The Challenges Ahead for Britain’s New Chancellor, Philip Hammond

Why three-party groupings can cause major problems between CEOs and venture capitalists, but also offer a solution.

Cicero, the Roman statesman and scholar, claimed in his famous work ‘On the Republic’ that an ideal form of governance should be a balance of three powers (the consuls, the senate and the assembly) effectively creating a system of checks and balances. But he witnessed himself how a combination of three in the form of the Triumvirate (Caesar, Pompey and Crassus) threatened his beloved Republic by the instalment of a de-facto dictatorship.

My research- “How does a conflict arise between a venture capitalist and one of its portfolio firms?” echoes this sentiment, as the answer is: a balance of three powers can both create and prevent conflicts.  

I interviewed numerous CEOs of university spin-off firms in the life-science industry in the UK and Germany, and asked them about their relationship with their venture capitalists.

One of the findings is that the majority of conflicts between the manager and the venture capitalists occurred in a scenario in which at least two investors were present. Rather than having a dual conflict between party A (the manager) and party B (one venture capitalist), conflicts were far more likely when party C (usually further investors) was present. The main reason for a conflict between the CEOs and the venture capitalists seemed to be differing strategic objectives and the perceived level of involvement of the venture capitalists. In a great amount of cases, the conflicts occurred around issues of financing or investors’ exits.

But does that mean that a three-party group should be avoided at all costs? No. For one, it is a reality of funding for early-stage, high-tech firms that several venture capitalists fund one firm in a so called syndicate. The syndicate members share the risk of the firm’s potential failure among them while still holding sufficient equity in the firm to benefit from a potential success.

In addition, some cases in the collected data have shown that a third party does not necessarily have to be a threat but can also be helpful, and prevent a conflict. How can that be? In several of the retold conflict situations, two parties were in a deadlock situation, and the conflict could be defused by introducing a third party.

In one of the cases the third party was an advisory board that was established by the CEO and the investor, to have an external, independent body verifying data. In another case, the CEO might have watched too many Hollywood cop-movies, since he chose a ‘good cop/bad cop’ strategy: during negotiations with another party, he used his venture capitalist as an excuse for not being able to agree on certain details, since this was an alleged ‘no-go’ for the venture capitalist.

The conclusion and take-away messages therefore are the following points:

• The majority of conflicts in academic life-science firms in the UK and Germany occur in situations with three parties.
• The introduction of a third party however, can also defuse a conflict between two parties.
• Therefore, a three-party situation poses a potentially dangerous scenario, but actively introducing a third party can also be a solution.

To avoid conflicts between venture capitalists and their portfolio firms, I suggest all parties keep Cicero’s lessons and the findings from this research in mind.