Post Category → Founders

VCs and Founder CEOs: Coaching v. Undermining

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:

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. 

Lawyers are Slow, But Firms Shouldn’t Be

TL;DR Nutshell: Don’t be fatalistic in assuming that working with good lawyers always means slow response times. But also don’t delude yourself into thinking that any particular lawyer, if she’s good, will be immediately available for your every need. Asking the right questions about responsiveness up-front will prevent a lot of frustration in your startup’s relationship with its lawyers.

In my discussions with founders re: what they look for in hiring lawyers for high-growth, investor-backed startups, I’ve found that everything usually boils down to 4 criteria (often in the following order from most important to least, but not always):

  • Quality – Top founders usually have a strong understanding that (i) decisions when the Company has $5K in the bank account can (and often will) have a material impact on the business when its hit $20MM ARR, and (ii) cleaning up legal mistakes is orders of magnitude more expensive than doing it correctly the first time.

Quality is typically the main reason that startups ‘upgrade’ from generalist lawyers. See: Startups Need Specialist Lawyers, But Not Big-Firm Lock-In

  • Trustworthiness/ Like-ability – Your lawyers will be (or should be) close advisors working with you on the most high-stakes, strategic decisions of your company’s lifecycle. That relationship will get dysfunctional quickly if you can’t trust them, or simply don’t like them as professionals.

Trustworthiness is typically the main reason startups switch lawyers/firms from those that their lead investors insisted they use. See: Why Founders Don’t Trust Startup Lawyers

  • Efficiency – Hiring good lawyers, like hiring good developers, will never be cheap. It’s a basic law of markets that top talent requires top compensation. That being said, there are a lot of ways that founders can ensure that their legal budget is paying for great lawyers and not for expenses/overhead that isn’t actually resulting in better value.

Efficiency is typically the main reason startups avoid, or stop using, very large firms with billing rates 4-5x of what top lawyers require in compensation. See: How Startups Burn Money on Startup Lawyers

  • Responsiveness – This usually comes last because many founders have, through frustrating past interactions with the legal profession, come to the conclusion that ‘dealing’ with lawyers inevitably involves long wait times. Sort of how I brace myself every time I have to enter a specialist doctor’s office, because I know a 9:30 appointment, which was scheduled weeks ahead of time, usually means actually being seen around 11.

Send your lawyer an e-mail and expect a response in 3-4 days, if he’s not too busy. That’s just what it takes to work with good lawyers when you’re a small startup with a modest legal budget, right? The big fish have their attention most of the time, so just get in line… It doesn’t really need to be this way. Understanding 3 concepts related to lawyer economics will help you avoid this scenario:

1. Appreciate institutional bandwidth – and why, for speed, firms > solos. 

If recruiting and motivating top lawyers requires competitive compensation, then with basic math you’ll see why great lawyers who work with early-stage startups must work with many startups, not just yours, to get paid. Good startup lawyers are busy people, because maintaining a strong portfolio of work allows a lawyer to get paid well without burdening any particular company with an excessively large bill.

However, while a solo lawyer who is very busy will have only one thing to tell her client when they need something done quickly – “wait” – lawyers in firms have institutional bandwidth. If I’m busy, and I often am, I have other lawyers (and staff) in my firm who can be assigned to keep work moving. Properly run law firms know how to manage bandwidth and ensure that work is “spread” throughout their roster, without a loss in quality. This allows great lawyers to stay busy (required for compensation), without burdening clients with ridiculous wait times.

This point is, however, related to a second important concept:

2. For your primary counsel, hire a firm, not a lawyer. But size of practice area matters more than the size of the whole firm. 

The old adage “hire lawyers, not firms” has a lot of truth in it, but that truth only applies with the right factual backdrop:

  • It’s usually said by in-house general counsel, who themselves maintain a roster of specific lawyers (at various firms) that they can task on projects to manage bandwidth. Founders do not have this, and trying to build it for them would be a waste of time.
  • It assumes that there is something very unique about a particular lawyer that you need that others in her firm cannot provide. If you are doing cutting edge niche legal work that is unique to your particular market – like perhaps a patent lawyer with a very deep understanding of your special technology that no one else on the market has, this may make sense. For general startup/vc law, this is flatly not true if the firm you’re working with maintains proper standards and training for its roster of lawyers.

Of course, your primary contact with a firm will be a specific lawyer. But if you want to avoid waiting days, or even weeks, for something as simple as a response to an e-mail, you need legal bandwidth, and that means a firm. Expecting a specific lawyer to handle everything you need is the fastest way to ensure you are going to wait a long time for that lawyer’s attention, unless you’ve got several hundred thousand dollars a year in your legal budget for him. That’s called “in house counsel.”

But take note: there are a lot of law firms with 500, 1000, even 2000 lawyers who are incredibly slow. Why? Because they don’t actually leverage institutional bandwidth. A lot of those lawyers inside these large firm are either (i) in completely unrelated practice areas and hence aren’t actually available to help your particular lawyer (useless to you), or (ii) working in silos (just sharing a brand) with no effective mechanism for collaborating with one another. There are deeper reasons behind this “silo” problem that span issues like technology and compensation structures, but that’s too deep for this post.

Keeping dozens of different specialties of lawyers under the same firm is massively inefficient – to use econ jargon, we can call it “diseconomies of scope.” But within a specific practice area, there are very large efficiencies – shared technology, training, templates, institutional knowledge, and access to client information  – that a focused firm has over a bunch of independent lawyers. That’s why the specialist ecosystem that MEMN leverages is made up predominantly of specialized boutique firms, not solo lawyers (although there are those as well), each with their own institutional bandwidth within their practice area. See: The Tech Law Ecosystem v. BigLaw. 

