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Ari Newman is an entrepreneur, mentor, investor, and a friend. He works at Techstars where his responsibility is to ensure that the connections between alumni, mentors, and staff are as robust as they can be – helping entrepreneurs “do more faster” day in and day out. His most recent company, Filtrbox, participated in the inaugural Techstars class (Techstars Boulder 2007) and was a win for all parties involved; Filtrbox was acquired in 2010 by Jive Software (NASDAQ: JIVE).
I’ve worked closely with Ari for a while and love his candor. He talks, from an entrepreneur’s perspective, with recent first hand experience. Following is his advice to early stage entrepreneurs for creating structure in their company.
Here’s the punchline: if you run your company as if you have closed a VC equity financing round even though you actually closed a convertible debt round, you’ll be in much better shape when it comes time to raise your Series A financing. Specifically, I am talking about putting a board in place, running formal board meetings, and making sure you have people at the table who act as the voice of reason and sanity. One of the key benefits of doing this early on is that when it comes time to raise that next round, the people you’ll need the most help from are already involved and engaged.
Convertible debt financings have become an increasingly attractive approach for seed rounds because it delays the valuation discussion, costs less from a legal standpoint, and is an easier financial instrument to “keep raising more small amounts of money” on. There are two different cases, with shades of grey in between: (1) there are only a few investors or (2) it’s a “party” round, with $1M+ raised and many investors. This second kind of seed financing can be a double-edged sword for the entrepreneur and company if not very carefully managed. This post is not about the economic implications of debt rounds versus priced rounds – there has already been plenty written about that including this great one from Mark Suster. Rather, this post is a call to action for entrepreneurs who have successfully raised a debt round and must now turn their idea into a serious business.
So why would you treat your debt investors (somewhat) like equity investors? This may seem counterintuitive, even even a pain in the ass. So, I’ll explain my reasoning through the story of ASC, a fictitious company that has a combination of characteristics I’ve seen across a number of early stage companies.
Acme SaaS Corp (ASC) was started by two entrepreneurs; they have a big vision and if they can execute on it, the business will be a clear home-run. One of them used to be a lead developer at [insert hot consumer tech company here]. They need to raise money before building anything substantial after determining that they needed a little dough to follow the Lean Startup methodology.
They decide to go out and raise money on a convertible note – several angel investors have signaled interest in participating in the note and they don’t feel ready to pitch VCs yet. Fundraising goes better than expected and they quickly find themselves with a $750k round consisting of several VCs and a bunch of angels. The investors, founders, and “community” are all super excited about ASC. They close on the $750k, hire a buddy or two, buy some Macs, and get to work.
ASC starts building product, but as they get into the thick of it, the team realizes executing on their vision is going to be extremely hard. Things start to get a little fuzzy in terms of priorities, but not to fret, the new office is coming along really well with all of the hiring! For the first the months, the team meets often and strategizes on what they want to build while some code gets written. Early customer development talks are going great which keeps the team really excited. Three months in, the burn is now at $70k/month.
Two more months go by and the team is continuing to iterate, but every two-week sprint results in some re-factoring and re-thinking. No updates, screen comps, or metrics have been publicly shared yet. It’s too early for that shit. Heads down on product, they say. Every now and then, investors are told things are going great and the founders are really excited about what they are doing. Soundbites from potential customers are encouraging. Eventually early product demos start happening but they’re rough and the product looks very alpha. At month six, one of the early hires leaves, a developer who turns out wasn’t a good fit. There is $350k left in the bank.
