The Board works for the Common Stock

TL;DR: Under Delaware law, the Board’s primary fiduciary duties are to the common stock; not the preferred. That includes Board members who are themselves investors. Keeping that in mind when interests between investors and common stockholders diverge is important for preventing lawsuits.

Background Reading:

Note: For purpose of this post, we’re going to assume Delaware corporate law, because the vast majority of startups are Delaware corporations. States like California, Texas, and New York have different laws, although they are not that far off from Delaware (usually).

There are situations in which the “right” thing to do is a black and white, easy to identify issue. But in many other situations, contextual nuances, ambiguity, and human loyalties/incentives make finding an answer more opaque. In those situations, I’ve found that two questions can help provide clarity:

  • Whom do you work for?
  • (and related) Whom do you not work for?

Corporate governance is the broad term for how corporations should be “governed” in the best interests of their constituents. And under Delaware corporate law, it’s a well-known fact that a Board of Directors, which manages the Company at the highest levels, works for the stockholders. The job of a Board of Directors is to maximize value for the stockholder base. 

But which stockholders? Again, we have some ambiguity. Some of the stockholders are sophisticated, repeat player investors holding preferred stock, and the ability to fund (and negotiate) future financings. Other stockholders are first-time entrepreneurs, or employees, with far more of their net worth already sunk in the specific company, in the form of common stock.

Common v. Preferred

As I wrote in Common Stock v. Preferred Stock, anyone who speaks of Common Stockholders (founders, employees) and Preferred Stockholders (investors) as being fully aligned economically either has no idea what they’re talking about, or is deliberately obfuscating the facts, and the relevant case law on the subject. Investors are typically diversified, experienced, advised independently by personal counsel, and have contractual rights that allow them, in certain exit scenarios, to take 100% of exit proceeds. Common Stockholders are typically significantly less diversified, less experienced, reliant on company counsel for guidance, and lacking in contractual preferences on their equity.

In one sense, Common and Preferred stockholders are aligned in desiring for the Company to get as large of an exit as possible. But after that point is made, it has to be acknowledged that between them (distributionally), they conflict in terms of how much risk they are comfortable taking on to achieve that exit, what percentage of exit they will take, who else might join the cap table to share in that exit, when to go for an exit, and any number of other scenarios.

So again returning back to the point made earlier: a Board of Directors works for the stockholders. But there are conflicts between the stockholders. So whom does the Board work for?

Delaware courts give a clear answer: the Common Stock. For those interested, the most commonly cited case on the issue is called In re Trades Shareholder Litigation, although there’s a huge amount of other material available online on the subject.

Yes, all Board members work for the Common Stock; even the directors who are themselves investors and preferred stockholders. That means that, when deliberating on issues for the Company as Board members, directors are supposed to put aside their personal interests, and all the ways in which they might benefit themselves over other stockholders, and do what’s best for the common stock, as a class. And if they don’t, they are open to being sued by common stockholders.

The Job of Company Counsel

Delaware’s answer to whom the Board works for also illuminates what the job of company counsel is: to help the Board do what’s best for the common stock. That includes paying attention to circumstances in which investor directors may be, shall we say, distracted by personal interests in ways that aren’t beneficial to the overall stockholder base.

The job of independent company counsel is, in part, to help a Board of Directors remain mindful of their fiduciary duties to the company’s stockholders, particularly the common stockholders, and to avoid placing itself in situations where they’re exposed to fiduciary duty violation claims.

Because company counsel plays such a key role in corporate governance and keeping self-dealing in check, very aggressive VCs will maneuver to have the company engage lawyers who are “captive” to the interests of the lead investors. I’ve written about this extensively, including in How to avoid “Captive” Company Counsel.

If the job of the Board is to do what’s best for the common stock, and to avoid favoring the preferred, then clearly the last thing a well-governed Board would do is force the company to hire lawyers who have long histories working for the Company’s lead preferred holders. In 90% of Boards I work with, this is seen as an obvious, plain as daylight fact; the Company should hire independent lawyers. Outside of the startup/VC world, it would be seen the same way by 100% of Boards.

