What is an Investment Committee?

In the past few chapters, we learnt the basics of VC and how the intention to invest is conveyed through a term sheet. And we mentioned the presence of an Investment Committee (IC) in a few chapters. Here is a quick explainer of what an IC is and how it is constituted.

An IC in a VC fund is a group of individuals, usually partners in the VC fund, responsible for signing off on an investment opportunity. IC is typically composed of experienced professionals with diverse skills and backgrounds.

While the investments within the VC funds are fronted by several members, the eventual decision on the go or no-go on the investment lies with the IC. Usually, the analyst leading the investment conversations does a few things before an IC meeting –

1. Prepare a detailed memo listing out the opportunity, risks, and details of the investment opportunity;
2. Predict questions that might be asked in an IC meeting by the IC members;
3. List out the exact ask for the IC – essentially the investment amount and why it makes sense to take the bet; and
4. Prepare a report on the Due Diligence (DD) that was conducted for the investment to be shared with the IC.

While all of this seems quite simple, there are several nuances with an IC. Ask any VC fund, and you will hear about how critical IC is to their decision-making. A well-rounded and experienced IC will help the VC fund avoid being blindsided by biases and a lack of understanding of the market. For an IC, the key role involves asking difficult questions that investment analysts who present the opportunity might have to answer or go back from the meeting and prepare for the answers. IC also reviews all the materials, including the DD that was conducted for the investment opportunity.

This is how the discussions are structured within an IC meeting. As the IC gathers, they have a list of investments to discuss. Each analyst or team member fronting the investment opportunity presents details of the business along with the memo that was drafted. The IC then discusses the opportunity, asks any questions, and then makes a decision. The IC spends a lot of time assessing the risks associated with each investment opportunity and making informed decisions to maximize returns while minimizing potential downsides. All decisions are made keeping in mind the fund’s goals, target industries, and investment thesis.

For some IC meetings, even founders are invited to present the investment opportunity and answer questions the IC might have. And in most cases, debates and disagreements are common. While every IC has a different way of making decisions, the most common method of deciding on an investment is consensus – not necessarily unanimous.

While we are on this topic, here is some more context around how IC helps long-term fund performance for VC. Taken from a  blog I read on IC –

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, it helps to have several people around the table who can bring a fresh perspective from their experiences. It’s also why diversity, in many forms, is important: it ensures as broad a point of view as possible.

The other reason why ICs matter is that they are more subtle yet as significant as all the other ones. They are an effective tool to fight off confirmation bias. A useful but sometimes pernicious effect of working on an investment opportunity is that Investors build bonds with the startup’s Founders. It’s useful because they will sit on the Board for years to come and hopefully provide advice in dire times. Trust is a critical parameter.

The unwanted effect is the risk for the deal team to lose objectivity and become biased supporters of the startup, disregarding obvious perils or putting them aside by focusing only on positive aspects. The deal team falls into confirmation bias territory, the main reason why VC due diligence fails. By basing the discussion on hard data – insofar as it is possible in VC – IC meetings force the deal team to question their judgment.

This is the seventh post by Dinesh Pai in the Venture Capital category. Dinesh heads investments for Rainmatter and is an avid blogger.