Guler, I. (2007). Throwing good money after bad? Political and institutional influences on sequential decision making in the venture capital industry. Administrative science quarterly, 52(2), 248-285.
Summary
This study investigates a well-known but puzzling behavior among venture capital (VC) firms: why do smart, experienced investors keep funding failing ventures? The phenomenon—called escalation of commitment or throwing good money after bad—is widespread in the VC industry, where investments are made in multiple stages (or rounds).
Despite having expertise, incentives, monitoring tools, and market feedback, venture capitalists often continue to invest in startups that show little chance of success. This article explores why they do it by analyzing both psychological biases and external pressures. The study combines qualitative interviews with VC professionals and a statistical analysis of 3,227 VC investment decisions between 1989 and 2004.
The key takeaway is that political and institutional forces—inside and outside VC firms—systematically distort investment decisions, leading to continued investments in ventures that might be better shut down. These forces include internal office politics, peer pressure from co-investors, reputation concerns, fund structure constraints, and fear of signaling failure.
Escalation of Commitment in Venture Capital
At the heart of this study is a puzzling behavior frequently observed in the venture capital (VC) industry: the tendency of investors to continue backing ventures that show little promise of success. Known in behavioral science as “escalation of commitment”, this phenomenon refers to situations in which decision-makers continue to invest in a failing course of action in order to justify previous decisions, rather than reevaluating the situation objectively and cutting losses.
What makes this behavior particularly intriguing in the VC world is that it occurs in a setting that is ostensibly designed to encourage rational, performance-based decision-making. Venture capitalists have access to data, they conduct due diligence, and they are trained to evaluate risk. Moreover, VC investment structures are sequential—funding happens in rounds precisely so that investors can reassess performance before committing more capital. And yet, Guler’s analysis reveals that VCs frequently continue to fund underperforming ventures, not because of data-driven confidence, but due to other, less visible influences.
The escalation of commitment in venture capital, then, is not just an occasional mistake—it is a systematic pattern shaped by deeper psychological, political, and institutional forces.
Psychological Biases That Drive Poor Decisions
Guler highlights how individual cognitive biases play a central role in these flawed decisions. First among them is the sunk-cost fallacy. Investors feel compelled to continue supporting a struggling startup because they have already committed time, money, and reputation to it. Abandoning the venture would mean admitting failure—not just to colleagues and external stakeholders, but also to themselves.
Another factor is emotional attachment. VCs often develop close relationships with the founders they support. They may admire the entrepreneur’s grit, believe in their vision, or feel a personal sense of loyalty. This makes it harder to make an objective decision about terminating support, especially when the founder remains passionate and persistent.
Overconfidence also plays a role. Many VCs view themselves as expert value-creators—capable of turning even a struggling startup into a winner through better advice, smarter recruiting, or refined strategy. This mindset fosters an internal narrative that their next intervention might finally make the venture work.
Lastly, there is the issue of face-saving. With so much of a VC’s reputation tied to the success of their deals, publicly walking away from an investment can be interpreted as a personal or professional failure. For some, it’s easier to continue funding and hope for improvement than to acknowledge a misstep.
Taken together, these psychological factors cloud judgment and prevent VCs from acting with the dispassionate rationality that financial theory assumes.
Internal Political Pressures
The article also explores the organizational dynamics within VC firms, revealing how internal politics significantly shape investment decisions. In theory, venture capital firms operate through collective decision-making, with partners evaluating and voting on whether to fund or exit from deals. However, this process can become a political game.
In many firms, each deal has a “champion”—a general partner who originally sourced or advocated for the investment. That partner’s reputation and internal standing are now tied to the success of the venture. As a result, they may lobby their peers to approve follow-on funding, regardless of the venture’s actual performance. Other partners, motivated by reciprocity or organizational harmony, may agree out of loyalty or a desire to avoid conflict. This leads to a kind of mutual protection culture: “I’ll back your deal if you back mine.”
