This post was prompted by Brad Feld’s release of the Startup Boards 2nd edition. I’ve been sharing the original since it was published 10 years ago, frequently shipping a copy to founders when I closed on a seed to Series A investment. This 2nd edition is packed with new content I find useful for not only startup founders, but also seasoned CEOs ready to do a gut check comparing their board with the book’s suggested best practices.
Learning about boards is an overlooked founder priority
For most founders, the onset of bringing on institutional investors triggers awareness of governance and responsibilities of a board. Though even at that stage, I’ve found it’s a rare early stage entrepreneur that grasps the priority of investing the necessary time and energy for learning how to build and manage a board of directors.
More typically, first time founders look to their venture investors for guidance on board composition, development and process – without realizing that the entrepreneur’s following rather than leading, is a huge missed opportunity to develop critical competency necessary to evolve as CEO through and beyond the growth stage of their company.
Once investor backed company CEOs start being held accountable to hitting growth targets, a founder’s narrowing focus to revenue and customer traction can drive attention further inward, coming at the expense of proper expectation setting and engagement at the board level. Not surprisingly, many founder departures happen when the company hits inevitable speed bumps in the growth stage, where the mix of managing both above and below is new territory for the entrepreneur CEO.
Startup Boards as a Field Guide
The book is a truly a field guide that founders may read through once, then find themselves going back for reference when board issues start rising to top of mind.
Understanding the basics of a board’s purpose, roles and functions lays the foundation for those just beginning their board journey.
A full chapter on VCs as board members demystifies several dynamics that can help immensely in forging productive VC Board member relationships.
Seeing best practices on how to recruit, interview, compensate and communicate with board members are all key, as is the understanding of why having a blend of independent directors is so critical.
With 34 years on TriNet’s board, seeing the arc of that evolution through challenging growth stages, (including rigors of the public market), gives me special appreciation for how the guidance in this book is spot on.
Buy it now and you’ll have the chance to take more control over your future by seeing the connection between good governance and successful companies.
Fred’s insights are absolutely on point, and reading them prompted me to dig up an unfinished post of my own on this topic – one that I began writing earlier this year following the exit of TriNet’s long time controlling shareholder, General Atlantic.
For context, consider that TriNet’s annual revenue was about $50 million at the time of GA’s 2005 initial investment and have now grown to more than $2 billion.
More important than the growth capital GA invested, was the expertise and support they provided through our doing 10 acquisitions and transactions, including complex ones like our pre-IPO purchase of a much larger public company which we then took private, large debt financings that benefitted all shareholders, our successful March 2014 IPO and the smooth transition of their shares to Atairos, another large institutional holder so there was no disruption of our share price in the public market.
GA support also was instrumental helping us recruit my successor CEO Burton Goldfield, top quality board members and key executives, all while helping us with a savvy investor’s outside in looking view on important board level strategic and governance issues as we navigated through challenges at each stage of the company’s growth in that 11 year span.
It is hard for me to imagine how TriNet would have evolved to both our current marketplace position and promising path to remain an enduring company of the future had we not had the richness of GA’s contribution led by Managing Director Dave Hodgson.
So it is with some reflection now that I share a few principles on investor attributes I bring up when mentoring entrepreneurs who are in earlier stages in the journey of finding and working with institutional investors.
Companies don’t invest, people do
Institutional investors are duty bound to stay within the expectations set for the limited partners who are the source the fund’s capital. While this baseline can never be overlooked, the partnership responsible for running the fund still has latitude within the fund charter to make the key decisions leading up to when and how the fund ultimately exits the investment.
How that latitude gets exercised has a lot to do with the quality of relationship and trust between the company CEO (and board), with the key sponsor inside the fund – typically the company board member who is at managing director/general partner level in the fund.
The person who is your financial sponsor will end up being the company’s advocate inside the venture fund’s partner meetings where tough decisions are hashed out on things like:
– how the fund’s holding in your company is valued
– whether to increase the fund stake with a new round
– should the sponsor orchestrate a change in company leadership
– how would the fund’s non capital resources be deployed in supporting a company transaction or initiative
– when and how the fund’s stake in the company will be sold
As the CEO, you won’t have insight to the dynamics of those internal fund discussions, but you’ll certainly be dealing with the aftermath once the decisions are made.
So WHO the person is that you are relying on to be your advocate has everything to do with the personal qualities of your sponsor and how well aligned he or she is with the company’s view of playing for long term success vs. building to flip for near term gain when the inevitable unanticipated speed bump occurs in stalled company revenue growth.
Relationships are tested when times are tough
It’s hard to gauge the quality and strength of any relationship when things are going well. But if you’re truly scaling up a company, the truism is that is that even with the boost that might come with a big slug of new equity capital, it is never a straight line to uninterrupted periods of steady growth.
