Post Category → Board of Directors

Startup Advisors: Best Practices

Background Reading:

Advisors. The best startups have great ones. They save you lots of headaches, time, and money. In fact, I’m not sure I’ve come across any successful client that didn’t have a strong set of advisors. Here’s some advice on how to not screw it up:

Advisory ‘Boards’ Rarely Exist.

A set of advisors is sometimes referred to as an advisory ‘board,’ but 99% of the time that’s just a term to make it sound cool. The advisory ‘board’ never meets as a group, and often doesn’t even know each other. They’re just a loose set of advisors that a company works with 1:1, or occasionally in smaller groups. Nothing like a Board of Directors, which actually does have to coordinate schedules.

Don’t Stay Local.

As the first linked post above explains in depth, 20 minutes on the phone with someone who has the right expertise is 1000x more valuable than days spent with someone who is more accessible, but can’t provide real insight that isn’t available already via blog posts or books. This means that if you’re relying solely on the very limited pool of people available via your local business ecosystem, you’re doing it wrong.

LinkedIn, Twitter, Angellist, E-mail, Phone. Work ’em. Connect with the key people in your local ecosystem who can make things happen, but don’t fish only in your little pond.

Don’t Confuse Mentors with Advisors.

Mentors can be really valuable to new founders. They can provide emotional support, friendship, coaching, and all kinds of other things. But are those the kinds of things that deserve an equity grant?

It’s ultimately the team’s call. But just realize that those are not the kinds of things that real advisors are meant for. Advisors provide real strategic insight, connections, recruiting, investor introductions, things that go beyond moral support for the founders and actually move the ball forward for the company in an obvious way. That’s the kind of value-add that typically merits equity.

Get Independent Viewpoints

For high-stakes, complex questions for which the answer isn’t clear, advice needs to be triangulated. You don’t treat any particular person’s perspective as gospel; instead you speak with multiple people and combine all of their viewpoints to make your judgment call.

That sort of triangulation is not possible when all of your advisors have the same background, are part of the same circles, etc. Especially when the questions involve big decisions for which various stakeholders have incentives to favor one option over another, you want advisors who are detached from those incentives, so their advice is objective. This, btw, is also the case with lawyers.

Favor Intellectual Honesty over Politeness

The whole point of getting outside advice is to help you see things you can’t see on your own. If your strategy for choosing advisors is to work only with the people who are agreeable to your own opinions, you’re wasting your time. People who are blunt with their advice, but deliver real insight when they give it, can be game changers for a company. 

Use an Advisor Agreement.

It’s not magical; templates abound. The Founder Institute’s FAST Agreement is perfectly acceptable, and even simplifies equity calculations. The most important thing is that an Advisor Agreement removes any ambiguity as to (i) compensation owed for advisory services, (ii) who owns the contributions, IP, etc. that result from the advisory (the company), and (iii) confidentiality of any info shared. Yes, any vc lawyer has seen founders get in trouble with these issues for not taking the time to document it properly.

Equity; %, Vesting Schedule, Cliff, Acceleration.

If an advisor expects cash from an early-stage startup, that’s usually a red flag, short of a really unusual circumstance.

The FAST Agreement has pretty solid guidelines for what’s appropriate in terms of equity %, depending on the Company stage. Pre-equity round, 0.25%-0.5% is a typical advisor. 1% is someone extremely strategic whose name you absolutely want behind your company. After an equity round, the %s naturally shift down a bit because the company is more valuable.

1 or 2-year vesting schedule and a 3-month cliff, and full single-trigger acceleration on a change of control.  Advisors get full acceleration because acquirers never expect them to stick around after a sale, unlike founders or executives.

Use that cliff.

We regularly see founders engage an advisor expecting tons of value to be provided, and then crickets once the equity is granted. But the founders don’t do anything about it. 3-months should be more than enough time to know whether a new advisor will really deliver the goods, and if not cut the cord and get that equity back for re-use.

 The hard part, of course, is finding the right advisors and selling them on your vision, so they’ll give you the time. If no one on your team knows how to hustle and sell, either start learning yesterday, find someone who can, or (honestly) just give up now. Selling, in a dozen different ways (including to advisors), is 75% of what a competent founder CEO does.

