The Founder/Investor Partnership Is Complex; Here’s How To Make It Work
The news that Benchmark Capital is suing former Uber CEO Travis Kalanick, alleging fraud, puts a spotlight on the complex relationships between founders and early investors. The venture ecosystem tries to keep founders and investors working in concert, but the alignment of interests is less than perfect, and the mind-sets of investors and founders can be profoundly different.
I’ve been a founder and worked with many others. Founders stand out from other leaders. First, they see themselves the creators of their business, and this is usually fair. They saw the market opportunity, designed the product, worked out how to win customers with attractive economics, hired the key team members one by one when there was a good story but little money, raised all the early money by selling the dream to investors, and rode through all of the near-death crises in the early days. They often feel that no one else truly understands their businesses.
This can lead to problems if the founders fail to realize how much they need to learn: e.g., about business strategies and models, competitors, and how to run a now-large organization. It can be hard to give founders advice, and they can feel a strong need to retain control of the business they created and uniquely understand. The Google founders were wise to hand the reigns to Eric Schmidt when the company entered its explosive growth stage. And, co-founder Larry Page had the opportunity to resume the CEO role later, when the business was well-structured and he had more experience.
Founders take risk at a level few of us do. They often say to me: “You have a portfolio to bring you success, I have this one company”. They are extraordinarily motivated to make their companies successful. This can take them further into the gray zone of business than investors can stomach, as happened with Travis Kalanick.
Founders often personify the business. In the early days the founder is the chief salesman, fund-raiser, and spokesman for the business, and of course the “key man” in the investment documents. They can come to think that the founder and the business are one, and what is good for the founder is good for the business. This can lead to arrogance (Kalanick publicly scolding an Uber driver) and misuse of company assets.
Founders are competitive with other founders, especially in hot-house locations like Silicon Valley. They keep score on the basis of how big their team is, how much money they have raised, how high their valuation is, and how “hot” their company is perceived to be. Founder competition was part of the drive for unicorn valuations, now shown to be hollow in many cases.
And, many founders are often extraordinarily intense people, with minds always going Mach 3 and work and travel schedules that would grind a SEAL down. They are deep in the details of every part of the business. They can be tough, uncaring, and dictatorial with employees (e.g., Steve Jobs).
Bottom line, founders are the vital, magical, powerful ingredient that makes their businesses and the venture ecosystem go, and I treasure my founder relationships. But they are not the easiest people to work with. So it’s not surprising that founders and investors can come to grief.
Investors live in a different environment and are often cut from different cloth. Angel investors put their own money on the line, and fund investors (venture capitalists, “VCs”) work in a structure that generally requires them to contribute two to ten percent of the fund’s capital in cash and receive no bonuses until 100% of the fund’s capital is paid back.
And, VCs’ underlying investors judge them mainly on the basis of financial performance: if their results are not better than three-fourths of their peers, they will have difficulty raising capital again. So, investors feel pain when capital is lost. Founders invest mostly their time with a big piece of the upside if the company succeeds. They care about lost capital too, because it causes dilution of their equity interest, but usually not as much as investors do. Founders are almost always willing to raise more money and try again if they still believe in the vision. Investors will usually pull back sooner, judging that risk/reward is no longer favorable.
Investors are often a different breed, especially after the early stage: founders may seem them as stodgy, prissy, and judgmental. They are less risk-seeking than founders, although often still real risk-takers.
They have an analytical perspective, looking across many investments through firm’s history for patterns and lessons learned. In the worst case they can be pedantic and numbers-oriented control types. They often believe that picking the right team is the most important success driver. This makes them fiercely loyal to high-performing entrepreneurs, but they also keep an eye on the key team members and think about whether they are still the best leaders for the company, and what changes are needed.
Founders are athletes on the playing field: great operators with a strong strategic sense. The best seek advice broadly, make prompt decisions, and deliver great results. Investors are coaches: the best know how to give advice and nurture talent, and they know to not try to run the business. Investors who have been founders have an advantage of empathy for and credibility with their founders. But they sometimes take too much control and rely too much on what worked in their start-up.
Investors think a lot about financial markets: who will buy this company or take this stock public? And their main goal is a high return on their investment: they may push for an exit if they think the market is receptive, pricing is good, and investor ROI is as high as it will be for some time. Founders think more about building something truly great (“changing the world”) and the absolute amount of money they will receive. They may want to exit earlier or later: earlier if they receive a big payday from an acquirer who will continue to back their vision, or later to take the long road to an IPO and an independent company the founders will control.
It’s no surprise that the founder-investor relationship can become strained. Founders can minimize the risk by keeping these things in mind.
First, understand your investor’s perspective: s/he has a job to do, just as you do. When things get difficult, put problems on the table as calmly as possible and resist the temptation to assume bad motives: it’s often your stress and frustration talking. Many apparently-bad problems are misunderstandings.
Keep in mind that all board members and company officers, when they took on their roles, assumed a duty to work for the welfare of the company as a whole, called “fiduciary duty.” This is not an exclusive obligation; they have other duties too. But it’s important, because companies have a better chance of thriving when the key people work together. Take this duty seriously, remind others of their duty and hold them accountable, and make this a litmus test for people joining/remaining in the director/officer group, and for which investors you accept. Several times I have seen founders take on a selfish investor because the price was right, and then suffer bad behavior for years through many critical times.
Keep investors informed: get bad news over with as soon as possible. It’s tempting to control information flow, however, problems have much greater impact when they come as surprises, and investors may be able to help when they know about the problem.
When things get difficult, work out what the realistic choices are and get the discussion focused on that. Some rhetoric, venting, and wishful thinking may be necessary until people settle down. But progress usually happens when the group gets focused on the realistic options and starts to engineer the compromises and path forward to get one of them done. Investors are mostly rational people who want to maximize the upside chance and avoid disaster, although they do like to negotiate. You can get them to face facts and make sensible decisions.
I’ve heard that in a good marriage each partner has to do more than half of the relationship work. Business partnerships are much the same. Understanding, communication, focus on the shared upside, and balancing interests will enable you to take advantage of the mostly-positive founder/investor dynamic that underpins the huge success of the U.S. venture ecosystem.
First posted @ blogs.forbes.com/toddhixon on Aug 21, 2017