Beware of Investors Who Will Undermine Your Company
VCs come bearing capital and, supposedly, sage advice. But at
critical times like these, they're more concerned about their interests than
yours.
BY HOWARD TULLMAN, GENERAL MANAGING PARTNER, G2T3V AND CHICAGO HIGH TECH INVESTORS@TULLMAN
As a serial entrepreneur, I've been accused of regarding most
venture capitalists much like a dog looks upon a fire hydrant. Nothing that has
taken place in the last few years has changed that opinion. There may be a few
good souls among these VC vipers but, if anything, it's become increasingly
clear that I may have been too kind. Then again, I'm an equal opportunity offender.
Watching shameless VCs circulate to their portfolio companies
the business plans submitted in good faith by hopeful startups (and potential
competitors of those portfolio companies) without the slightest regard for
confidentiality is just one of my many grievances. At the same time, I've also
cautioned startup entrepreneurs to be a little less greedy and aggressive in
their own valuation demands when dealing with VCs. And I've suggested to board
members some basic ground rules for effective and supportive
participation.
But as we enter a new season of triage, salvage, and self-interest,
where the VCs serving on hundreds of boards find themselves grossly conflicted,
I fear further challenges. There are so many who have divided duties, and they
can't serve two masters at once. Every entrepreneur trying to sustain and save
his or her own business needs to keep a very watchful eye on the worst of these
folks. Because, when push comes to shove, there's only so much room in the
lifeboats and so much cash, resources, and time to devote to individual
situations. Be attentive and proactive, because you don't want to be the one
without a seat when the music stops and the VCs decide which firms to back,
which ones to bury, and which ones to bail on.
Right now, in the most viable businesses, we're seeing serious conflicts at the
board level between the concerns and objectives of the management teams trying
to stabilize and prudently rebuild their businesses and the venture investors
concerned mainly with their own timetables and exit strategies. But whenever
the company's financial condition, current performance, and long-term prospects
are uncertain and challenging, the board level conversations quickly turn to
triage, and the VCs are the last people an entrepreneur can count on and the
quickest to jump ship and forget their fiduciary obligations to the
business. It's possible that it's actually impossible for a venture
capitalist running an investment portfolio to not be conflicted, and to honor
their duties as directors and act completely objectively, independently, and
faithfully in the best interests of each portfolio company.
Over the last few decades, we've regarded the ability of the VCs
to cross-pollinate, coordinate, and share opportunities and technologies among
their companies as a clearly positive competitive advantage for all
concerned. Whether it's Y Combinator, the PayPal mafia, or any of the many
other variations of the Japanese keiretsu model that gained as
much currency and popularity in the last decade as the kaizen manufacturing
doctrines did in past times, spreading and sharing the wealth throughout one's
portfolio is increasingly SOP for the VCs. But when hard choices have to be
made, this approach can far too easily shift to robbing Peter to pay Paul. What
worked well in the best of times can be a double-edged sword.
As the CEO of a challenged portfolio company, you don't want to
wake up one morning and find yourself sitting on the sidelines as your business
is sold out from under you for scrap, folded into someone else's shop that is
also in need of salvation, or - worse yet - cannibalized by your own
self-interested venture investors looking to poach your key employees,
customers, or technologies and move them to their other, more viable, portfolio
companies.
And don't think for a moment that it can't happen to you because
this is happening all over the country. The post-pandemic portfolios of many VC
firms are in shambles and, in their frenzy to protect theirs, venture capital
partners who are serving on the boards of several of their portfolio companies
are finding themselves torn between competing interests. There are multiple
potential conflicts: the needs of each business they've invested in; their own
anxieties about their firm's scorecard; their competing fiduciary obligations
as directors; and their own arrogant belief that they uniquely know what's best
for all concerned. These are people who simply believe that they make their own
morality and that the traditional rules and legal obligations don't apply to
them.
This awful combination of personal concerns, questionable
judgments, and complete callousness leads to borderline or worse behaviors by
conflicted directors. Their book of breaches of fiduciary duties includes
interfering with management's responsibilities, directly approaching company employees
with criticisms of senior management, using budgets as instruments of torture
rather than planning documents, and soliciting or offering senior managers
positions at their other portfolio companies. Beyond being unethical and
unprofessional, these acts - especially in stressful and uncertain times - can
do serious damage to a company's morale, common purpose, direction, and
progress.
Unfortunately, there's an overwhelming tendency among board
members to be aggressive conflict avoiders. They value their venture industry
contacts and relationships far more than any of their portfolio companies.
That means it's very difficult for entrepreneurs to rally and induce
board members to take action when "one of their own" is misbehaving,
even in clear cases of breach and other inappropriate behaviors.
In many instances, the other board members may be conflicted --
especially where they have co-invested with the offender. And frankly, no one's
interest is served by initiating formal legal actions or board motions and
sanctions. Apart from direct confidential conversations with the problem
directors, which may result in a change or replacement of the investing
entity's board representative, there's not much to be done other than to hope
that the discovery and warning of the inappropriate actions will prevent a
repeat of the same kind of behavior.
The bottom line is simple -- forewarned is forearmed. Even if
the available remedies are modest at best, it's still your job as CEO to be
attentive and observant and to take whatever steps you can to protect the
company in every possible way from directors who insist on placing their own
selfish interests ahead of those of the business.
NOV
29, 2022
The opinions expressed here by Inc.com columnists are their own,
not those of Inc.com.