When You’re Not CEO Material

TL;DR: Before you even talk to VCs, know your own strengths and weaknesses as a leader, and work on them. Know your VCs by asking honest questions early on, and verifying answers in the market. And be proactive and honest about what you really want to be doing at your company, and what matters most to you. When CEO succession drama starts to damage a company, it’s almost always because the founder and the VCs failed to (i) align themselves on their approach to Company management and recruiting early on, and (ii) create an environment of trust and transparency where founders can give up some control without fearing that the fruits of their hard work are being given up as well.

Background Reading:

No matter how much certain investors market themselves as “founder friendly,” no competent VC can guarantee a Founder CEO that they will stay CEO. VCs have a job to do: to turn other people’s money into more money. To the extent they are convinced that keeping a founder as CEO will maximize their chances of doing that (long-term), they will do so. Otherwise, they will tell a founder CEO, sooner or later, that a new CEO is needed.

“Founder Friendly” VCs are the ones who’ve concluded that being friendly to founders helps them make more money.  They are not your BFFs, and you shouldn’t need them to be.

The below are some thoughts, from someone who’s seen it play out many times, on how founders should approach the “Are you CEO material?” issue; both before the hard conversation has arrived, and after.

First: Answer Your Founder’s Dilemma: Rich or King?

If staying in control of your company is much more important to you than achieving an excellent financial return, you should significantly reconsider whether venture capital is right for you at all.  Remember: VCs have a job to do, which is to make lots of money. You bring them on to align yourself with them so that when they make lots of money, you make lots of money.

It’s fine and common if you have a certain ‘mission’ that runs alongside the goal of building successful, profitable business; most great founders do.  But if you’re working with VCs, (i) that mission better be the kind of mission that unlocks lots of benjamins, and (ii) you better be OK at some point handing over the crown and becoming a part of, but not the leader of, management. Because, statistically, most founder CEOs eventually get replaced; voluntarily or involuntarily.

Second: Find Out if a VC is a Coach or Underminer

While all VCs are in it to make money, their philosophies regarding how much “coaching” to give founder CEOs vary wildly. Some VCs know that a founder CEO most likely will need to be replaced once the company has become a true enterprise, but they see value in keeping a founder in the CEO seat for some time and coaching them on their gaps, and also helping them fill some those gaps with other senior hires.  Other VCs virtually never let a first-time founder CEO remain in their position post-Series A. They are fine having them as CTO or COO, but they will almost always make their large check contingent on bringing in one of their preferred professionals.

There is no way to know whether you are working with a Coach or an Underminer other than to (i) directly ask (early) the VC what their perspective is on senior management post-closing, and (ii) examine the existing portfolio of the VC to see what has in fact happened every time they’ve closed a round. Trustworthy advisors who are active in the market are helpful here, as is LinkedIn.

If you’re working with an Underminer, and there are no other options, it is what it is. Work within that reality (see Step 4).

Third: Realize that you are being “sized up” from the moment you first speak to investors.

No one should pretend that “good CEOs” fit neatly into some contrived stereotype. Their personalities, appearance, backgrounds, etc. can vary significantly. However, the core jobs of a CEO, particularly at early stage, are quite uniform: (i) recruit employees, (ii) recruit investors and strategic partners, & (iii) manage and lead everyone to execute effectively on the strategy. From the moment you first interact with investors, they are asking themselves whether a founder CEO can do those things.

Fact: everything about your interactions with lead investors, from the tone and confidence of your communications, to body language and eye contact, and how you respond to push-back and calculated aggression, will influence their perception of whether you are “CEO material.” Complain all you want about prejudices, bias, judging books from covers, etc., but that is just reality. Leadership is not handed charitably. It’s asserted by behavior and results. The concept of “executive presence” is something worth familiarizing yourself with.

No, this does not mean you need to pretend to be some gun-slinging, type A alpha executive. Many great CEOs are calm and collected. But the fact of the matter is that being a CEO of any company requires the ability to have hard conversations and take some heat. If you can’t hold your own in a direct conversation with a VC, they will infer that you can’t do so in the many other key conversations that a CEO needs to have to lead a company.