But there’s still that 10% of funds (bad actors) who use any number of excuses for putting captive lawyers in the counsel seat. And yes, I have seen lawsuits, both against investors and against lawyers, result from parties playing those kinds of games. Piss off the wrong stockholder, and leave enough evidence, and you won’t like the outcome. 

When Board’s don’t do their job

It’s one thing to say that the Board’s job is to represent the best interests of the common stockholders, and not take actions to enrich the investor base at their expense, but ensuring that it actually gets done is a whole other issue. Again, there are many funds out there who care deeply about their reputation, and try hard to fulfill their fiduciary duties. But every serious corporate lawyer knows of the tactics that bad actors will use to push through their agendas, often with thinly veiled arguments about why they are best for the company. Some examples:

  1. Telling management that they should not be talking to outside investors (who might offer competing terms, or more competitive valuations), because it is “distracting” and they should “focus on the business.” Or that they simply “aren’t ready” for fundraising yet, despite the fact that the company will run out of cash without getting talks going.
  2. Making up reasons why their preferred lawyers / firm will offer favorable economics (lower cost) to the Company if they are engaged, and using cost savings as a reason why it’s best for the company.
  3. Running executive recruitment processes without the involvement of founders/existing management who are Board members, citing that they prefer not to distract them. The end result being that their loyalists end up getting hired, and not other candidates.
  4. Insisting that their preferred “independent” director choice be elected, despite clear loyalty issues, and holding up other key decisions until they are put in place.
  5. Using made-up data to impose onerous budget constraints on the Company, unless management “gives” on other issues they want.

Unfortunately, once you’ve allowed an asshole onto your Board, it takes constant vigilance and offense/defense to counter the many tactics they might use to push the Company in directions that increase their power and ownership, without actually benefiting the company overall.  Sometimes you have no choice but to go down that path.

But without a doubt, the best thing a team can do to ensure their Board stays aligned with its fiduciary duties is to avoid bad actors altogether, and that takes diligence before any checks are written. All money is green, but some of it is rotten.

As I wrote in Local v. Out of State VCs and Ask the Users, as startup ecosystems become more transparent and open, relying less on one or two dominant funds, the value of diligencing the reputations of investors goes up significantly.  VCs rely heavily on their reputations for deal flow, and there are many good players in startup ecosystems who will use reputational information to either push more deal flow toward VCs who play by the rules, or penalize bad actors. 

I have seen companies go deep into talks with Fund A, and then choose to go with Fund B primarily based on very negative feedback they received, off the record, from entrepreneurs and other market players who know how Fund A worked. Reputation is powerful. Use it.

Key takeaways to wrap this up:

  • The job of a Board of Directors is to do what’s best for the common stockholders of the Company, and not enrich or empower themselves at the common’s expense.
  • Even with that fact, bad actors will use shady tactics and excuses to push companies to do things that favor the VCs over the remainder of the stockholder base.
  • Your best defenses are (i) do diligence to find out who the bad actors are, and avoid their money if you can, and (ii) hire independent advisors who will hold their ground against bad actors during Board meetings.

Why Startups Need Signals

Here are a few uncontroversial facts about the general early-stage startup ecosystem:

  • The cost of starting a tech company has dramatically gone down over the past 10 years.
  • In the early days, the caliber of the founder team is at least as important for success as the caliber of the idea/technology.
  • New networks – like AngelList and LinkedIn – have dramatically increased the transparency of relationships in the market, and the ease with which currently unconnected people can become connected.

Putting the above points together, you could easily conclude that it’s never been easier for talented founder teams to obtain needed resources in the market, particularly early-stage capital. But, in some ways, you would be wrong.  Many would argue that while the difficulty of starting may have gone down, the difficulty of actually succeeding has gone up, due to increased competition (and noise) in the market. 

The reduction in cost/friction in the startup world has been met with an increase in volume, and that volume has made the market far more noisy and competitive. Far more entrepreneurs producing far more ideas, and flooding top tier resources with far more pitches. If you want a clear illustration of this, look up newly created companies on AngelList.

