The Myths of Power
September 18, 2016: In startup financings there is usually much discussion about control. The founding group always wants to maintain voting control, and there is a valid argument for leaving enough room in the cap table to allow for subsequent higher value rounds. As I have frequently written, most professional investors will give you the psychological win of maintaining a voting majority but will protect themselves on the downside with the terms and conditions of a new class of stock such as a participating preferred. They know well that it’s distributions from the waterfall chart at the exit that matter, not percentages on the cap table at inception.
The founders cede absolute control when the first arms-length investor comes aboard. Even one share of common must be respected, and the fiduciary duty of the management team thereafter is to the company and not the personal interests of the founders. Generally a board of directors is established as the primary governance mechanism, and even a 90% owner ultimately reports to the board. Of course, he or she can vote out the board if relationships sour, unless the aforementioned T’s & C’s of the stock classes have their customary provisions about board composition. And, any one shareholder can always bring a lawsuit against the officers for actions that clearly favor self-interest over the good of the organization. That shareholder can even easily instigate what is called a derivative action on behalf of all other affected holders.
Last week’s TechDrawl essay was about the transition from “vision” to the cold-blooded tale of the numbers, and this one is a corollary to that. Real power in a startup, especially one that is funded and trying to scale, has to be constantly earned. Certainly there is an organizational hierarchy, and the buck has to stop with someone if anything is to be accomplished. But, startups are a team sport, and you have to win the unbending trust of your team to get them to perform at the above-and-beyond levels required of such nascent companies. If they see you wandering off the reservation and doing things on your own whims that detract from the company mission, you’ll quickly lose the best of your colleagues. There’s no more telling warning sign about a startup than early changes in senior leadership. That’s a disclosure requirement in any financing document, for good reason.
You must also earn your standing with shareholders. I’ve found that folks who invest in early stage tech deals are generally aware they’re taking a flyer, and they’ll accept the consequences if things just don’t work out. However, you will win their support, which you might need for a follow-on round or for a subsequent startup, by keeping them well informed. Austin-based AngelSpan has made a nice business out of providing the tools for doing just that. Private deal investors don’t like surprises, just like public market investors. They know there will be ups and downs in your startup and will ride with those if they are kept in the know. But, don’t go silent for a few months and then call them up on a Tuesday and ask for a loan to make payroll on Friday. You may have done your very best with the business and be on track for something great, but that message will be completely obscured by your inattention to your shareholder base when you didn’t have an urgent need. Keep in mind also that investors in startups get a lot of psychic income from the adventure. They want to be helpful if called on for introductions or general commiseration; they like to see that their money is creating something valuable; they enjoy talking up the deal with their buddies; they want to win points with a spouse; and they can be your best salespeople. All that goodness only happens if they’re kept up to date on the playbook and on the results. Take the time to pitch them once in a while, just to add to that psychic income, make sure they are on message, and keep yourself sharp.
Similarly, you must earn your sway with your customers. They too want to be kept informed of new developments and not get caught by surprises. People who depend on your product, whether it’s B2B or consumer, develop high expectations of you. They better you deliver what is promised, the more bargaining power you will have with them. That comes in quite handy when it’s time for price increases, or things like removing the earphone jack. I’ve heard several people recently mention the notion of creating a “movement” and not just a customer base. That’s a good way to look at what you want your marketing to achieve. And, stick to your promises. If, for example, you are developing a tool that another company uses as an input to its business model, don’t mess with standards that may have consequences downstream. A case in point in my biomedical startup occurred this past week. Our developers discovered a bug in the operation of a major oncology database on which we will depend and pointed it out to the supplier. Under the category of no good deed going unpunished, to fix this bug they rearranged their data in a way that obliterated our carefully constructed workaround. We got no advance warning of that and lost countless hours over a long week rewriting our code to accommodate their change and keep our delivery date on course. If you’ve spent much time in the software business, this is a familiar story for you, and I’m sure we’ll have to endure this fire drill again. But, when it comes time to renew that particular data subscription, we’ll have grounds for some concessions. I’m also betting we were not the only customers affected so drastically. In this episode the supplier gave up some its power to us users.
In summary, unless your goal is to own 100% of nothing, don’t kid yourself about how much power you have as a startup founder. None of us is guaranteed tomorrow, much less the success of a business idea. The real power you will maintain is what you earn, not what you claimed at the beginning.
<Opposing powers: U.S. Secretary of State John Kerry and Russian President Vladimir Putin pose for a photo before their bilateral meeting on March 24, 2016, to discuss Syria and Ukraine at the Kremlin in Moscow, Russia. State Department photo/ Public Domain>