I’ve lost track of how many times I’ve heard something like “That founder? He’s got a bit of an ego,” to which I usually respond, “What do you think it takes?” Ego? Thick skin? Stubborn? Chip on their shoulder? A little prickly? You better f***ing believe it.  Industries usually don’t get blasted open by people overflowing with tenderness and sensitivity.

Fourth: Focus long-term on transparency and influence. Not control.

I’ve found over time that many founder CEOs do not actually enjoy being CEO, especially as the company starts growing significantly (~post Series B). They insist on staying in the CEO seat, not because they truly think it best suits their skillset, but because of a fear that stepping down from the top automatically means totally losing influence and visibility into where the company is headed. A culture of transparency and clear communication at the board level can resolve this disconnect and avoid dysfunction.

The key issue here is not whether the Company needs a new CEO, but how to handle succession. The perfect way to create mistrust between founders and their board/management is for VCs to parachute in C-level hires with minimal founder involvement in the recruitment and selection process. It looks something like “We are getting a new CEO, and it’s X (often who was a CEO at a prior portfolio company).” In this scenario, the recruitment of new executives feels far less like the leveraging of much-needed, independent new talent for the benefit of everyone, and more like the investors taking control over management by hiring their loyalists under the pretense of ‘upgrading’ the team. 

When a founder CEO is able to propose her own candidates for the CEO position (and other C-level positions), and play a lead role in interviewing, vetting, and training the prospects, succession goes substantially smoother for everyone. In that scenario, much like a truly independent director, the founders will view the new CEO and other C-level hires as balanced people whose long-term vision and values are closely aligned with the original team. Trust is preserved, and that trust, along with a continued seat at the Board table and contractual protections around their equity and compensation, frees founders to move to positions in the company that are better suited for their skills (CTO, Chief of Product, Chief of Strategy, COO, etc. etc.), and which they usually enjoy more.

Again, different VCs have different philosophies on how to approach CEO/Executive succession, including timing. The only way to find out is to get a dialogue going early on, before term sheets are delivered, and verify the answers by talking, privately, to portfolio companies. As always, having your inner circle of advisors to, confidentially and off-the-record, help you gather that information is key.

Don’t Rush a Term Sheet

TL;DR: No matter how many blog posts and books are out there (many of which I recommend) attempting to explain the mechanics of VC term sheets in simple terms, the reality is that VC term sheets are complicated, both in terms of how their math works and in how the various control-related provisions will impact a founder team over time. Take time to understand them, and don’t rush to sign, even if investors make you feel like you have to.

Background Reading:

Similar to the ‘automation delusion’ that I’ve written about in Legal Technical Debt, which has led some very confused founders to think that most of what startup lawyers do is getting eaten (as opposed to supplemented) by software, there’s a sentiment among parts of the founder community that VC deals have become so standardized that the only kind of analysis needed before signing a term sheet should look something like:

“$X on a $Y Pre?”

“5-person Board, with 2 common, 2 Preferred, and 1 Independent?”

“Great, here’s my signature.”

Take this approach, and you are going to get a lot of ice cold water splashed on your face very quickly, and not at all in a good way. I’ve seen it many times where founders run through a VC deal, so excited about how awesome their terms were, only to realize (sometimes at closing, sometimes years later when things have finally played out) that there were all kinds of “Gotcha’s” in the terms that they failed to fully appreciate. Having solid, independent, trustworthy advisors to walk you through terms before signing is extremely important, and it needs to be people whose advice you take seriously. See: How to avoid “captive” company counsel and Your Best Advisors: Experienced Founders. 

Some simple principles to follow before signing a term sheet are:

A. Fabricated Deadlines Should be Pushed Back On – It is very common for a term sheet to end with something like “this term sheet will expire on [date that is 48 hours away].” That deadline is very rarely real. It’s just there to let you know that the VC expects you to move quickly.

It is unreasonable to sit on a VC’s term sheet for weeks without good reason. By the time they’ve offered you a term sheet, they’ve likely put in some real time diligencing your company, and the last thing they want is for you to take their term sheet and then “shop” it around to their competitor firms to create a bidding war.  Doing so is not how the relationship works, and will almost certainly burn your deal. So expecting you to move somewhat quickly in negotiating and then signing is fair, but if a VC is pressuring you with anything remotely like “this needs to be signed in 24/48 hours, or the deal’s gone,” what you have there is a clear picture of the kind of power games this VC is going to play in your long-term relationship.