Where there’s an increase in noise (weak teams, weak products, me-too companies, etc.), the value of signals – credible ways to cut through the noise and indicate to the right people that you are, in fact, worth talking to – goes up. This post is about why all early stage entrepreneurs need to be very mindful of the importance of signals in the marketplace, and what those signals often look like.

First, a quick clarification: signals are ways of effectively indicating information, but they are not the information itself. In other words, they are ways of credibly sending a message to someone like “hey, we’ve got something truly interesting over here” when simply saying those words won’t work – perhaps because everyone says that, or because you simply can’t get the face-to-face time, and when hard metrics like revenue growth/customer traction may not be available (because it’s too early).  Imagine the startup world as a very dense fog – and the fog is getting denser, btw – good signals are your very visible beacons to flash into the fog so that investors and other resources can find you.

A Series B company needs to worry far less about signaling its value proposition to investors, because its history, financials and reputation in the market can already speak volumes. Successful serial entrepreneurs don’t have much trouble either. A seed stage, or pre-seed company run by new entrepreneurs, however, is in a completely different situation, and needs a different toolkit.

Common early-stage startup signals:

  • A really good logo
  • A really good website
  • A really well-done AngelList profile
  • A strong social media presence
  • Well done blog content
  • Very well-crafted messaging
  • A great pitch at a pitch competition
  • Connections to respected people on LinkedIn
  • Acceptance into a well-respected accelerator
  • Strong academic or professional history

Notice how none of these really have anything to do with the fundamentals of your business/technology? You’re a very early-stage startup. No one really knows whether your business will be successful, and at this stage you can’t even get the face time with the right people to sell them on it. That’s what signals are for.

Remember the point about how startup investors care at least as much about the strength of the team, especially the CEO, as they do about the business? Why is that? Because talent (properly defined) is highly correlated with success, and talent is easier to analyze in the early days than the future prospects of a business. Great entrepreneurs tend to be highly talented generalists (multiple skills); it’s what allows them to hit milestones without a staff of more specialized people.

Doing any or all of the things on the above list credibly signals some kind of skill/talent. Just take a good logo (which may seem silly to an engineering type, but that’s a big mistake): it takes good judgment/taste (marketing skills), and the ability to find a talented logo designer (recruiting skills). Strong LinkedIn connections signal strong networking skills. A great pitch signals strong sales skills. A degree from a respected school, or employment with a well-respected company, certainly isn’t essential, but it clearly signals strong technical skills/training.

Getting into a top accelerator is one of the strongest signals available (because of how thoroughly they vet companies), and that’s why demo days are so well attended by early-stage capital. But getting into a top accelerator often requires its own earlier set of signals.

Yes, in many ways the world has become flatter, more transparent, more meritocratic, etc., and it’s a very good thing.  Yes, the “good ol’ boys” network is weakening in the sense that there are far fewer true gatekeepers. But don’t delude yourself for a second into thinking that this means success in the market has gotten easier. And absolutely don’t think that networking and referrals from well-respected people don’t matter.

A warm referral from someone known and respected in the market is still – simple, cold fact – an incredibly powerful signal. Think about what it takes to get a strong referral. You first had to get connected to that (usually very busy) person (networking skills). Then you had to interest them enough to think your business is worth supporting (credible business idea, sales skills). People care so much about good referrals because in a market full of noise, they are a very efficient filter. And no one has time to work without filters.  

This point is worth repeating: the “democratization” of the startup landscape has certainly reduced the power of gatekeepers – specific people (usually men) whose approval you needed to raise capital and connect with important resources – but it has not (and will not) eliminate the importance of building relationships with credible, trustworthy people who can then refer you to other people who trust their judgment. The democratization arrived in the form of diversifying the number of possible referral sources; not from eliminating the need for referrals altogether.

Utopian visions of a world in which great entrepreneurs will frictionlessly connect with capital purely based on the merit of their technology/business, eliminating all the superficialities of networking and personal marketing, are a dead end.  Someone on your team needs to be good at building relationships, because relationships are incredibly powerful signals. 

Just don’t expect your lawyers to connect you with investors. See: Why I (Still) Don’t Make Investor Intros. Signals can be negative. And the fact that, of all the people in the market whom you could’ve convinced to refer you, you chose someone you’re paying (instead of someone who refers based on merit), is very often, in today’s environment, a negative signal.