Whether due to bad planning, execution failures or external factors outside the company’s control, the time will certainly arrive when the company misses hitting critical budget goals expected to show progress in the investment.
When things go awry, whoever your financial sponsor is now has the added burden of convincing his/her partners of the fund on whether the setback is navigable or requires an investor driven change (e.g. like firing the entrepreneur CEO).
This requires the partner to have a deep enough understanding of the business and capabilities of the CEO and team, as well as the credibility and persuasiveness to advocate a difficult position that might run counter to conventional wisdom or prior experiences inside the private equity firm.
Don’t shortcut the investor diligence
The best sources to diligence someone who is a candidate to be your financial sponsor inside a fund would be founder/CEOs that sponsor has worked with in prior investments.
Here are a few areas that could be worth exploring to diligence someone lining up to be your financial sponsor:
– How well did the sponsor set expectations and deliver on them? When did he or she have to walk back expectations they previously set?
– Describe examples of where the sponsor dug into the details of the company’s business and applied that knowledge in a way that surpassed contributions of other board members?
– How persuasive was the sponsor at influencing the view of other directors on the board to get to the right outcome?
– How did the sponsor help when company results fell below budget?
– How did the sponsor affect a company outcome that might have involved responding to a company crisis or pursuing a major opportunity in a compressed time frame?
Don’t stop at just one diligence call. Speaking with CEOs from at least 3 former portfolio investments will provide a richer picture than any single source.
Viewing company success as personal success
Like most entrepreneurs who’ve been on a company journey a decade or longer, my ambition has always been about building a company to last – knowing that if the company is able to grow profitably over a sustained period of time it would be achieving what I set out to do in filling a market need and growing a team responsive enough to adapt to ever changing conditions that challenge others in the same industry.
If I was able to lay the foundation for building a company to last, I wouldn’t have to fret about where I would end up financially since the pace of growing the company’s value would far exceed dilution of my percentage ownership stake.
While it’s a straightforward financial proposition to see it’s better to own a minority slice of a huge pie than be controlling shareholder in a small company, the bigger issue many founders wrestle with is whether they can separate themselves from company leadership if that is in the company’s best interest.
Whether the founder opts to exit the leadership team or is nudged by the controlling shareholder(s), either case involves a high stakes transition where the financial sponsor is in a position to influence the outcome in a manner that all involved emerge as winners.
The long game begins with shared vision and trust
Some entrepreneurs, and investors drive towards generating a decent return over the near term by building a company likely to be sold for a profit at the earliest possible time.
If you’re in the other camp of wanting to build a company to last, continuous company growth will still provide meaningful exit opportunities where you could be in the envious position of passing today’s sale to stick with the vision of building a larger and enduring company.
That can end up with a more financially rewarding and satisfying journey, but likely to be achieved only when there is alignment with that shared vision and trust between the financial sponsor and CEO. Figuring that out before the investment is made is the first step towards what can become a long and mutually beneficial relationship.
The entrepreneur gushed “We just closed a $2.5 million Series A on an $8 million pre-money valuation.”
My response: “Great news – now that you’re a couple months past close, what’s the probability estimate of hitting the 1st year revenue target you set for the VC’s?”
The smile quickly vanished as the entrepreneur acknowledged it was far from being a lock to hit the target. Both the risks and attendant pressures were already starting to hit home.
Valuation optimism can be masked with insufficient data
Unfortunately, this is a much too common scenario as founder drive to minimize personal equity dilution by grabbing the fattest valuation possible seems to override their judgment on what happens post deal.
Typically the culprit is too little thought given to the underlying assumptions behind a detailed bottoms up financial model. Proper models take into account factors like average deal size, sales process steps and time to close, productive lead sources beyond executive team personal relationships and diminished close rates of non founder sales reps. [See my post: Leading Sales as a Startup CEO].
The worst offenders set their valuation target first and then back into a set of projections that align revenues with the valuation goal as they scurry about for data points supporting their wished for revenue trajectory.
While VC’s will certainly review assumptions behind revenue as part of their due diligence, entrepreneurs will get some leeway if the product offering is distinctly different with what’s already in the marketplace (thereby lacking trend comparison with similarly situated companies) and you’ve already racked up a few sales to your credit.
Overly optimistic projections come with consequences
The path to judgment day starts with board meetings in which the new institutional investor board members are now brought up to speed with the insider’s view of your progress against the expected revenue targets that were in the deal.
If you’re absolutely confident you’re right on path to meet or exceed the targets then you’re golden.