Move quickly and be respectful, but make sure you’re given enough time to consult with your advisors to fully grasp what you are getting into. It should be in everyone’s interest to avoid surprises long-term.

B. Model The Entire Round – VC Lawyers are usually the best people to handle this because they see dozens of deals a year and will be the most familiar with the ins-and-outs of your existing capitalization, but having multiple people running independent models is always a good idea, to catch glitches. You want to know exactly what % of the Company your lead VC expects for their money, before agreeing to a deal.

I have seen many situations where founders get distracted by a ‘high’ valuation, but when everyone is forced to agree on hard numbers they realize that the VC’s definitions were very different from what the founder team was thinking.  This is absolutely the most crucial when you have convertible notes or SAFEs on your cap table, because how they are treated in the round will significantly influence dilution. The math is not simple. At all.

C. Understand The Exclusivity Provision – Most term sheets will have a no-shop/exclusivity provision “locking you up” for 45-60 days, the amount of time it typically takes to close a deal after signing a term sheet. This is reasonable, assuming it’s not longer than that, to protect the VC from having their terms shopped around. But it also means that if you are talking to other potential VCs, the moment one term sheet arrives, everyone else should be told (without disclosing the identity or terms of the TS you have in hand) that it’s time to put forth their terms, or end discussions. Because once signed, your job is to close the signed term sheet.

D. Focus on Long-Term Control/Influence Over Decision-Making – Thinking through the various voting thresholds, board composition, and consent requirements is extremely important. Will the board be balanced, with an ‘independent’ being the tie breaker? Then being extremely clear on who the independent is, and how they’ll be chosen, is crucial. Will one of the common directors have to be the CEO at all times? Then understanding exactly how a successor CEO will be chosen is crucial, because usually at some point it’s not a founder.

If X% of the Preferred Stock is required to approve something, then you need to know (i) what %s of the Preferred will each of your investors hold, and (ii) who will the other investors be? Usually the Company gets discretion as to what money gets added to the round apart from the lead’s money, ensuring there are multiple independent voices even within the investor base, but some VCs will throw in a provision requiring that only their own connections fund the round. That heavily influences power dynamics.

There will be many situations in the Company’s life cycle where everyone on the cap table doesn’t agree on what’s the best path for the company. Ensuring balance on all material decisions, and preventing the concentration of unilateral power, is important, and yet not simple to understand without processing terms carefully. 

E. Shorter Term Sheets are Not Better – There is debate within the VC/VC Lawyer community as to whether shorter, simpler term sheets are better than longer, more detailed ones. I fall squarely in the camp that says you should have clarity on all material terms before signing and locking yourself into exclusivity; not just the economic ones.  That means any sentences like “the Preferred Stock will have ‘customary’ protective provisions” (meaning they will have the right to block certain company actions) should be converted into an exact list of what those provisions will be. I can guarantee you your counsel’s perspective on what’s ‘customary’ is going to differ from their counsel’s.

The view among those who prefer shorter term sheets is that you should sign as soon as possible, to avoid ‘losing the deal’ (as if VC investment is that ephemeral). I don’t buy it. The moment you sign a term sheet, you are going to start racking up legal fees, and you are now bound by a no-shop/exclusivity. That means your leverage has gone down, and you are much more exposed to being pressured into unfavorable terms to simply ‘get the deal closed.’ Politely and respectfully negotiate a term sheet to make it clear what all of the core economic and control terms are. The alignment and lack of surprises on the back end is well-worth the extra time on the front end. 

In short, the core message here is know what you are signing. Make sure your VCs know that you are committed, and aren’t going to play games by shopping their terms. But also make sure you are talking to the right people to ensure that the deal you think you’re getting is in fact the one in your hands.

Separate but related note, make sure the counsel helping you negotiate the term sheet doesn’t have conflicts of interest with the VCs who delivered it. See: When VCs “Own” Your Startup’s Lawyers.  It’s not uncommon for VCs to suggest their preferred lawyers to a founder team, claiming that they’ll be more “efficient.” Whatever nickels and dimes you “save” by using their preferred lawyers will be completely negated 50x by the fact that those lawyers will really work for them long-term, and not the common stock.