Too Much Communication – NEVER

I have posted about communication often.  Just type “communication” into the search field and see what pops up.  This morning I read Mark Suster’s post called “8 Tips To Get the Most Out of Your Investors and Board”.  It is all about communication with board members (a bunch of whom are often investors).  No surprise – I love what Mark wrote.

I thought it might be helpful to state a few reasons why it is just about impossible to over-communicate with your VCs:

1.  Our VC partners at a firm are constantly asking “what’s going on with XYZ company”.  Frequent communication from the CEO helps us give good answers to our partners.  You should assume that “update” type emails from CEOs are forwarded to partners inside our VC firms.

2.  Limited partners of a VC firm also ask the VCs “what’s going on with XYZ company”.  Nice to be fully loaded with information to give solid answers, even if the company is not doing that well.

3.  Doing inside rounds (which happen frequently) are way easier if the key constituents (board members and investors) are all on the same page.  Inside rounds are often done in pressure filled situations so not having to spend lots of time getting people up to speed is a huge plus for a CEO.

4.  A statement a CEO never wants to hear from a board member is “I did not know that…..”   Frequent updates solve that problem.  And, if a board member says that it is awesome to be able to say back “well, it was in the update email recently sent”.  You might be surprised how much time can be spent (sometimes wasted) dealing with a cranky board member who feels surprised by company developments.

Those are just a few of the reasons off the top of my head.  Hope you had a great long weekend…..

 

Best Startup Blog Posts of 2012

I am not a huge fan of all the “Best Of” lists that come out just after Christmas, but I just read one that is absolutely worth a look.  It is a full compilation, broken down by practical categories, of the best startup blog posts of 2012.

Here it is – Best Startup Blog Posts of 2012.  It is like a startup textbook!  Enjoy.

When Does a Seed Stage Company Need a Board with More Than Just the Founder?

I recently engaged in a conversation (over a few days) about the need for a seed stage company to have a board member other than the founder.  There is not a “right” answer to this, but the positions are worth exploring.  For clarity, a company with one founder can have a one member board (assuming a corporation).  Might be kind of lonely, but completely legal.

There are many angel investors that rarely take or want a board seat.  It is not their operating model.  Dave McClure (500 Startups) and David Lee (SV Angels) are 2 examples, but there are many many others.  Their model is invest relatively small amounts in ($50K to $200K) in lots and lots of companies.  No way to be actively engaged with all of them day in and day out with board seats.

And there are some angel investors that know that even with “light” preferred stock terms (sometimes called Series Seed), there is enough control built into the terms of the preferred stock that the company is still mostly restricted when it comes to making key decisions.  So why need a board seat when the control already exists? Fair point.

My subjective view is that once a company raises money from a few institutional investors over $400K – $500K in total that the company should have an investor representative on the board.  This is particularly true if the founding team is new in terms of “running a company” experience.  I think that the founders will benefit from the oversight and hopeful board partnership and I think that the investor board member benefits by being more engaged and learning more about the business.

This can be a tricky line.  The decision to have an investor on the board is really one for the founder.  If the investor insists, the founder can turn them down (if other investors are waiting in the wings).  And the other investors not taking a board seat should defer to the founder’s desires too.  If the founder is ok with an investor board member that is the what counts.

One final thought – what about the VC’s fiduciary duties to its own investors (called limited partners).  We are investing other people’s money.  Let’s say a seed stage company raises $600K from a group of seed stage VCs.  It is reasonable to think that the limited partners would expect their money managers (i.e., the VCs) to have a board representative to better oversee the investment and hopefully help build value at the company?  I think many limited partners would answer “yes”.

Love to hear your thoughts on this.  Happy holidays too!

Early Employee Dilution

I recently got a question from a person in a large company who is thinking about joining a startup that expects to raise venture capital.  Actually, I got many questions.  But here is one that I want to focus on in this post:

“Can I ask for undiluted stock (non dilution clause)?”

To use Brad Feld’s expression, this question kind of gave me a “vomit moment”.  The short answer is that no one should ever ask for this type of protection.  The longer answer is:

1.  I am not even sure what “undiluted stock” is, but safe to say the person (I will call him Exec X) meant stock that his equity would not be dilutable in terms of ownership.

