The Missing Link: What VCs Need to Do About Ethics

Business practices that are based on ethics and integrity are important not just for a company’s reputation but also for its ultimate success. The same is true for VCs who invest in these companies. In fact, there is a lot that the investors can do to make sure a company pursues a strategy based on high integrity and ethical values.

This is not just good citizenship but also good investment strategy. As we have seen in the past few years from examples of Zenefits, Uber, and a number of other companies, when growth at any cost is held as the only goal, integrity suffers and eventually the markets reject the company, and investors suffer.

The Failure Points

A company that starts to fail often lacks a solid culture of adherence to core ethical principles. Sometimes the deviation starts with an enticing potential of faster than expected growth. In other occasions a company adopts practices to remove or alleviate barriers that it has encountered. But most often, the slip is not so intentionally planned and it just creeps in gradually until it becomes almost standard operating procedure.

Companies start to lose their ethical bearings when they fail to:

· Focus on providing value to the customers, as their main goal

· Be committed to being environmental and socially responsible

· Be committed to respecting everyone equally

· Make sure the above are an integral part of their company culture

The focus on customer value proposition is a kind of insurance against deviation from these values. A company that is customer focused is very unlikely to engage in practices that took down startups like Zenefits, Ubiome or Theranos. While the exact nature of the alleged wrongdoing was different in each case, all of these companies were focused on maximizing growth at any cost, rather than doing what was in the best interest of their customers.

The focus on customer value proposition is a kind of insurance against deviation from these values.

Many startups are also pressured by their VCs to show hockey stick growth and accelerating revenues, without being held accountable on other metrics such as customer satisfaction and retention, adherence to ethical behavior, and being a responsible corporate citizen. As a result, any practice that is legal and will accelerate the growth becomes justified.

The Unraveling

Business models that sacrifice integrity and long-term resilience for fast growth eventually damage the company in three ways:

- Loss of mission and vision (Zenefits)

- Loss of employee and investor trust (Uber)

- Regulatory and legal challenges (Facebook)

A company’s mission statement is its ultimate guiding light and since mission statements are public, few companies will fashion a statement that is not socially responsible and customer centric. Yet, many companies will fail to follow their mission and their stated values, and this becomes even more so when the company starts to take shortcuts. As the company loses its mission, it loses a coherent culture and fails to retain employees.

A company’s mission statement is its ultimate guiding light

As a company’s reputation suffers, the investors get worried about sustainability of the high growth. Nervous investors are not very likely to increase their investments. Eventually, lack of ethical standards leads to regulatory challenges and potentially legal problems.

The Solution

What could investors do to prevent these? It’s simple: First, they have to insist that their start-up company has a clear and ethical mission statement that is customer centric and defines its corporate role in the society. Then at every board meeting, the investors have to see if the company is adhering or deviating from its mission. The Board can then push for course correction if needed to make sure long-term integrity of the company is preserved, while it avoids setting goals that will force the company to take shortcuts.

VCs must guide their portfolio companies to focus on their customers, define and adhere to a solid mission statement based on social responsibility and civility, and deliver sustainable growth with positive unit economics. These practices are more likely to keep the companies on path of high integrity as well as high investment return.