Larry Cheng: When the Majority Is Wrong
Despite the fact that often times the majority rules, that doesn’t mean the majority is right.
The most poignant example comes from a premier venture capital firm I once worked for. One of the opportunities they gave their investment professionals was the opportunity to invest personally and on a discretionary basis in each round of each financing the firm participated in. You didn’t have to invest, or you could “max out”, or you could do anything in between. There was a maximum amount you could put into each round based on your level in the firm.
Most interestingly, after each financing round closed, they would publish to the entire investment team how much each person invested for their discretionary investment in that round. There is no better way to tell how a person feels about an investment than to see the size of their personal check. 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 (e.g. the “max out scenario”). And, there was a similar frequency of cases when nearly everyone didn’t participate except the individual partner sponsoring the deal (e.g. the “zero out” scenario). These decisions were always made after individuals would talk to each other 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 when the max out scenario took place. If everyone loved a deal and backed up the truck on their personal investment, it was more than likely to not succeed. In fact, those deals often failed in quick fashion. The inverse was surprisingly true as well. More often than not, for those investments where the zero out scenario took place, they often became successes — sometimes the biggest successes. At the other firms I have worked at, 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 — 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 minimize conflict and reach a consensus decision without critical evaluation of alternative ideas and viewpoints.” There are important cases in history where groupthink played a material role such as in Pearl Harbor and the Bay of Pigs.
The reason venture partnerships foster groupthink is best articulated by Irving Janis, a preeminent researcher on groupthink. He suggests that certain contextual ingredients make groupthink more likely including:
- High Group Cohesiveness
- Group Insulation
- Lack of Impartial Leadership
- Lack of Norms Requiring Methodological Procedures
- Homogeneity of Members’ Social Background and Ideology
Venture partnerships are often cohesive, insulated, and homogeneous groups — a perfect breeding ground for groupthink. (See peHUB story about recent survey on makeup of venture firms. -Ed.)
How do you protect against groupthink? I think you simply ask yourself two questions, trying to be as impartial as possible:
- Ask yourself: 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 their point of view as it may very well be the right one. Give it weight in your mind.
- Ask yourself: 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, don’t think too highly of your own point of view.
Until you’ve understood how your majority opinion could be wrong, you should strongly question whether your opinion is right. Until you’ve 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 dissenting opinion well — irrespective of which one you hold.
The best venture partnerships understand this dynamic and take it into account in their decision-making. One firm I used to work at 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 doesn’t have to, nor should partnerships let it be the deciding factor at the end of the day.
Larry Cheng is a managing partner with Volition Capital. This column first appeared on his blog, Thinking About Thinking. You can follow Cheng on Twitter @larryvc.
@kWIQly said on November 25, 2011
I think this is not surprising from an entrepreneurs perspective.
In many many meetings, I have seen advisers suggest that we pivot to be “more like the competition” though not in those words – “hey if it works for them”?
A really successful opportunity involves “going out on a limb”, into “new territory”, and these are inherently poorly understood, lonely places.
I am now more that ever convinced we are onto a good thing – because our clients seem to love the idea, but we cannot get backing from the “usual suspects” – perfect for us to “buy the farm” so to speak
@techlibido said on November 25, 2011
Isn’t it strange that a vast majority of Investors suffer from groupthink, while Entrepreneurs suffer from the “I will do it alone” idea? A good balance often leads to a great partnership.
James Geshwiler said on November 27, 2011
Larry,
Good article. Thanks for raising. If group think exists in venture firms, it can be even more prevalent in angel groups. The trick is to get the benefit of the “wisdom of the crowd” without succumbing bandwagoning. The big risk in the latter is failing test assumptions and winding up with either a false positive as you mention above–or equally as perilous in this business–a false negative and passing on a fantastic opportunity.
A few simple tools can prevent or break up bandwagining. These include: having each partner or member write down an assessment before discussion; active moderation of discussion so neither the strong positive voices nor the strong negative voices dominate; and, as you note, an appointed devil’s advocate.
I’d also recommend adding Graham Allison’s “Essence of Decision” to your reading list above for investment managers.
Bryan Beatty said on November 28, 2011
Interesting post.
I wonder if there is an element of self-fulfilling prophecy going on as well. If the majority of partners invest in a startup, are they also more likely to meddle and second guess the Executive team?