But if you’re starting to break out in a cold sweat soon after the deal closes, then you’ve got the hard choice of perpetuating expectations you may not have confidence in or going about the delicate process of resetting expectations.
Perpetuating the improbable is a gamble that ever optimistic entrepreneurs take, believing somehow, someway they will find a solution over time.
However, as projections don’t get fulfilled, that factor alone becomes the biggest reason entrepreneurs get pushed out of the CEO role in favor of someone who has a proven track record of “meeting the numbers.”
And that equity stake the founder was concerned about? When projections get missed and Series A funding dries up while there is still a substantial burn rate – you then have the classic down round scenario where in order to keep the company alive with a new financing, founder shares can get crammed down to a pitiful percentage of ownership compared to their post series A stake.
De-risk with detailed assumptions behind revenue components
You can mitigate risk by building a detailed model for how revenue projections are derived.
List assumptions behind each component of a revenue formula so there is complete transparency and no “black box” – even tilting assumptions towards most realistic, if not outright conservative achievement at critical components of the revenue formula.
The best entrepreneurs don’t settle on just a high level view of 2-3 revenue component steps to come up with a formula. Instead they tear apart every step in the customer acquisition process to find patterns which can be reasonably tracked (with a minimum of admin burden) that help point to predicting success at that particular step in the sales process, and in the aggregate – timing of future revenue flows.
Since early stage companies typically won’t have a large enough team for a professional CFO on staff to build such a model, they can fill the expertise gap with an “Interim CFO” who has the background and strategic perspective to dive in and gather input from multiple team members to guide a true bottoms up model with detailed, defined assumptions.
The best interim CFOs divide their time among a cadre of early stage companies and often have the pattern recognition of having been through this exercise across many similarly situated companies. This helps not just in developing the model but with an ongoing retainer relationship will help their client tweak the model as more data comes in and analytics for management and board are refined.
While it’s best to avoid optimistic projections pre-deal, the earlier that investor expectations get reset to the proper level the more likely you are to retain your credibility as a leader.
So don’t wait for your next round to beef up the visibility and accuracy of your forecast. When you’re depending on other people’s money – than your success, and that of your company, may end up riding on how well you can predict the future with a financial model that you actually deliver on.
Overcome seed investor exit bias with vision and passion
As an active seed investor with my UpVentures, it’s not unusual for me to be weighing odds of investing in one company with some plausible acquirer targets on the horizon, versus another startup with a more speculative moon shot based on a large, but totally unproven, market opportunity.
This dynamic plays to entrepreneurs too. Wouldn’t a more likely pay day come in a space where others have shown some traction, ahead of being out there on the “bleeding” edge because you’re pioneering something that almost no one else sees yet?
There is no absolute here. Though as a seed stage investor, it is probably a good idea to have a portfolio with a mix of these two opportunity paths.
Investors can under appreciate market timing
Being ahead of the curve in a new and unfamiliar industry raises seed investor uncertainty about where the exit paths will be. This prompts a subtle bias for us to instead focus attention on opportunities that seem to have nearer term possibilities for liquidity.
But as IdeaLab founder Bill Gross recaps in this video reviewing data from 110+ companies he had a hand in, his search for causality in the factors of idea, team, business model, funding and timing (five classic early stage investor criteria) shows evidence that market timing had more to do with startup success than any of the other key criteria we seed investors rely upon.
Even one better is the wisdom of Paul Graham and his insights that come from decades of seed stage investing and running Y Combinator.
While multiple Paul Graham essays touch on this theme of market timing, one of my favorites is Black Swan Farming – he nails this seed investor bias against new models and markets by sharing logic behind his thinking why he felt Facebook was a lame seed investment opportunity when he first heard of it.
Biggest opportunities powered by multiple macro forces
While startups generally have some kind of societal, market or technological trend underlying their plausibility for being an investable growth business, if you parse through any list of $1B+ exits, you’ll see the big winners enjoyed a confluence of multiple macro trends that drove growth for an extended period.
My appreciation for this factor of multiple trend convergence began as it was probably the biggest reason prompting launch of my own startup journey in founding TriNet in 1988.
While very much a rookie entrepreneur then, I was more than a little passionate about how certain trends were both irreversible and directly related to powering our business model behind outsourced HR services including:
Increasing government regulations burdening employers
Shift in employment landscape from large companies to small
Smaller companies needing benefits to compete for talent (previously the domain only of big companies)
Technology adoption driving both speed of business (narrowing core competency that would in turn drive outsourcing) plus add new capabilities to enable efficiency in service delivery across a large number of smaller company customers.
As obvious as these trends might seem today, the late 1980’s was a different world and even venture investors couldn’t warm up to our opportunity since they didn’t then appreciate how our perceived pure service business could be sufficiently technology enabled to scale and leverage these converging trends as fully as TriNet proved to do.
