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VC’s are conspiring to take over your business

John pointed me to a Peter Ireland blog post and asks whether VCs really do co-opt businesses on a regular basis – investing with a plan to replace founders and bring in their own management. "[S]ounds kinda scary," he writes, "the thought that a ‘clever’ VC could take away one’s company just like that…"

Scary indeed.  And while founding CEO’s are certainly replaced in venture backed businesses, it’s significantly overstated to say that "in about 50% of instances where an early stage company actually succeeds in raising venture capital, the founder CEO is fired within the first year".

Before I get into this, however, I feel compelled to remind you that you really should not be taking venture capital in the first place (remember?) and that investors in your business get both positive control (the ability to vote as shareholders and board members for various actions) and negative control (the long list of things that you can’t do without your investor’s approval) – see Brad and Jason’s term sheet series for more detailed information on this.

So . . . now that you’re not taking venture capital, or if you are you fully understand what control your new funding partners have over your business you can hopefully minimize the chances that your big bad VC’s term sheet is just a back-door way to gain control of your business.  Most VCs are actually pretty up front about this as they are making their investments.  After all, a significant part of what we’re investing in is the people who actually came up with the idea in the first place (meaning you and your co-founders).  That said, recognize that differences of opinion really do happen in companies, and that you may not always see eye-to-eye with your investors (or they with your management team or co-founders for that matter) about the right path forward.  Founders are sometimes asked to leave their companies or to take on a diminished role.  Founders themselves sometimes have disagreements that lead to one or more co-founders leaving a company. 

Here’s a couple of things I’d suggest that you think about to avoid the situation that John is asking about:

  1. Know your investors.  All money may be green, but what comes along with that money is most certainly not created equally.  Make sure you do due diligence on your investors and board members.  Ask other entrepreneurs who have worked with them about their experiences.  Talk to friends in the industry to get a sense for their overall reputation.  Ask your prospective VCs how they imagine working with you and the company.  You’re about to enter into a multi-year relationship with these people – make sure you’re comfortable.
  2. Understand the agreements you’re signing and have good representation.  Investment documents are complicated and pretty specialized (and not something you’ve probably dealt with on a regular basis).  Make sure you have a good lawyer and that they fully explain to you what you’re signing.  Know what rights you have and what rights your investors have.
  3. Negotiate up front.  Things like your vesting schedule, vesting acceleration if you are fired, voting agreements and board representation are all negotiated as part of your financing deal.  While you can’t solve for every possible situation, the good lawyer you hired (see #2) should be able to help you figure out with your investors how these and other key items will work.
  4. Fill your board.  If you have a spot designated for an independent board member, find one.  If you and your co-founder each get a seat – make sure you’re active participants in the business of the board.
  5. Stay close to your investors and board – keep things in the openTake responsibility for your relationship with your investors and your board.  Reach out to them on a regular basis for advice and help.  Make sure they are up to speed on important decisions and be open about the challenges you are having running your business and determining strategic direction. 

At the end of the day, it comes down to a combination of trust and communication.  The best way to avoid surprises is to know your investors and board before you formalize your relationship with them and to stay close to them once you do. 

February 12th, 2008     Categories: Uncategorized