A good logo, or a well done AngelList profile, can seem superficial, but signals are often about how seemingly superficial things can help people with low information sort through noise. If it takes talent to produce it, and it’s the kind of talent needed for market success, it’s a signal worth caring about.

Negotiation and Inexperience

TL;DR: Having access to trusted advisors, and the time to consult with them, is essential for anyone negotiating terms with which they have very little experience. Don’t accept someone’s argument that you must negotiate important issues live. It’s simply untrue, and a tactic for gaining unfair leverage.

Background Reading:

A recurring theme of SHL posts is that entrepreneurs, particularly first-time entrepreneurs, need to be extremely mindful of the imbalance of experience between themselves and the many sophisticated, repeat players they’re going to be negotiating with as they build their companies. It’s obviously common for entrepreneurial personalities to be more comfortable (than most) with risk, and to go head-first into negotiations and activities without proper backup. But for really big, irreversible decisions, it will backfire, and others will happily use it against you.

One of the most overused phrases for getting naive negotiators to give in on issues they should push back on is “this is standard.” When you have no historical or market perspective – what’s normal, what’s fair, what are the risks, how will this play out in 5 years? – you can be easily manipulated into all kinds of bad outcomes. I’ve been at more than my fair share of board meetings or negotiations where someone at the table makes a completely biased, nonsensical claim that something is “standard,” at which point I’ve had to step in to set things straight, and gladly offer up data or a quick market survey.

There are two main things that I tell all companies to focus on in this regard:

  1. Have a group of experienced, trusted advisors that you can quickly communicate with on serious issues.
  2. Do not let yourself be bullied into a setting where your inexperience puts you at a substantial disadvantage.

Trusted Advisors

When I speak of trusted advisors, I’m not referring necessarily just to your Company’s “advisory board,” which serves a broader purpose of helping you on long-term strategic, business, and technological issues. I’m referring to people you can call or e-mail for specific, tactical guidance on more pressing matters; your “inner circle.” Seasoned entrepreneurs, mentors from accelerators, lawyers (who are independent from your lead VCs), and trustworthy angel investors often make up this group for most CEOs I work with. The most important thing is that they (i) have visibility into the broader market, to help you actually understand what is acceptable, and (ii) will be direct and honest with you when you most need them to.

Imbalanced Negotiation Settings

While it is far less common in the tech world than in other areas, you occasionally still encounter people (particularly VCs) who insist that the only appropriate way to “really” negotiate is live, and in person. And let me tell you: this is bullshit.

Of course, live discussion is important for communication and relationship-building; it has its place. But more often than not, attempts to force entrepreneurs and company executives to negotiate key issues live, or under a very tight deadline, is a tactic to gain unfair leverage from their inexperience. Of course the guy who’s done this type of deal 30 times wants you to agree to terms live, face to face, away from your set of advisors. It has zero to do with business norms. Plenty of high-stakes deals are negotiated asynchronously. 

How you push back and (respectfully) assert yourself in negotiations with other business parties will set the tone for your long-term relationship. If you allow them to force you into circumstances that favor them, they will do it indefinitely. There is nothing wrong with responding, diplomatically, that while you of course would love to grab beers and meet up in person for more casual matters, for real business, you expect time to consult with advisors.

If you’re working with people whom you should want to build long-term relationships with, they will respect your request.  In fact, I’ve known some great VCs and other business people who are very upfront about the experience imbalance with new entrepreneurs, and insist that companies work closely with key advisors.  Those are people playing a long game, and who know that their reputation in the market matters more than short-term opportunism.

If the person you’re negotiating with rejects your request, and dictates to you the medium of negotiation, then at a minimum you’ve gained some key information on what the relationship is going to really look like if you choose to move forward.

Commercial / Tech Transactions Lawyers

TL;DR: Apart from early-stage specialized corporate lawyers (startup lawyers), there’s a second kind of lawyer that almost every early startup needs: a commercial/tech transactions lawyer.

