It’s tough out there for many startups and their investors, as economic pressures hit growth prospects and new funding proves harder to come by. A recent survey indicated that 81% of early-stage startups are facing failure in 2023 because, as of the end of October, they had less than 12 months of capital left to keep going. The new reality has been a rude awakening for many founders, who had become accustomed to the cheap capital and favorable climate of the last few years.
One potential consequence is that founders may find themselves facing more investor conflict than before. Many investors who entered the market in the last couple of years were non-traditional, such as private equity or hedge funds, or new VCs, without experience of operating through more challenging times. Many are finding that their light touch approach to due diligence is coming back to bite them, as the growth bubble pops, and the market returns to ‘normal’.
From concerns about growth to disagreements about costs and hiring, or misalignment about future strategy, a range of issues can come to a head when growth hits the buffers. Funding strategy is another matter of contention, as existing investors face the prospect of having their equity diluted, as is exit timing if investor interests don’t agree with the route you want to take.
Conflict is inevitable – but how can you make it constructive?
Conflicts between venture investors and entrepreneurs are not uncommon, where multiple stakeholders and shareholders are involved, each with their interests and objectives. Disagreements are part of running a business and can even be constructive, enabling better decision-making. But if not properly managed, they can have severe detrimental effects on the company. Lack of respect and trust can lead to value destruction, delays in decision-making, and even complete breakdowns in communication.
So, as a founder, how can you best manage investors, so that any conflict is positive rather than negative for the business?
· Investment documentation: A framework for handling conflict should form part of your investment documentation, outlining the levels of decision-making, from CEO to management, board, and shareholders. Part of the deal process is to foresee potential sources of disagreements, and contracts should help to outline the steps you should take. It is easy to gloss over these kinds of details when you’re under pressure to do a deal, but they can trip you up later. So ensure that you understand the implications of what you’ve agreed to.
· Regularly review board structure: It goes without saying that entrepreneurs should carefully choose their investment partners, but the composition of the board is also critical to managing conflicts. Don’t allow the board to become too big, as this can increase the chance of conflict, and ensure the structure suits the stage of your company. Consider the skills and recent experience you need at the top table, based on your objectives, and have open conversations to reduce the involvement of those who don’t fit the bill. Five board members is about right, and additional investors can become board observers if they still want to be involved.
· Scenario planning: As the business context and economy continue to change, ongoing scenario planning is a critical tool to ensure that the board and stakeholders are on the same page in terms of potential challenges, solutions, and areas of disagreement that may arise. This gives you an insight into how key stakeholders feel about certain situations and how to handle them, to prevent or mitigate conflicts. It might not be possible to envisage every possible eventuality – the pandemic being a recent case in point – however, having these strategic conversations regularly strengthens the board’s ability to work together constructively to overcome issues, build trust, and hone decision-making processes.
· Communicate early, even (especially) when it’s bad news: The earlier information is presented, the more effectively the board and wider shareholders can discuss and find possible solutions. As a founder, make sure you provide frequent updates, communicating with as much data and detail as possible. If you are confronted by a difficult decision, don’t drag it out because it will only make things worse. By fostering a culture of open dialogue and understanding, conflicts can be managed constructively, leading to better outcomes for all involved. And don’t play investors off against each other; discussions should be open between stakeholders, the board, and investors.
· Offer constructive solutions: The ability to be constructive, apply solid reasoning, and create optionality when under pressure is a key strength for a founder and will help keep investors on side. Communicate the benefit for the company (and shareholders) to pursue a certain path, while presenting scenarios, data, and budgets, to highlight the best path for the company. In most situations, if your case is sensible and sound, the board and shareholders should take guidance from you as the founder or CEO, as you know the business better than anyone else, as well as being a significant shareholder (in most cases). But ultimately, solutions must be edible for all stakeholders, not just one-sided. If a course of action is only beneficial for the founder(s) then investors will fight back.
· Maximize your independent chair: Independent board members play a critical role in managing conflict by helping to guide the process and provide an objective viewpoint on key decisions. The independent chair member will often have the gravitas and experience to steer the board through challenges, help to control meetings, set boundaries about what should be discussed, and rein in any tensions. Maximize their role to ensure that any decisions are taken impartially, in the interests of the business as a whole, rather than being swayed by individual parties.
· Find a legal way out: While it’s important to have legal frameworks in place, it goes without saying that these should be a last resort. It is always better to solve any disagreement through dialogue without reverting to legal clauses. However, in certain cases, this may be the only solution, and you should ultimately fall back on what is written in investment contracts. If you can’t agree, then there is also the possibility of proposing changes to the legal framework to facilitate improved and fair decision-making, including voting, vetoes, exit processes, drag-alongs etc. Also, speak to legal advisors about how certain shareholder(s) can be forced to exit or offered an exit path. Although bear in mind that this is often a very cumbersome and difficult process and could lead to a period of uncertainty, friction, or value destruction.
In venture capital-backed companies, it is a case of when rather than if you’ll face disagreements, and as a founder, you must be prepared for anything. Try to take it in your stride and remove the emotion from any conflict as much as you can. It is just business at the end of the day. Approach everything with an attitude of respect, trust, and effective communication, and few problems are insurmountable.
Read the full article here
