Veto Power and Decision Making Process

Jan 11, 2022

Imagine you're a venture capital partnership that has make decisions on whether to invest in a startup or not. A partner comes to the Monday meeting after having met a promising new startup, but not everyone agrees that it's a worthwhile investment. What is the optimal decision making process for the group to maximize their return?

Majority vote? Supermajority? Unanimous? Does anyone have veto power? Can a single individual with high conviction make a unilateral decision?

Turns out the answer in practice depends in part on the riskiness of the decision being made. Think about it in terms of the probability of a "yes" decision. All other things equal, the more votes needed to pass the proposal lowers the probability of success. Veto power lowers it even more.

You can observe this by generally looking at the spectrum of early-stage to later-stage venture capitalists (in practice, the decision-making process at firms is more complicated).

From the paper, How do Venture Capitalists Make Decisions by one of my Stanford GSB professors, Ilya Strebulaev

Early-stage investors take on more risk. Unproven technologies and markets. Non-consensus bets. It's difficult to get everyone on board for extremely risky decisions. Contrast that with later-stage investors, who (usually) have much more information at their disposal. Past performance, market validation, more capital and lower multiples.

A few simple takeaways:

  • There's no one-size-fits-all decision making process. It should depend on the risk propensity of the group and the type of decision (e.g., is the decision a one-way or two-way door?)
  • There's mechanisms like veto power that can fit different risk profiles.

Since I've spent a lot of time thinking about distributed systems, I have to acknowledge that computers face some of the same issues. Decisions need to be made when some members may be unavailable (some servers may fail or take too long to respond). A final decision needs to be made when there's differing opinions. The correlation between risk and decision making process still applies, even to computers.

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