Winning entrepreneurs articulate vision with passion
Vision and passion are important for any startup CEO. But if you’re forging new paths in unchartered models, you’ll be hard pressed to raise seed funding without a founder CEO getting across both these qualities.
Take the time to unpack specifics behind your supporting macro trends. Cite independent sources with data that supports your thesis. Tying multiple trends to defined elements of your business model and execution strategy boosts credibility in your vision.
But even those actions are not enough to sway seed investor interest if there isn’t a clear sense of deep personal passion on why this means so much to you.
Passion comes through when investors become convinced about the entrepreneur’s emotional commitment to the “why me” behind the problem the venture is solving. Our senses pick up the cues for this emotional commitment probably more so by how you articulate, than the logic supporting your argument.
A deep, passionate commitment is essential to overcoming the many obstacles ahead, including attracting the right team members who you’ll be asking to take their own risks in joining a team with an unproven model and/or industry.
Entrepreneurs who get seed investor attention are the ones whose vision and passion are so ingrained in their persona that they clearly differentiate from the crowd of their startup peers.
So don’t fear being “over the top” in getting across your passion and commitment. How you message that emotional commitment, coupled with a clear vision that ties specific trends to your model is what we’re looking for.
Winning investor hearts, along with our minds, is the combination that unlocks wallets to speculate with even greater risk than the semi plausible exit strategy we’re weighing you against as our investment alternative.
Tips for pitch event organizers and startup founders from an investor’s perspective
Last week I attended a local pitch event for the Upstate tech community that included four entrepreneurs pitching their startups. Like many other such events, the audience was a mixed group of entrepreneurs, community supporters and a small handful of investors.
The pitches unfolded in typical fashion. When I saw the most common pitch errors across each of the four presenters, I did wonder about how the event organizers went about setting expectations and guiding the entrepreneurs doing the pitching.
Entrepreneurs know these opportunities are important. They definitely spent time preparing, yet missed the chance to deliver a compelling case. Most importantly, none of the presenters specified what help they were seeking.
What follows in this post are a few suggestions aimed at both event organizers and pitching entrepreneurs who seek to avoid the boring pitch syndrome.
Tip #1: Problem and solution are not enough
Entrepreneurs (particularly those with a technical background) fall too easily into the trap of using precious minutes in a pitch to dumb down the science. They hope to compel the audience by spelling out the technical challenges that were overcome, and the uniqueness of the startups’ product design.
If half or more of the pitch is spent defining the scope of the startup’s technology, it comes across like an academic exercise. The presenter is seen as working too hard to impress with his or her technical mastery – shortchanging the opportunity to secure support beyond defining problem and solution.
Tip #2: Pitch to investors, even in mixed groups
Even in situations where there is a mixed audience with diverse backgrounds and interests, I’m a fan of crafting pitches as if the entire audience were investors.
Everyone wins by taking this approach in the pitch because:
A standard set of guidelines can be provided to all presenters that directs them to a specific outcome
The event can run on a consistent track, making it easier for the audience to compare pitches with a lens that helps everyone think about how investors look at who to fund
The entrepreneur gets an opportunity to further hone the investor pitch, addressing things like business model, channels of distribution, margins and other critical business issues
Tip #3: Close with telling people what you want
I believe it’s essential to end a pitch with a specific appeal for help. Often times someone in the audience can assist the entrepreneur. They just need to ask!
Requests for help shouldn’t be limited to financing. Telling people what else your startup needs right now gets everyone thinking about how and who they know that can assist.
Whether it’s introductions to a specific type of customer or channel partner, or finding new team members, mentors and service providers, pitching is an opportunity to make a personal appeal. Someone in the audience may know the right resource for your company, but only if you tell them what you need.
Tip #4: Event organizers call the shots
With so many startups clamoring for the opportunity to get more exposure, event organizers have the leverage to set high standards for who they choose to present.
Instead of filling slots with whoever raises their hand first, consider inviting entrepreneurs to apply for the opportunity.
Even better, give them a short set of pitch guidelines on what you would like to see included in the pitch, and ask them to send a sample deck for you to evaluate.
It’s ok to tell applicants that their submission is just a sample. Ideally you and members of your supporting team can guide development of the final pitch so that it meets your target standard.
If you need pitch mentoring support, resources like Upstate Venture Connect’s UNY50 Network or investors in any of our local seed funds can help. These same groups can also help recommend qualified startups to pitch.
Setting a high standard for your pitch events, and helping startup founders deliver compelling pitches will not only satisfy your audience, but reflect well on you as a sponsoring organization.
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