Seven months in, there is a beta product. It’s better than before, but not by miles. The people on the sales side don’t feel they can charge for it yet because who’s going to take out their wallet for something that isn’t perfect. A bunch of potential customers are kicking the tires on the product but it seems that every engaged beta customer needs something slightly different or feels as if the product is not ready to be truly used in production. “This is all a part of the normal product and customer development process,” the CEO tells the team. The burn is now at $90k/month as they had to hire a “customer delight” person to handle the beta process. The team thinks their investors still love them and that they are still a hot company. The first material update goes out to the investors, with lots of positive quotes from VPs at potential customers, and they all indicate future product acceptance if a bunch of other stuff gets in place. Investors are dismayed that there are no real customers yet. There is no discussion of burn, runway, and more financing yet. The team wants to make a little more progress first.
A month later, another email update goes out to the investors – the team has decided to pivot based on feedback and they are super excited about the new direction and once they have the product updated to capture the new, bigger opportunity, it’s going be great. Oh, and the email says the founders will be in touch to discuss another round of funding since there are only 2 months of runway left.
Sound familiar? I could continue but the odds are that this story isn’t going to end well. The company flames out and the team gets aquihired. The investors get nothing.
While you may think ASC is an extreme case, it happens all the time. I’ve observed too many companies that have some or all of these elements in their story. I’m not saying, under any circumstance, that the debt round was the catalyst or sole reason for the company’s missteps but there are a number of times in this story where good company hygiene, good governance, and a properly utilized board would have helped to positively affect the outcome. Following are a few ways that a board would have helped out.
Easy Debt Round Lasting A Year – Even if the raise wasn’t that easy, the company was able to raise enough to buy a year or more of runway. In startup time, that feels like forever. It’s enough time to hang yourself if you are not careful. Had the company created a board and run it properly, they would have ratified a budget, reviewed compensation plans, and agreed on spending levels during early product development. The year would have been a full year, not just 7-9 months.
Real Product and Market Focus – This company lost 3-6 months of execution because they got lost building towards a high level vision. That high level vision was a beast to tackle, and being younger founders, they they didn’t realize they were in over their heads. With advisors or a board, the founders could have opened the kimono and asked for guidance. There are about a dozen corrective actions, best practices, or methodologies that could have been applied during this critical time. It’s up to the team to be able to execute them, but they had their heads in the clouds for too long and no one else at the table with them.
Don’t Pivot in a Vacuum – Had ASC properly used its board, advisors, and investors, it would have brought the pivot strategy to the table early on. A discussion around overall business viability, time to market, and capital impact would have ensued. A review of the cash position, burn rate, and execution plan would have revealed there was not enough cash on hand to nail the pivot while leaving 3-6 months of time in market before raising again. The plan would have to get way tighter, way faster. They didn’t keep the investors up-to-date, then pivoted without engaging or validating whether there was going to be follow-on support. They took a right turn into a brick wall. Investors do not own the company or its strategy. I often say “it’s your company” when I’m bluntly asked what direction a company should take, especially if I’m wearing my investor hat. While that is true, if you rely on outside capital to reach escape velocity, keep the cockpit talking to the engine room.
Use The Smart Money or Lose It – Almost every investor I know makes investments because they want the return, but they also believe they can be helpful to the company in some way. When teams don’t communicate and engage with their investors, the void is often filled with skepticism, doubt, and (often false) assumptions about the business or the team. You borrowed money (or sold a portion of your company) from these folks – they want you to be successful. Leverage them for the better of the company, whether that means using their wisdom or their rolodex. They also can create major signaling problems for your next round if you allow the radio-silence void to be filled with doubt and distrust. Who would blindly give ASC another big check after what occurred above?
Company Hygiene Matters – One of the responsibility of a Board of Directors is to regularly discuss financials, burn rate, and cash management. Had ASC created a board, the company would have potentially managed their cash more conservatively and had the wherewithal to initiate the shift of the company sooner, whether it be through M&A talks, raising more capital, or making the pivot earlier.
I bet that some of you reading this post are entrepreneurs who are in this situation. I beg of you, treat your debt holders like equity holders, and utilize their expertise to help further your business. One easy way to do so is to act as if they are board members. In the super hard, fuzzy, pivot-happy early days of a company, a little structure, accountability, and organizational discipline can be all the difference between running headlong into a brick wall or creating a meaningful, well-operated company.