2.  It is legally possible to grant non-dilution via a contractual right.  For example, let’s say Exec X is asking for 10% of the fully diluted cap table via a stock grant or option grant that is non-dilutable.  He is asking for 10% because he is joining as a high level officer like CEO or COO and he is a very early employee.  The company could grant Exec X a right to receive more stock (or more likely stock options to avoid tax issues) as the company issues additional equity in the future.  Those additional grants would prevent Exec X from being diluted.

3.  But, the problems with doing so are numerous.  First, it means that every time the company issues more equity, the other stockholders (most notably the founders) are going to be diluted again by this “non-dilution” issuance to Exec X.  So, the founders get diluted by the triggering equity issuance (like a financing) and then they are diluted again by Exec X’s non-dilution protection.  That is an untenable result and really stinks for the other shareholders.

4.  Second problem:  it raises a huge red flag for investors.  Not only will the investors ask why on earth did the founders grant Exec X such a right, but they will also ask why on earth did Exec X ask for such a right.   It will spook the investors.  They won’t (or should not) tolerate it and will end up making Exec X give up this right going forward.  Not a great way to start a relationship.

5.  Third problem:  the right given to Exec X gums up the company’s cap table.  New investors would have to build in the “non-dilution” shares into their valuation per share calculation.  This will create headaches and investors will not like dealing with it.

This is not to say that Exec X won’t ever get an additional equity issuance in the future.  For example, if the company raises lots of $$ and Exec X’s ownership drops to say 3% ownership over time, then the Board of the company would likely grant Exec X options to get him back to a “CEO level”, which is typically 6 – 8%.  It will all depend on Exec X’s performance.  For that matter the Board could also replace him……

Happy to entertain your questions.  Thanks.

Back and Forth Communication – Officers “Open Access”

I got into a discussion with a startup CEO recently and also one of my venture fund partners regarding directors of a startup having open access to all officers at the company.  This is a very delicate topic.

My mindset is that directors of a startup should be expected to talk with all officers of the company without “going through” the CEO.  I think the CEO should expect this to happen and should also encourage it.  I think the CEO should view this as a way to empower his/her team members.  I call this communication scheme “open access”.  Yet I actually know a number of CEOs who cringe instead at the concept.

I do have some basic assumptions that are critical for “open access” to work:

1.  The CEO runs the company day to day.  The other officers (COO, CFO, VPs, etc.) report to the CEO (there are infrequent exceptions when another officer (typically a co-founder) does not report to the CEO, but rather directly to the board; often this ends in $%^#show, and I don’t recommend it).

2.  So, having the board members have access to the officers requires that the CEO be comfortable with his/her position in the company and his/her level of respect with the board.  This is not always the case.  Confidence and security levels vary.  The need to control (whether justified or not) varies.  The ability to delegate correctly varies.  These facts add variables that board members need to acknowledge and deal with.  They are challenging variables.

3.  The directors have to have the proper skill set to handle the information that they receive from officers as a result of open access.   The directors should NOT be tasking the officers – that is the CEO’s job.  Rather, the directors should ask officers for their views on company culture, strategy, product development and related high level matters.  Then, proper use of the learned information is key.  Ideally it should produce honest discussion among all the board members, including the CEO when appropriate.

4.  Getting “inputs” by asking for views is critical.  The officers must understand that the directors are not trying to undermine the CEO by asking for input.  Rather the directors are trying to enhance how the startup functions.  One way to ensure this is to establish the “director to officer” communication channel very early and make it part of the normal governance procedures.  Simply, it should be expected.

5.  The “director to officer” communication channel does not need to be frequently tapped to be effective.  Perhaps a given officer has a conversation once every month or two with a director.  Again, these communications are empowering.  They are often ad hoc and not regularly scheduled.

So, I encourage you to practice open access at your startup companies.  And here is one more point to consider:  officers owe the same fiduciary duties to the company’s shareholders as directors do.  See this article for a good summary.  This means that officers have a duty to report up to board members and bypass the CEO when necessary (in other words when reporting up on issues concerning the CEO).  If an officer believes that a CEO is not responsibly executing, then the most sound course of action is to get the ear of a director to discuss.

More to come on this topic.  Look forward to your comments.