Why I Look for High Conviction, not Consensus, in Venture Capital Decisions
One of the least understood parts of the venture capital industry and venture capital firms is how investment decisions actually get made. The truth is that each firm is different and there isn’t one standard but over the years I’ve talked with enough of my peers to get sense of how many firms work.
Often if it’s a bigger firm (say 4 partners or more) and it’s a super small investment for their fund size (let’s say $250–500k when they normally invest $5–7 million) they will just require 1 or 2 partners to decide. For anything that would be considered a normal investment for the partnership most firms try to make sure every partner has seen the deal and has a chance to weigh in. That’s why the investment process begins with a partner meeting and if they really believe in your business then they “champion you” by inviting you to a full partner meeting.
What happens next feels like a black box to outsiders. They only know if they get a yes, no or “I need to do more work” after that process. Some firms have formal voting structures but in my experience most don’t. If a deal has a lot of support and no strong detractors it will often but up to the sponsoring partner to know what he or she wants to do with the deal. The sponsoring partner will be given feedback on what some partners don’t like about the team, the market, the product, the competition or the deal terms and that partner may have to answer back on those topics at the next partner meeting or maybe even just later that day (depending on time sensitivity of the deal).
If you have a strong-minded sponsoring partner who has a high degree of influence at his or her firm they will often be able to overcome any objections and will just report back what they found to answer the doubters. If you have a NINA (no influence, no authority) or somebody timid or who cares too much about CYA then your deal may not overcome objections raised. In fact, choosing the right partner to champion your deal can have a huge impact on whether or not you get a term sheet in the first place. It’s why in life I always tell people to align yourself with egg-breakers.
Some firms are dictators where there is a “vote” of some sort but the strong-minded leader really decides in the meeting or after the meeting and he or she has the power to kill deals, bless deals or change deal terms (sometimes massively in favor of a high-priced deal). You’d be surprised how many firms are “dictator VCs” — even those that don’t formally acknowledge it internally. The number of partners who have told me, “yeah, we all decided X in the meeting but then [insert dictator VC name] decided he wanted to win the deal so badly that he was willing to pay up to win it.”
Some firms are collegiate. They like to have deals in which a large number of people agree or perhaps where nobody is against a deal. I would call these “consensus VCs” and most likely are inhabited by country-club partners who are used to avoiding conflict.
There’s a problem with consensus driven decisions by VCs. I personally believe the most interesting companies are often doing things that most rational people would too outlandish, too against industry norms, too difficult technically, too much regulation or similar. I can’t imagine most consensus-driven decisions would have thought Oculus, WhatsApp, Airbnb, Uber or DropBox would have been as massive as they have become.
When you’re newer in VC many partners choose to play it safe, doing smaller investments and not trying to bet on something that a “far out” risk. I understand that and actually think it’s ok because that partner gets experience with making investments, sitting on boards, finding co-investors, managing founder relationships, etc. But once your feet are firmly under the desk, I believe the job of a VC is actually to make the harder bets.
I think the best VCs don’t mind the snickering of their VC industry peers (and believe me our peers love to snicker) and the doubting of their friends or colleagues or spouse. I have developed a line of thinking and a common retort for people who ask about some of these deals and I often say,
“I don’t mind being wrong. If we don’t have any deals that go sideways we probably aren’t taking as much risk as we should.
But if I fail, I want to fail for the right reasons. I want to fail because I backed an extraordinary entrepreneur with a super-ambitious project and we were just wrong about market timing, customer adoption, competition, regulation or similar.
The beauty of venture capital is that on any given deal I can only lose one times my money. But if I get it right then I need to bet on things that could deliver 50x return or even 100x. I need to bet on things that could help create an industry.”
And obviously that’s hard to do. We’ve been betting more aggressively on agriculture technologies because we believe that water scarcity will be one of the defining issues of the next generation and we believe this will drive huge economics and have an impact on the world. We’ve backed more healthcare companies even in parts of the industry with regulation.
These deals seldom have complete consensus. And as a firm we try to breed that culture. We want really high conviction amongst the sponsoring partner so that he or she is acknowledging that he has heard the strong negative feedback, will be thoughtful about it and if he or she still feels strongly he will continue to advocate aggressively for the deal. Often we look for at least one wingman partner to believe but it’s not a requirement. And if 3 or 4 partners are opposed to a deal or if there are extenuating reasons we shouldn’t do the deal the negatives may carry the day.
But the defining factor of our internal decision process is “conviction.” I trust my partners to make hard calls on investment decisions because no decision to invest millions of dollars is easy and if it’s an obvious idea I can promise you 20 other teams are raising money to do the same thing.
I thought to write a bit about this because last week I was asked by Jonathan Triest to agree to a short interview for his series called Carpool VC. He and his partner Brett deMarrais drive around in a car together and interview VCs. You should follow these guys on Twitter. They have insights others don’t, they are getting into early-stage deals across the country that have become big but they backed the companies before others. They run a firm based in Detroit called Ludlow Ventures and do deals on a national level. And they have started cranking out super interesting videos. Honestly, they are a refreshing group of hustling, young, early-stage VCs and I love working with them. And if they asked me for money in their next fund I would definitely say “yes.” Guys?
In the show, they asked more insightful questions than I typically get. They asked both “Why and how did you change your brand” but also the obvious follow-up nobody thought to ask, “what was your alternate choice?” I revealed it but you have to watch the video :)
They asked what “I hate about LA,” “What question I would ask to decide who to marry” and importantly, they asked me, “If there is a deal that comes across your desk that you fall in love with but your partners vehemently hate it, what happens?” I talk extensively about this in the interview.
The interview on YouTube is here (I started it about 3 minutes in where I first dial in) or your can watch it embedded below. If you’re ok with 3 minutes of schtick start from the start if you want to get straight to the interview it starts just after the 3 minute mark. I hope you get a chance to watch it (or listen to it). It’s both fun and informative.
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