Follow Ari on Twitter at @arinewman or ask him about the power of the Techstars network at email@example.com.
I’ve been on a lot of boards. I’m still on a lot of boards. And I’ve been thinking about boards a lot as I work on my next book Startup Boards: Recreating the Board of Directors to Be Relevant to Entrepreneurial Companies.
I used to think every board needed a chairman and early in my investing career I was often this chairman (or co-chairman). At some point I began feeling like the chairman role in a private company both undermined the CEO and sent the wrong signal to the employees of the company, and I preferred that the CEO be the chairman. I also started disliking being the chairman, as it seemed to create a view that I had some kind of ultimate power and responsibility for the company that I rarely had, and that almost always belonged to the CEO. So I stopped being chairman and in a number of cases refused to be called it, even when I played the role of it. The one exception I made was non-profits, where chairman seems to have a somewhat different connotation. And since I’ve decided not to be on public company boards, I don’t have to make a decision in that context.
Several years ago I started using, and encountering, the phrase “lead director” more frequently. Recently, I decided it’s the right one and have used it to replace chairman in my vocabulary. And, when asked the question, “does a private company board need a chairman”, I now say “no, but it needs a lead director.”
The lead director is responsible for working with the CEO to manage the board of directors. The lead director is always the most active director and in many cases represents the largest non-founder shareholder in the company when a company is private. The lead director is not the communication conduit to the CEO – every director interacts directly with the CEO – but the lead director gets involved in any conflict between a director and the CEO, any concerns that arise, and any conflicts between directors. And the lead director helps the CEO manage the board meetings.
The lead director should be the CEO’s board confidant, organizer, and conflict resolver. I sort of like the word consigliere, as used in The Godfather, a lot, although it has both obvious negative connotations and a different actual function in real life than the one represented in the film, so I’m searching for a better one.
When I look at the boards I’m currently on, I play this role in many, but not all of them. And the phrase feels correct to me.
Do you have a lead director on your board? How about a chairman? What do they do and how does it feel? And is there a better word than consigliere?
I joined my first board of a company other than mine in 1994 (NetGenesis). Since then, I’ve sat on hundreds of boards and been to a zillion board meetings. It crushes my soul a little to think of the number of board meetings I have sat through that were ineffective, poorly run, or just plain boring. I guess that’s part of the motivation I have in writing Startup Boards: Reinventing the Board of Directors to Be Useful to the Entrepreneur (the next book in the Startup Revolution series which should be out sometime this summer.)
In the mean time, over the past two years I’ve done a lot of experiments with the boards I’m on. I’ve tried a lot of different things – some that are awesome, some that don’t matter, some that suck, and some that have been epic fails. For any that aren’t awesome, I’ve tried to kill the experiment quickly so it didn’t hurt anything and when I reflect on everything I’ve tried I think I’ve managed to “do no harm”, which is more than I can say for a lot of the other VCs who I’ve sat on boards with since 1994.
By this summer, I expect I’ll have a very clear view on the best practices from my perspective for making a Startup Board effective. Until then, I’m still running experiments, or experiencing experiments that the entrepreneurs run. And I’m thinking out loud (including in posts like this) on what has worked and hasn’t worked.
One of the things I’ve played around with is the board package. The number of different formats, styles, information incorporated, and distribution methods over the years boggles my mind. I not-so-fondly remember toting around “binders full of board meeting material” in the 1990s. Or pre-Gmail having a “board meeting folder” in Outlook so I could quickly find the upcoming board meeting documents. Or fighting through 19 attachments to an email to figure out where the actual board material was. PowerPoints, PDFs, Word documents, text files, Excel spreadsheets, Prezi docs, videos, email outlines – the list goes on.
