ontrary to what you might’ve seen in the movies, investors normally do not hand out term sheets to startups after a single meeting or a random encounter. A venture capital firm will often spend weeks if not months researching a prospective investment.
Pitches will usually flow in and start at a firm’s analysts and associates, who will then eventually present the idea to the decision makers at a firm, which are usually the partners that sit on the investment committee (IC). This makes the IC a critical part of any VC firm because it’s the members of the IC that will ultimately decide on whether or not to pull the trigger on an investment.
While they can come in all different shapes and sizes, here are five best practices for building a strong and effective investment committee.
1. Make sure the firm has a strong investment thesis
While IC meetings are supposed to be at least somewhat free-flowing and conversational, members of the IC should be basing the merits of a prospective investment on a specific set of criteria they have laid out and all agreed upon. These criteria will ideally be established in the VC fund’s investment thesis, business plan, or mission statement when the fund was just getting started.
For instance, if a VC fund invests in climate tech startups should they really be investing in a healthcare startup? Maybe, but if the investment is off the beaten path then members of the IC should really make sure it clears a high bar when it comes to other aspects of the VC firm’s investment thesis.
Don’t worry about the investment thesis or business plan making investment decisions too rigid. We can promise you that there will be plenty to debate when it comes to whether or not a company lives up to the standards set in the thesis.
2. Who’s in the IC?
Other than the investment thesis, the single most important part of building the IC is who will be in it and how many members it will have. There’s certainly no right answer and a number of different strategies can be used.
According to a survey conducted by the British Venture Capital Association on more than 100 investment professionals, the typical IC has four to six members, although ICs can range from three to 10 members in larger funds.
The website globalventuring.com also conducted a survey and found that 80% of respondents said ICs were composed of five people or fewer, so the main takeaway is that most are no bigger than five or six people.
Scott Lenet of Touchdown Ventures has written extensively regarding what kind of members should be on an IC. Lenet argued that there are three types of people that should not be on an IC: scientists, business unit leaders, and naysayers.
Scientists, while great at evaluating a product, may not be able to properly evaluate the business opportunity. Business leaders may be too focused on the business alone, while naysayers can be too big of an inhibitor to decision-making. Rather, Lenet believes IC members should possess five key traits.
- Fiduciary mindset: prior experience as a startup founder or serving on a board so they can understand the holistic approach of managing a company and looking out for shareholder interests.
- Financial skills: the ability to actually evaluate a startup so they can push back against assumptions made about burn rate, growth, etc., while also being able to tell when assumptions look accurate.
- Strategic Fluency: Being able to stick to the firm’s business plan and overall strategy. This one is probably more prevalent for corporate venture capital, where Lenet has a lot of experience but can also be applied to other firms as well.
- Availability: being able to show up for meetings and sometimes on short notice, like, say, if you need to move on an investment decision quickly.
- Willingness to trust: The investment will be brought to the IC by a person or team that has done a lot of due diligence and research on the concept. Don’t be afraid to push back on things but make sure to take their research seriously and listen to their opinions.
One other important matter when it comes to ICs is whether or not there should be external participation. Generally, according to Aakar Vachhani, a partner at Fairview Capital, an IC is composed of a firm’s partners.
But it’s important to make sure different views are being represented on the IC. You’ll want to make sure investment proposals aren’t getting approval too easily and you’ll also want to make sure there are enough different viewpoints being represented to study the investment from all angles.
If not it may be worth bringing on another perspective from within the firm or maybe even looking outside if you can’t find the proper perspective internally. A lot of ICs will also rotate so partners serve on the IC for a set period of time and then other partners get an opportunity to serve.
3. Is there a clear voting process?
There needs to be a clear voting process for how each investment decision gets made, especially because there is bound to be disagreements over which companies to invest in. That’s why establishing a clear voting process is crucial.
This could be unanimous, where everyone on the IC must approve the investment, or just a simple majority. Although more uncommon, some firms use a points system, where each member assigns a certain amount of points to an investment and the company must cross a certain threshold of points to get approval.
The important thing here is to make sure the voting system aligns appropriately with the composition of your IC. For instance, if there is a nine-member IC would you really want a unanimous voting system? That’s likely going to bog down decision making. On the other hand, if the IC is only three members maybe a unanimous or points system makes sense. These are all things to think about.
4. Laying out a schedule
ICs obviously need to meet to make decisions and given that everyone on the IC is likely to be incredibly busy, there should be a schedule made in advance, so members have adequate notice and so the schedule can be adjusted accordingly.
It’s hard to say how often ICs will meet but given the amount of pitches a typical VC firm will see in a given year there needs to be adequate time to evaluate the serious investment proposal, whether that’s meeting more regularly or doing some kind of big meeting once a quarter.
Time is money so the last thing you’ll want after all of the decision makers are finally in the same room is to have to waste time going over the basics of a prospective startup. That’s why investment memos and presentations should be circulated well in advance of the meeting so members of the IC have time to go through the materials, get a good grasp of the proposal, and think about questions. This will promote more efficient use of time during an IC meeting and create a more productive conversation at the meeting as well.
Building an effective investment committee is critical for any venture capital firm. A strong investment thesis should guide the criteria for investment decisions, but it should not be so rigid as to limit the committee's ability to assess each investment on its own merit.
Choosing the right people to be on the committee is also crucial, with a focus on individuals who possess fiduciary mindset, financial skills, strategic fluency, availability, and a willingness to trust. Clear voting processes should be established that align appropriately with the committee's size. External participation can also be valuable for providing diverse viewpoints. By following these best practices, venture capital firms can build investment committees that effectively identify and evaluate promising startups.
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