The more hierarchical and larger the VC firm, the more likely it is that such politics will interfere with purely economic decision-making. As a result, investments may be continued not because the numbers add up, but because pulling the plug would damage internal relationships or office morale.
External Institutional Pressures
Even when individual biases and internal politics are set aside, VCs face external pressures that nudge them toward escalation. One of the most important is syndication dynamics—that is, when multiple VC firms co-invest in a startup. In such arrangements, pulling out early can be seen as a betrayal or as an admission of poor judgment. No one wants to be the first to signal that a venture is failing, especially when their peers are still supporting it.
Further, VCs must constantly manage their reputation in a tightly knit industry. Backing out of a deal early could make a firm seem unreliable or short-term oriented, especially to other investors or limited partners. Thus, continuing to fund a troubled company may be seen as a way to maintain credibility and honor within the professional community.
There are also structural issues tied to the life cycle of VC funds. These funds typically have a fixed duration—often 10 years—with most new investments made in the early years and follow-on investments made later. As the fund matures, partners are under pressure to demonstrate that their existing portfolio is progressing, since launching a new fund depends on how the current one performs. This can lead to an overcommitment to existing investments, even when better alternatives are available.
In essence, institutional norms, peer expectations, and the pressures of the fund structure all conspire to encourage continued investment—even when it is not warranted.
The Influence of Status and Reputation
Interestingly, Guler’s study finds that not all VCs are equally susceptible to these distortions. Firms with high status in the industry—such as those with long track records, well-known partners, or elite institutional backers—tend to behave more rationally. They are more willing to cut their losses, walk away from failing ventures, and ignore pressure from peers or internal stakeholders.
Why? Because high-status firms are less reliant on any one deal for their reputation. Their market position affords them the freedom to make unpopular decisions without fear of reputational damage. Other VCs, founders, and limited partners are more likely to interpret their actions as prudent rather than as panic or failure. In contrast, lower-status firms must work harder to maintain credibility, and so may cling to ventures that no longer make sense in the hope of salvaging reputation or demonstrating loyalty.
This finding has practical implications. It shows that the ability to act objectively is not just a matter of discipline—it’s also a function of perceived power and social standing. In many ways, status inoculates decision-makers from some of the most harmful escalation dynamics.
10 Practical Insights for Business Owners and Managers
- Recognize escalation tendencies early. The longer you’re invested in a failing initiative, the harder it becomes to walk away—emotionally, politically, and institutionally.
- Treat sunk costs as sunk. Don’t let past investments drive future decisions. Focus on updated forecasts, not historical commitments.
- Establish “exit criteria” upfront. Define clear performance milestones and pre-agree conditions under which you’ll stop funding.
- Watch for internal politics. Ensure investment decisions aren’t swayed by alliances or quid-pro-quo arrangements inside your team.
- Use fresh eyes in decision reviews. Bring in outside perspectives or rotate decision-making roles to reduce attachment bias.
- Beware of peer pressure. Don’t let other stakeholders’ decisions (co-investors, advisors, etc.) override your independent analysis.
- Manage your reputation with transparency. If you exit a venture, communicate clearly and professionally to avoid negative signaling.
- Consider fund age in capital allocation. Don’t let the lifecycle of your budget or fund trap you into suboptimal decisions.
- Track outcomes by round. Continuously monitor how expectations shift with each stage of funding and make decisions accordingly.
- Aspire to “elite firm” behaviors. High-status VCs act more independently because they’ve earned credibility. Build your brand to gain similar flexibility.
Closing Thought
This study serves as a warning to all business leaders, not just VCs. Even in high-stakes environments filled with smart people and financial discipline, bad decisions persist—not because of lack of skill, but because of hidden biases and pressures.
The core lesson? Effective decision-making isn’t just about analyzing data—it’s about managing psychology, politics, and institutional context. Knowing when to walk away may be the most profitable skill you can develop.