Recently, I had a magical moment. I’m a huge believer in distributing the board material a few days in advance, having all the board members comment on it in advance of the meeting, and then having the meeting without going through the board material page by page. No death by endless Powerpoint, no reading a document I’ve already read. My favorite board meetings are the “one slide board meeting” where the only piece of paper allowed in the room is the agenda of the meeting.
When entrepreneurs don’t get this, I suggest that they pretend their board members can read and cognitively process the information in advance. And, if they don’t believe their board members will do this, just start having the board meeting under this assumption and watch how they board members get their shit together and read the material in advance.
In this recent magical moment, rather than receiving anything via email, a Google Doc notification showed up in my inbox. I went to it and the entire board package was in a single Google doc file. The entire management team and the entire board was included on it. As I read through the Google doc, whenever I had a comment or a question, I highlighted the section in question, hit Command-Option-M, and left a comment. Then, as other people read through the package, they left comments. And then the management team responded to the comments.
Voila – an interactive board package. Zero special technology. It wasn’t planned, or assigned. It just naturally happened. When we showed up to the board meeting, everyone had the issues in their mind. We’d already cut out an hour of setup, and probably another hour of discussion. So we got right down to the higher level issues that the board material, and comments, and the responses generated.
In this case, the CEO created a very simple agenda immediately before the board meeting that captured the strategic issues we needed to address. There were a few tactical questions outstanding – they got knocked off quickly. We had a two hour board meeting – 90 minutes of it was intense and fruitful. No one referred to any paper – we looked each other in the eyes for 90 minutes and had a deep, engaged, substantive discussion.
I’ve been describing this as a part of a “continuous board engagement” – similar to “continuous deployment and continuous innovation” in Eric Ries’ The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses. I get information daily from most of the companies I’m involved in. I’m in the flow of a lot of information – some “noise” but a huge amount of “signal.” Then – the week before the board meeting, the current state of things gets consolidated into a dynamic document that allows everyone involved to interact with each other around the content.
I’m going to play a lot with this in the next few months. Any suggested tweaks or changes to this approach? Any obvious pitfalls?
This week I had two meetings with CEOs of companies we’ve recently invested in where the question of “what is an ideal board meeting” came up. I’m writing an entire book on it called Startup Boards: Reinventing the Board of Directors to Better Support the Entrepreneur so it’s easy for me to define my ideal board meeting at this point since my head is pretty deep into it intellectually.
One of the things I always suggest to CEOs is that they be an outside director for one company that is not their own. I don’t care how big or small the company is, whether or not I have an involvement in the company, or if the CEO knows the entrepreneurs involved. I’m much more interested in the CEO having the experience of being a board member for someone else’s company.
Being CEO of a fast growing startup is a tough job. There are awesome days, dismal days, and lots of in-between days. I’ve never been in a startup that was a straight line of progress over time and I’ve never worked with a CEO who didn’t regularly learn new things, have stuff not work, and go through stretches of huge uncertainty and struggle.
Given that I am no longer a CEO (although I was once – for seven years) I don’t feel the pressure of being CEO. As a result I’ve spent a lot of the past 17 years being able to provide perspective for the CEOs I work with. Even when I’m deeply invested in the company, I can be emotionally and functionally detached from the pressure and dynamics of what the CEO is going through on a daily basis while still understanding the issues since I’ve had the experience.
Now, imagine you are a CEO of a fast growing startup. Wouldn’t it be awesome to be able to spend a small amount of your time in that same emotional and functional detachment for someone else’s company? Not only would it stretch some new muscles for you, it’d give you a much broader perspective on how “the job of a CEO” works. You might have new empathy for a CEO, which could include self-empathy (since you are also a CEO) – which is a tough concept for some, but is fundamentally about understanding yourself better, especially when you are under emotional distress of some sort. You’d have empathy for other board members and would either appreciate your own board members more, or learn tools and approaches to develop a more effective relationship with them, or decide you need different ones.
