Three things you should always tell your investors, and three things you should never tell them
I’ve asked this question to a lot of startup founders, and most of them think the answer is obvious. The trouble is, their answers disagree. Some say it’s obvious that honesty is the best policy. Others follow the view of Lucy Kellaway, the in-house professional cynic of the Financial Times, who argues in a witty column that there are four lies every CEO must tell.
Lucy’s advice may work well for CEOs of big public companies, but it has perils if you run a startup. When you compare venture capitalists on the boards of private companies with institutional investors on the boards of public companies, the VCs usually have more ownership, more power, more inside knowledge, and more perspective.
Unless you believe you are smarter than all your investors put together, there’s a high risk of being found out if you are dishonest — especially when you remember the old saying attributed (tenuously) to Abraham Lincoln:
“You can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time.”
The consequences of dishonesty are serious, too. In both startups and public companies, a well-drafted CEO contract will usually include a list of things that constitute ‘cause’ in the US or ‘repudiatory breach’ in Britain. These are equivalent to what hospitals call never events, like leaving a scalpel inside a patient’s abdomen, or amputating the wrong leg. If you get caught doing one of them, you’re liable to be fired immediately and without notice or compensation.
That’s bad enough in a public company, where a CEO may have a few million dollars at risk. In a startup, the consequences of a repudiatory breach can, paradoxically, be a lot worse. This is because the founders’ shares represent a far higher proportion of their rewards, and many startups have ‘reverse vesting’ provisions on the those shares.
The primary purpose of reverse vesting is to stop founders from leaving by putting a proportion of their shares at risk —initially all of them, and then over time a declining proportion. This is reasonable, since a loss-making nascent business is going to be almost worthless if it doesn’t have anyone to run it, and only over a period of a few years does it acquire the resilience to survive a founder’s departure.
But a common provision in reverse-vesting agreements is also to ‘hold your feet to the fire’, or to give you an extremely powerful incentive not to misbehave. The typical arrangement is that if you’re fired for cause at any time during the reverse vesting, then you lose not only your unvested shares but all your shares. That $100 dinner with your partner inappropriately charged to your company expenses could prove to be the most priciest meal of your life. So the stakes are high.
Morals apart, there are good practical reasons to stick to telling the truth to your board.
The more subtle issue is how to behave when talking to your board about your company’s current situation and its prospects. There are two risks.
One is that you’re too downbeat. If you do this, you’ll be following the lead of Cassandra, the ancient Greek heroine who was gifted with foresight, but cursed that other people would never believe her dire predictions.
The other risk is that you’re too upbeat, like Pollyanna, the hero of a 1913 novel, who was so relentless optimistic that she found reasons to be positive even after losing the use of both legs.
As an investor, board director and CEO coach, I’ve seen both extremes. One CEO was a Pollyanna who ran a high-ticket marketplace business, where transformative partnership deals were always ‘about to happen’ but never quite did, and where the CAC ratio looked great because her metrics silently assumed (without any evidence) that every customer who spent $50,000 would come back and do the same again every year for the next four years. Pollyanna fooled most of the board for a year, but got fired in the end.
Cassandra did better: she preached doom so often that her board meetings were a succession of pleasant surprises, where the predicted disasters were always less bad than expected. But there were some disasters. She admitted to the board she’d hired the wrong CTO. On their advice, she fired the entire tech team and got the product built more cheaply by an agency. Then a key partner whose blessing was essential to the success of the project pulled out at the last minute. That problem was too big to fix. She called an emergency board meeting, and suggested winding up the business and returning the remaining cash to investors.
Yet even that turned out to her credit. Her two biggest investors — who both lost money on the company — were so impressed by her honesty that they offered to back her next startup, sight unseen.
Perhaps there’s some reverse psychology to be aware of here. Many VC investors are smart and original people, who never want to take things at face value. So when a Pollyanna comes along declaring that everything’s going gangbusters, they look for problems. And at the board meetings led by a Cassandra, they look for reasons why things are better than they seem.
Across 50-odd investments, I’ve seen that founders who are more honest with their boards generally outperform those that are less honest. I’ve also seen three things that successful founders always tell investors, and three things they never tell them. Here’s the list.
1. Always tell board members the most important news
However clever and diligent they are, investors are unlikely to have time to know more about your company and your market than you. That puts the burden on you as a CEO to make sure your board knows promptly about important things. If a technical outage harms your relationship with clients, or a competitor makes a mouth-watering acquisition offer, tell your board now, not next month. It doesn’t go well when they find out from elsewhere.