3. Don’t hire an M&A or IPO Lawyer who uses startups as lead gen. Hire a startup/vc lawyer.

There is a massive difference between a lawyer who focuses on M&A (large exit transitions) and simply pursues startup clients as lead gen for very large deals v. a lawyer whose focus is startups and venture capital. The technology law firms that have very good response times have segmented large exit transactions as a specialty that operates alongside, but separate from, emerging companies corporate work. On top of improving response times, this results in better startup/VC lawyers and better M&A lawyers.  Find one of those firms.

Compare these two lawyers:

  • Lawyer A is assisting this month on (i) a formation, (ii) two seed deals, (iii) a Series B and Series C financing, and (iv) a $500MM acquisition.
  • Lawyer B is assisting this month on (ii) a formation, (iii) three seed deals, (iii) 2 Series A financings, and (iv) a Series B and Series C financing.

If you’re a startup client w/ one of those seed deals or VC financings and have a question, or you’re just a client with a quick question on a new hire, who do you think is more likely to respond promptly to your e-mail? Lawyer B will.

Lawyer A, because of the fundamental fact that large, high-stakes, fast-paced exit deals tend to consume lawyers’ attention (for understandable reasons, big fees at stake) is going to take a lot longer. Hire Lawyer B over Lawyer A, and just ensure that Lawyer B’s firm has M&A specialists for when you need them… or hire Lawyer A and take a number.

Recap: Startups move fast. It is extremely frustrating to founders when their lawyers can’t keep up.  That doesn’t mean you should expect McDonald’s like responsiveness – these are highly skilled, busy professionals managing a portfolio of clients, not your in-house assistants – but if it takes days to even get a response to your e-mail, there’s an underlying problem that should be dealt with. For primary corporate counsel, find a firm with lawyers who focus on early-stage/emerging tech work, and with institutional bandwidth within that specific practice area.

And if you want the truth on how responsive a group of lawyers are, there’s no better place to go than that firm’s client base.  Believe me, if a founder CEO is frustrated with the responsiveness of her lawyers, you’ll have zero trouble getting her to talk about it.

Converting Your Startup to a Delaware Corporation, Correctly.

TL;DR Nutshell: If you’ve accepted that you need to convert your startup to a DE corp from a different entity type, then it’s also time to accept this: there is no off-the-shelf, “click a button and file” way to convert to a DE corp. It is highly contextual. The right lawyers can do it efficiently and correctly. The wrong ones will tell you it’s simple, screw it up, and require you to pay the right lawyers 5x more in the future to clean it all up.

Background Reading:

The purpose of this post is not to debate whether your startup should be a Delaware corporation. While we do work with a decent number of VC-ish backed Delaware LLCs (sometimes LLCs really do make sense), the vast majority of technology companies that raise venture capital either start or end up as Delaware corps. And the moment a lawyer starts playing contrarian with me, talking up why Delaware isn’t needed, or C-Corps are tax inefficient, I quickly end the exchange by asking how many VC-backed companies she’s actually worked with. We are talking about scaling tech companies and venture capital. Not small businesses or companies funded by local, non-institutional investors.

So for purposes of this post, we are going to take it as a given: you need to be a Delaware corporation, but you aren’t one right now. Converting is simple, right? Just file a form?

Converting from any kind of entity to a DE Corp is not “standard.” Ever. 

Properly forming a DE corp startup from scratch has, thanks to standardization and automation, become a relatively straightforward process.  The reason, of course, is that you’re starting from nothing, and nothing is the easiest condition to automate from; no messy context throwing a wrench in the system. Conversion, however, involves a history with any number of possible permutations, and that means all the shiny templates and technology must give way, partially, to human judgment.

  • What are your state’s rules around entity “conversions”; is a “statutory conversion” allowed, or will you need to do a merger or possibly even an asset sale? It depends. 
  • What approvals does your state’s rules require? It may be a majority of all equity, it may be 2/3, it may be unanimous. It depends.
  • What specific documentation (like a “Plan of Conversion”) and filings (often in both states, not just DE) do the rules require? It depends.
  • Are there any existing agreements in place that might require a separate consent to be obtained before the entity can convert? Ok you get the idea.
  • Does the company’s existing capital structure require a (hopefully quick) discussion with tax counsel regarding possible tax hits (phantom income) resulting from the conversion? This is a crucial issue to consider when converting an LLC to a Corp. 

Converting a Non-DE Corp to a DE Corp (Corp to Corp) is generally simpler than converting an LLC to a Corp. Converting any entity in a state that allows for statutory conversions (TX and CA do, NY does not) is generally simpler than having to do a statutory merger.  Whatever the context, you will screw it up trying to do it yourself. In fact, I’ve lost count of how many law firms have screwed it up, requiring founders to pay us 5-10x in cleanup costs than they would’ve paid if they had just hired competent counsel from Day 1.

The reason you will never just push a button to receive medical treatment is that every person is different, and tailoring high-stakes treatment to individual differences is precisely what professional judgment (supported by tech, of course) handles best.  Startup law is no different. Technology and tools absolutely cut down on waste, and yes there is a lot that is standardized even in conversions.  But in the end the institutional knowledge of the law firm you choose will determine whether it gets done efficiently and correctly, or whether you’re just deluding yourself into thinking that the guy promising a cheap, simple conversion actually knows what he’s doing.