Background Reading:

Imagine you run into a doctor who says he can (i) perform heart surgeries, (ii) treat cancer, (iii) treat your asthma, and (iv) provide pregnancy care, on his own, and all at a lower than market cost. Is your first reaction “wow, this guy is an incredibly affordable genius!” ? A cardiologist, oncologist, pulmonologist, and OB/GYN all in one!

Probably not.

One of the first points I make to young tech entrepreneurs about how to source legal counsel is that the statement “I need a lawyer” is almost completely useless without specifying what kind (specialty) of lawyer. The complexity of the legal issues that even young emerging companies deal with is simply too high to entrust all of them to a single “generalist” claiming to be a jack of all trades. This is not a coffee shop, or a bakery. The stakes, and potential liabilities, are much higher.

OK, you might say. I’m a startup, so I need a startup lawyer. Well, that’s an improvement, but what exactly is a “startup lawyer”?

In my experience, the correct definition of a “startup lawyer” is a corporate lawyer with a strong specialization in early-stage emerging companies and venture capital/angel financings. Very different from an M&A Lawyer, or a corporate lawyer who handles middle market or public company work. Startup lawyers typically serve as GC (General Counsel) for early-stage startups, which requires them to have a workable understanding of tax law, securities law, commercial issues, IP, and labor/employment legal issues.  They’re not experts in those areas (corporate law is their specialty), but they’ve seen those issues enough to cover the basics, while also knowing when to rope in deeper expertise. Your corporate/startup lawyer should serve as the quarterback of your general legal team.

For most startups we see, probably 50-75% of Pre-Series A legal needs are covered by these startup-specialized corporate lawyers: formation, financing, hiring and firing, equity compensation, etc. Small amounts of patent or trademark work may be needed by appropriate specialists, but that’s a minority of cases pre-Series A.  But there’s a second kind of lawyer – who isn’t a “startup lawyer” – that virtually all of our early clients end up needing, and that all founders need to be aware of in sourcing their own counsel: commercial, or sometimes called “tech transactions” lawyers.

Startup/corporate lawyers typically handle the more ‘internal’ issues of a company and its stakeholders: relating to the company’s founders, its employees/service providers, and stockholders.  Commercial or Tech Transactions (let’s use C/T) lawyers, in contrast, typically manage legal issues and contracts relating to a company’s customers/users and potential commercial partners. A good 25-50% of pre-Series A legal needs will often get handled by a C/T lawyer. Examples of C/T Lawyer work:

  • License Agreements (Inbound and Outbound)
  • OEM, Reseller / Distribution Agreements
  • Terms of Service and Privacy Policies (which may also require Data/Privacy Lawyers, but usually not)
  • EULAs, API / SDK terms
  • Technology Transfer Agreements
  • Manufacturing / Supply Agreements

The nature of these kinds of agreements is very different from the kind of work a classic “startup lawyer” does, and while most solid corporate lawyers probably could wing a simple version of a tech transactions document, I am deeply skeptical of a lawyer who claims to be able to handle both all of a company’s corporate needs and their commercial/tech transactions needs for a serious amount of time. In the very early days it *may* work, but even with a small level of scale it’ll start to look a lot like the “genius” doctor mentioned above. The most dangerous (and, in the long run, expensive) type of lawyer is the one who doesn’t admit what he/she doesn’t know, but incentives to maximize personal revenue often lead lawyers to exaggerate their abilities.

So, in short: if you’re building a tech startup, you don’t just need “a lawyer.” You need specialists. And a true startup lawyer, even a very good one, is very rarely enough. Ensure you have access to a solid commercial/tech transactions lawyer (reputable startup lawyers work with them). If you don’t, you’ll eventually regret it.

Founder Burnout and Long-Distance Thinking

TL;DR: “Life ain’t a track meet; it’s a marathon.” – Ice Cube

I’m prone to deep thinking about life. It’s why I quit the honors program in a great business school within weeks of entering college, and switched to Philosophy (adding Economics later). Best career decision of my life. No offense to the business school grads out there.

I’ve always had this feeling that people devote far too much brainpower toward things that ultimately amount to nonsense, and yet things that are infinitely consequential – like what you want to do in life, where and how you want to live, who and when to marry, whether and when to have kids – people seem to either follow a script, or just let their surrounding culture/peers push them in the direction of the current zeitgeist. And the truth is, the zeitgeist doesn’t give a shit about you. Slow down, and think it through. You get one shot.