2. Always tell them your biggest challenges
By temperament, startup founders have to be optimists — otherwise, why would they be crazy enough to think that a new company could disrupt an entire industry and become enormous? But that optimism can easily slip into a habit of delivering only good news, to reassure investors that they made the right decision by backing you. This approach makes board meetings useless, since it gives directors nothing to help you with. If you honestly reveal your biggest problems, you’ll get free consultancy from two or more smart, experienced people.
3. Always tell them about serious mistakes and setbacks
Years ago, when I was running an e-commerce business, we had such a nightmare managing our logistics that from time to time I’d ask everyone in the company to down tools, and pack boxes or answer customer-service emails in order to clear our backlog. One day, a newspaper wrote up the story of an angry customer whose shipment had suffered a succession of woes. At the next board meeting, our biggest investor duly gave me a roasting. At the time, I felt hurt and wrongly accused. But with hindsight, it was my fault: I had assumed he knew how much trouble we were having building a smooth operation, but I hadn’t actually alerted the board in detail that we were struggling. There’s a general moral here: if you ever wake at night worrying what might happen if your board finds out about a problem in your business, tell them about it today.
But there are also things you should never tell your board.
1. Never tell your board that you’re thinking of giving up
When you’re a CEO, you are like the captain of a ship — it’s your job, among other things, to set the direction and inspire the crew. That goes for your investors too; you should acknowledge your difficulties, but always work on the assumption that you will find a way through them, and focus the discussions at board meetings on how. If you do decide to give up, though, it’s your moral obligation to tell them immediately. You’ll then be able to have a useful discussion about your options: whether to hire someone else to run the business, leaving you with some equity in it; whether to return the remaining capital to investors; whether to pivot; or whether to try to for an acquihire.
2. Never tell one board member that you dislike another board member
Investors who sit on boards can sometimes be aggressive and unhelpful, and if things are left unaddressed they can make your life a misery. But when you have a board member of this kind, don’t try to make another director your punchbag or your intermediary. This can destroy your relationship with both. It can also makes the entire board opaque and dysfunctional.
Painful though it is, it’s better to deal with the issue at source. One of the best entrepreneurs I’ve backed went to one of his VCs, took a deep breath, and said this: “I know you’re doing your best, but we’re not getting on well, and I don’t think you’re the right director for my company. Could you please get one of your partners to take the board seat instead?”. The VC was astonished, angry, and then embarrassed. But he agreed.
3. Never share your cofounder woes with your board
When cofounders aren’t getting on, the first step should be to speak to each other — to be frank about the discontents, and to have an honest discussion about how to fix them. Sometimes, they may not be fixable. But one founder I’ve coached did exactly this with her cofounder, telling him calmly but directly that she had lost confidence in his ability to lead the business as CEO, and why. Surprisingly, the CEO agreed that she should take over, and they successfully presented the board with the decision as a done deal.
Talking to your board members about your cofounder is like talking to your mother-in-law about your spouse
It’s not easy to apply these observations in your own company. The items on the always-tell can seem hard to confess. Maybe you can’t find the words, or don’t know how to structure the discussion, or what to ask your board members for. And the never-tell list presents a temptation in the other direction. If you get on with your board members, and you’ve known them a while, it can be easy to say something that can never be unsaid.
The obvious solution is to work with a coach: an independent third party, contractually bound to confidentiality, whose job is to support you and who has enough understanding of the context and the industry to help you predict how your investors will react.
But if you don’t have or can’t find a coach, there are alternatives. You can reach out to another CEO, preferably one whose company is either at the same stage as yours or a bit further on. Or, if you have a patient and understanding spouse, partner or parent, you can talk to them.
Whoever you choose, you’re likely to find the best way through your difficulties by following two simple principles: don’t tell lies, and ask for help when you can.
I’m Tim, and I run a seed fund out of London that invests in SAAS, platforms, marketplaces and tools. I’ve backed 50 companies and sat on 19 boards, and I also coach Series A and B CEOs introduced by VC firms in Europe, America and Asia. I founded a startup and took it to an IPO on the NASDAQ, and before that worked for The Economist and the Financial Times.
This is one in a series of blog posts covering nine of the most important skills I’ve seen in founders who are most successful in scaling their companies. If you’d like to read more of them, please follow.