to find deals that LPs like, instead of deals that are good but the LPs may not understand.
Example 2: Four GPs with Scoring System with 10 points per Partner and 37 point threshold
With this system, every partner has 10 points and if the total is 37 the deal goes through. In this case, the system is similar to a 4 GPs unanimous system. The problem is that basically all the GPs must be very, very comfortable with the deal. If only one person gives a score lower than 7, then deal does not pass. The outcome is that the portfolio will be made only by obvious bets without enough risk.
Example 3: Three GPs with a Majority System and a Silver Bullet per GP
In this case, every partner – even in a minority position – can still push through a deal she/he really believes in. Overall, the design of this system is decently balanced compared to the other two as it integrates the objectiveness of a larger team while leaving space for exceptions.
We realize that the IC composition and rules are often the result of a negotiation, and that decision-making is not always aimed at the best output but at the best compromise. However, we recommend thinking carefully about the trade-offs of your decision-making structure. Not in all fields does being very creative lead to good decisions.
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Authors
About Danchun Chen
Danchun joined Blue Future Partners as an Analyst in 2020 as part of the research team. She is fascinated by the great impact of venture capital and tech startups on the future economy at a global scale. Before joining BFP, she spent time in Strategy Consulting, Startups and Venture Capital across China, France, Singapore, India and Switzerland.
Danchun holds a Master in Management from EDHEC Business School in France and a Bachelor of Arts from South China Normal University.
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About Marco Cesare Solinas
Marco is an Investment Professional at Blue Future Partners. He is passionate about Technology and Venture Capital and focuses on both direct and indirect investments. Previously, he has built an international and multicultural background across Italy, US, Germany, Turkey and Malaysia.
Marco holds a CEMS Master’s in International Management and a Bachelor´s in Economics and Finance from Bocconi University.
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