TL;DR: “Founder friendliness” should mean not being hostile, but also not being submissive, to founders. Good entrepreneurs and advisors know that.
- Local v. Out of State VCs
- When you’re not CEO Material
- Preferred Stock v. Common Stock
- Ask the Users
Because we’re known as Startup/VC lawyers who don’t represent VCs (just companies), I often get asked about my thoughts on “founder friendliness.” Occasionally it’s someone inexperienced expecting me to say something totally one-sided, as if “founder friendly” means always giving founders what they want. The truth is, I’ve put my fair share of founders in their place, when appropriate. As I’ve written before, company counsel does not mean founder’s counsel.
Serious lawyers provide counsel, and represent something apart from the preferences of any particular person. They don’t just push paper in whatever direction someone tells them to. Real lawyers know when and how to say “no.”
To me, “friendly” means the opposite of “hostile.” It means respecting a person as an equal, being transparent with them, and strongly taking into consideration their own values, goals, ideas, etc. But that is very different from spinelessly doing whatever they want you to do. The best founders seek out advisors, including investors, who will provide real, critical input; knowing that a bunch of sycophants will get them nowhere.
On the one hand, there is very much a culture among certain venture capitalists that treats entrepreneurs as necessary, but ultimately dispensable, steps toward returns. I have seen it firsthand, and while it exists everywhere, it is directly (negatively) correlated with (i) the number of investors willing to write checks into a particular ecosystem, and (ii) the degree to which entrepreneurs confidentially share information among each other on VC behavior, producing adverse selection issues for the real assholes. You very rarely hear about this on blog posts or twitter, but when the pep rallies and PR-oriented speaking panels come to an end, it is there.
VCs in this category vary in the level of sophistication with which they implement their “founder hostile” strategy. Most know that playing hardball out of the gate won’t get them the deal, and they prefer more of a “bait and switch” approach where they sing the praises of the entrepreneurs upfront, and then slowly move the chess pieces over time. The moves are identifiable by people who know the game:
- put “captive” lawyers and advisors in place;
- avoid providing coaching / training resources to founders;
- tightly control the recruitment of new executives to phase in loyalists;
- keep a tight grip on unreasonable budgets so that achieving results is very hard, and failure justifies “necessary changes”;
- maneuver to prevent competitive funds from putting offers on the table;
In the end, it doesn’t matter what the cap table says; it’s “their” company now.
On the other hand, in the most competitive deals and ecosystems, there is a counter-dynamic where VCs compete with each other, essentially, on how much unilateral control they’ll give entrepreneurs. This dynamic is strongest in California. It’s, in part, due to the failure of many VCs to effectively apply basic strategic concepts – like differentiation – into their market positioning. If you’re just another VC/fund with a few connections and ideas among dozens of others, what else can you do but try to be the “easiest money”? The end-result of having these “founder submissive” investors is often immature management teams that aren’t able to effectively scale. VCs with real brands are able to avoid this.
As I’ve written before, a Board of Directors has fiduciary duties to all stockholders. As you’ll read in many different places, the moment an entrepreneur decides to take on investors, they have to step off the “king” train and focus on growing the pie, and eventually achieving an exit, for everyone.
That being said, under DE law Boards have primary fiduciary duties to common stockholders, insiders and outsiders. As the largest common stockholders (usually), and those who’ve held the equity the longest, entrepreneurs are extremely important representatives on the Board for fulfilling those duties; whether or not they are in the CEO seat. We know that preferred stockholders and common stockholders regularly have misaligned incentives. A truly “balanced” Board will prevent one part of the cap table’s incentives and preferences from overriding those of the others.
“Founder hostile” VCs are problematic because they push for the perspective of institutional investors to override those of all the other constituents on the cap table. “Founder submissive” VCs are equally problematic because they expose the company excessively to founders whose priorities may conflict with the economic interests of the broader stockholder base.
The proper balance is, of course, in the middle; where the VCs with the best reputations operate. Be transparent about your goals, incentives, and plans. Don’t beat around the bush about your investment horizon, exit expectations, and how you’ll approach executive succession when that time comes. Let the common stockholders, including founders, do the same. No BS or opaque maneuvering. And then work together, knowing that no one has the singular right to override the perspective of the others at the table.