And instead of asking your friends, ask people who’ve gone the distance. It’s well documented culturally / sociologically that spending all of your time with people your own age leads to all kind of mental dysfunctions and myopic thinking. The only way to get real perspective is to listen to other perspectives, and that means age / generational diversity.

A lot of the advice out there on founder burnout amounts to a kind of checklist on health and wellness. Let’s go ahead and get that checklist out of the way:

  • Sleep – Don’t delude yourself into thinking that pulling all-nighters and not hitting your 7/8 hour a day quota will make you more productive. It won’t. The data is clear.
  • Exercise – Same. Go for a run. Lift some weights. It’s not time wasted. Again, it makes you more productive.
  • Eat well – Eat shit, and you’ll feel like shit. Read up on carbohydrates, insulin, inflammation, and energy. You’ll learn some things.
  • Delegate – Build systems, and then hand those systems over to other people. If you can’t figure out a way to scale your skills, you will fail at life and at work.

But in my opinion, and from what I’ve observed among certain entrepreneurs, there’s a deeper, longer-term issue at play regarding founder burnout (and life burnout in general) than just getting overworked and not taking care of your body. The best way I can explain it is using some old school philosophy concepts: higher and lower pleasures.

Speaking very generally, lower pleasures require constant replenishment, because the feeling they generate just doesn’t last. They’re the “simple carbs” of life. Sex, drugs, and rock n’ roll are the typical go-to’s when someone wants to explain lower pleasures, but lots of cleaner forms of activities in life fit this category. Once they’re over, all you’re left with is a memory, and a desire for another one.

In contrast, higher pleasures have a kind of lasting effect. They have staying power and can bring satisfaction to life even when you’re not at the moment “doing” anything about them. Long-term friendships, love, family, and a sense of meaningful (not just financial) achievement are all classic examples of higher pleasures. They can be entertaining (or the opposite) and take up your time, but that time is a kind of investment toward building something that carries you forward in life, and is still there when you’re in your 40s, 50s, 60s, and later. David Brooks wrote a good op-ed called The Moral Bucket List that is worth reading.

The deeper kind of life burnout that goes beyond health/wellness results from years, or even decades, of failing to build durable “higher” pleasures into your life. You can ensure that you’ve slept enough, exercised, eat well, and have built a great management team, and yet at 40, 45, 50, find yourself sipping martinis on Christmas Eve, alone, or with someone who means absolutely nothing to you. That end-result really burns, because there’s no checklist for resolving it. Fail to build/invest into things in life that last and will help you really go the distance, and it can eat you alive in the long run.

When asked by young law students about how to vet law firms for employment, I’ve always said to look at the older partners, and watch/listen very closely. Look for divorces, kids in therapy, anger management issues, drug addiction, alcoholism. In the legal profession, and in all areas full of high performance personalities – including entrepreneurs – they’re everywhere. People who treated life like it’s a track meet – narrow your vision and run as fast as you can – when it’s really a much longer, much more intricate marathon.  Rock stars in their earlier years, but they failed to go the distance.

So my personal advice to ambitious entrepreneurs about preventing burnout long-term is, yes, sleep, exercise, eat well, and delegate, but also build a real life, not just a company. Emphasis on the word build; as in, activities that contribute to relationships and things that will be there tomorrow, and next year, and a decade later, when you’re a different person, with different priorities. Look ahead, and plan for the distance.  Most of the people around you telling you to just “keep hustling” care more about your stock than they do about you personally, or are themselves ignoring how long the marathon is.

Look for mentors who’ve built their own companies, but while maintaining a sense of balance (even if loosely defined).  Even if zen-like balance isn’t really achievable, the simple act of trying hard to achieve it will ensure you land somewhere sustainable. Like a speed limit, you know you’ll break it, but it’ll still help pace you.  

Think things through, and spend some of your time really building a life, apart from your company. The building may take longer than just narrowing your goals and running as fast as you can, but the end-result will be something much more durable.