Despite the fact that the majority often rules, that does not mean the majority is always right.
The most poignant example comes from a premier venture capital firm I once worked for. One of the opportunities it gave its investment professionals was the chance to invest personally and on a discretionary basis in each round of each financing in which the firm participated. You did not have to invest, or you could invest the maximum, based on your level in the firm, or you could do anything in between.
Most interestingly, after each round closed, the firm published to the entire investment team how much each person invested in that round. There is no better way to tellhow a person feels about an investment than to see the size of their personal cheque.
It was the most honest moment of the entire investment discussion. There were certainly cases when everyone in the firm maxed out their personal investment, and there was a similar frequency of cases when nearly everyone declined to participate except the individual partner sponsoring the deal – the "zero out".
These decisions were always made after individuals talked to one another behind the scenes to discuss how much they were going to put into each investment – they were rarely made in isolation. What I learned from watching these personal investment decisions made over and over again was somewhat surprising.
A great predictor of failure for an investment was the max out scenario. If everyone loved a deal and backed it with their personal investment, it was more than likely not to succeed. In fact, those deals often failed quickly.
The inverse was surprisingly true as well. More often than not, those investments subject to the zero out scenario often became successes – sometimes the biggest successes.
At the other firms at which I have worked, various forms of this experiment have taken place and this observation holds true through different economic times, different investments and different firms.
Why? How can it be that when a group of intelligent, seasoned investment professionals agree that they are often wrong? The answer is simple – investment partnerships are the perfect breeding ground for "groupthink".
Groupthink, according to Wikipedia, is "a psychological phenomenon that occurs within groups of people … Group members try to minimise conflict and reach a consensus decision without critical evaluation of alternative ideas and viewpoints". There are important cases in history wheregroupthink played a material role, such as the incidents involving Pearl Harbor and the Bay of Pigs.
Irving Janis, a researcher on groupthink, suggests certain contextual ingredients make groupthink more likely, including high group cohesiveness, group insulation, lack of impartial leadership, lack of norms requiring methodological procedures and homogeneity of members’ social background and ideology.
Venture partnerships are often cohesive, insulated and homogeneous groups – a perfect breeding ground for groupthink. See the report of a survey of the composition of venture firms in the box on the next page.How do you protect against groupthink? You simply ask yourself two questions, trying to be as impartial as possible.
First, could the dissenting opinion be right? Listen to and fully understand the point of view of the person expressing a dissenting opinion, especially if that person is the sole voice in the room. Fully consider that point of view as it may very well be the right one. Give it weight in your mind.
Second, could your majority opinion be wrong? Have you arrived at your opinion without sufficient critical analysis?
Are you basing your position on assumptions that you presume to be true but that perhaps are not sufficiently tested or researched? Be humble, do not think too highly of your own point of view.
Until you have understood how your majority opinion could be wrong, you should strongly question whether your opinion is right. Until you have understood how a dissenting opinion could be right, you should strongly question whether it is wrong. A great and simple test is whether you can argue both the majority and irrespective of which one you hold.
The best venture partnerships understand this dynamic and take it into account in their decision-making. One firm at which I have worked mandated a dissenting partner on all deals. Another firm always allowed for a single champion to carry a deal through rather than requiring partnership consensus.
While groupthink may ultimately exist within the partnership model, it does not have to, nor should partnerships let it be the deciding factor at the end of the day.
This column first appeared on Cheng’s blog, Thinking About Thinking. You can follow Cheng on Twitter @larryvc
Box: US venture capital remains insular, based on a report by peHUB
Venture capitalism in the US continues to be an insular industry with men vastly outnumbering women and ethnic diversity at low and shrinking levels.
Eighty-nine percent of industry workers with investment roles were male, according to a survey of 600 professionals by local trade body the National Venture Capital Association and data provider Dow Jones VentureSource. In 2008, 14% were women.
Last year’s survey found 87% of the industry’s workforce were Caucasian, 9% Asian and 2% African American or Latino. In 2008, 88% were Caucasian, 8% were Asian and 3% were African American or Hispanic.
However, younger industry professionals are more diverse – people with less than five years of experience are 77% Caucasian, 17% Asian and 3% African American or Latino, the survey found.
And there was differences depending on sector. Life sciences had the highest level of women investors, at 18%, followed by cleantech with 15%.
Education is a factor. Stanford and Harvard universities each educated 10% of venture capitalists, followed by University of Pennsylvania (8%), University of California Berkeley (5%) and MIT (4%).
Fifteen percent of investors were once chief executives or founders of venture-backed start-ups.