TL;DR Nutshell: For a first-time founder CEO, the process of acquiring the skills to run a successful, scaled company will inevitably involve mistakes, learning, refining, iterating, etc. The best VCs engage founder CEOs as coaches, constructively pointing out weaknesses and pushing them to become great leaders. The worst VCs go into an investment having already decided that the company needs a “real CEO” and will use every mistake, no matter how common, as a reason to reinforce their viewpoint.  Know how to distinguish between the two, or you’ll be sorry.

Background Reading:

• What I Would Look for When Choosing a VC – Mark Suster
• The Board of Directors: Role and Responsibilities – Fred Wilson
• What Makes a Great VC? – Bijan Sabet

One of the great things about being a VC lawyer is that you get to observe a volume and breadth of companies and founder teams that really isn’t accessible to most ecosystem players. Executives see only their own companies. Investors see only the ones they’ve invested in. But VC lawyers interact with teams that cross geographical, investor, industry, and all kinds of other boundaries.  More data points means more opportunities for pattern recognition, and I’ve noticed that the relationship dynamics between a first-time founder CEO and her lead investors – one of the most important relationships in the trajectory of a startup – often fall broadly into one of two categories:

• Coaching – The functional category – The founder CEO understands, from Day 1, her role as the leader of the Company and that, cap tables and corporate governance issues notwithstanding, the Board and VCs are there to provide input, guidance, constructive criticism, and whatever else is needed to help the CEO exercise her judgment in leading the Company.  If the CEO makes a mistake – the budget was missed, some projections were off, a new hire turned out to be a dud, all mistakes that happen very often, especially in the very early days of a startup – everyone acknowledges the error, provides guidance on how to improve, and keeps moving. Investors offer suggestions, connections, and other resources all built around developing the CEOs personal skillset.

• Undermining – The dysfunctional category – Because of the differences in experience, influence, and often age, an almost parent and child-like relationship develops between VCs and the founder CEO.  Very common mistakes like those described above don’t result in constructive advice for improvement, but in “this should NEVER happen” scoldings and early discussions about what kind of ‘talent’ is missing on the team. Communications become far more about what the founder CEO is doing wrong than about how she could start doing them right.

No one is born with the skillset needed to run a successful, scaling company. Founders know that, and experienced investors absolutely know it. Even more so, the early days of a startup are often so fast-moving and full of uncertainty that problems arise through no fault of the management team, but just because sh** happens. A lot.

A group of VCs who are committed to giving the founder CEO the necessary runway and resources to become a great leader is an invaluable asset to a founder team. But, unfortunately, in every ecosystem there are also investors whose routine playbook is to pretend that every hiccup, every miss, is just another reason why they need to pull out their rolodex and bring in some ‘adult supervision.’

Coaching ≠ Entrenchment

To be crystal clear, founder CEOs sometimes do need to be replaced, particularly when the Company has reached a size/scale where it really isn’t a ‘startup’ anymore; think Series B/C+. A Board of Directors has a fiduciary duty to do what maximizes the value of the entire Company, and if it has become clear that, after repeated attempts at building the necessary skillset, a CEO simply doesn’t have what it takes, she should step aside or be removed.  If the ship is sinking, it’s unfair to let everyone drown when you could’ve replaced the captain. 

My experience is that great founders are often (but not always) quite good at acknowledging when they’ve reached their limit– they obviously want their ownership stake to produce a great exit just like everyone else’s, and if they feel like bringing in new management will get that done, they will move aside. But not until they’ve been given a real chance. Even if we all universally accept that no one who raises outside capital is entitled to run a company forever, the best investors and advisors should all agree that, given the massive personal sacrifices that founders make to build their companies, every founder CEO deserves an opportunity to make mistakes, learn from them, and mature into her leadership role without being constantly undermined.

If it’s been 2 years post-investment, you’ve cycled through ideas suggested by your Board, done the reps, studied the books, met with the mentors, things still just aren’t clicking and your Board is throwing out some names, think hard about it. That is just the Board doing its job.

But if you haven’t even closed a decent A round, your VC has you on a “tight leash” because you missed last quarter’s projections, and names (from the VCs own network) are already being suggested for new management, that is bullsh**. What you have there is an investor who planned to replace you before the ink even dried on the check.

The Importance of Transparency and Competition in Ecosystems

When I work with founder CEOs who’ve found themselves in the unfortunate situation of having an “underminer” on their cap table, my first piece of advice is simple: whining will get you nowhere. If a VC has managed to build a decent personal brand all while maintaining a consistent playbook of undermining a CEO’s leadership role from the very beginning, then he’ll respond only to consequences, not complaints.

Scarcity and opacity are the mothers of bad behavior in almost any market. If a market participant has thrived while being an a**hole, it’s because the market mechanisms needed for punishing that behavior, transparency and competition, have been absent. If you want to change the behavior, you have to change the environment. That means:

A. Never stop meeting with outside investors, and avoid contractual provisions that lock you in, early on, to a particular group of investors. Founders do themselves, their companies, and (frankly) their ecosystems a massive disservice by deciding that, once they’ve found ‘their VC,’ it’s time to stop investor discussions and ‘focus on the business.’

This does not mean that you should spend all of your time in full pitch mode – of course not – but you better believe that an investor’s knowing that you may be taking meetings with deep-pocketed California or East Coast VCs (who are increasingly looking outside of their core markets) will make them think twice about their behavior on the Board. It should not surprise anyone that the country’s VCs with the best reputations for how they treat founders (in addition to financial returns) are predominantly located in ecosystems with much more capital (and hence competition among capital) than the rest of the country.

B. Find Truly Independent Perspectives for both the Board and the management team. See: How Founders Lost Control of Their Startups, Apart from Ownership. Your independent director(s) should be actually independent – not people whom your ‘underminer’ has picked for 4 other boards before yours.  And you should know that pushing executives from their personal network onto the management team is a common way that ‘underminer’ VCs slowly unhinge the existing leadership. People remember who really got them their job.

C. Talk to other founders. Every founder approaching a VC round should be talking to the companies who’ve already taken money from their prospective VCs.  And I don’t mean just the rocket ships your VC suggested you talk to.  Recruiters know that the real data on a recruit comes from the people she didn’t list as references. You want to know how a VC treated the companies that hit road bumps, and that means doing your own diligence.

And when future founders come to you for feedback on a particular VC, play your proper role in the ecosystem and be honest. I certainly will be.  The best VCs deserve your praise – every ecosystem needs more of them, and the underminers deserve to be called out.

In any ecosystem, the best way to increase the number of coaches and marginalize the underminers is to (i) bring in new, competitive outside capital, and (ii) be transparent and honest about the capital that is currently available. Don’t whine about the players. Change the game.