There are lots of other subtle benefits. You’ll extend your network. You’ll view a company from a different vantage point. You’ll be on the other side of the financing discussions (a board member, rather than the CEO). You’ll understand “fiduciary responsibility” more deeply. You’ll have a peer relationship with another CEO that you have a vested interest in that crosses over to a board – CEO relationship. You’ll get exposed to new management styles. You’ll experience different conflicts that you won’t have the same type of pressure from. The list goes on and on.
I usually recommend only one outside board. Not two, not three – just one. Any more than one is too many – as an active CEO you just won’t have time to be serious and deliberate about it. While you might feel like you have capacity for more, your company needs your attention first. There are exceptions, especially with serial entrepreneurs who have a unique relationship with an investor where it’s a deeper, collaborative relationship across multiple companies (I have a few of these), but generally one is plenty.
I don’t count non-profit boards in this mix. Do as much non-profit stuff as you want. The dynamics, incentives, motivations, and things you’ll learn and experience are totally different. That’s not what this is about.
If you are a CEO of a startup company and you aren’t on one other board as an outside director, think hard about doing it. And, if you are in my world and aren’t on an outside board, holler if you want my help getting you connected up with some folks.
tl;dr – Yes.
I’m on the firstname.lastname@example.org list for a number of the companies I’m on the board of. CEOs and entrepreneurs who practice TAGFEE welcome this. I haven’t universally asked for inclusion on this list mostly because I hadn’t really thought hard about it until recently. But I will now and going forward, although I’ll leave it up to the CEO as to whether or not to include me.
In an effort to better figure out the startup board dynamic, I’ve been thinking a lot about the concept of continual communication with board members. The companies I feel most involved in are ones in which I have continual communication and involvement with the company. This isn’t just limited to the CEO, but to all members of the management team and often many other people in the company. Working relationships as well as friendships develop through the interactions.
Instead of being a board member with his arms crossed who shows up at a board meeting every four to eight weeks to ask a bunch on knuckleheaded questions in reaction to what is being presented, I generally know a wide range of what is going on in the companies I’m on the board of. Sure – there are lots of pockets of information I don’t know, but because I’m in the flow of communication, I can easily engage in any topic going on in the company. In addition to being up to speed (or getting up to speed on any issue faster), I have much deeper functional context, as well as emotional context, about what is going on, who is impacted, and what the core issue is.
Every company I’m involved in has a unique culture. Aspects of the culture get played out every day on the email@example.com email list. Sometimes the list is filled with the mundane rhythms of a company (“I’m sick today – not coming in”; “Please don’t forget to put the dishes in the dishwasher.”) Other times it’s filled with celebration (“GONG: Just Closed A Deal With Customer Name.”) Occasionally it’s filled with heartbreak (“Person X just was diagnosed with cancer.”) Yet other times it is a coordination mechanism (“Lunch is at 12:30 at Hapa Sushi.”) And, of course, it’s often filled with substance about a new customer, new product, issue on tech support, competitive threat, or whatever is currently on the CEO’s mind.
As a board member, being on this list makes me feel much more like part of the team. I strongly believe that board members of early stage companies should be active – and supportive – participants. My deep personal philosophy is that as long as I support the CEO, my job is to do whatever the CEO wants me to do to help the company succeed. Having more context, being part of the team, and being in the flow of the firstname.lastname@example.org communication helps immensely with that.
There are three resistance points I commonly hear to this:
1. “I don’t want to overwhelm my board members with emails.” That’s my problem, not yours, and the reason filters were created for people who can’t handle a steady volume of email. If you are a Gmail user, or have conversation view turned on in Outlook, it’s totally mangeable since all the messages thread up into a single conversation. So – don’t worry about me. If your board member says “too much info, please don’t include me”, ponder what he’s really saying and how to best engage him in continuous communication.
2.”I don’t want my board members to see all the things going on in the company.” That’s not very TAGFEE so the next time you say “I try to be transparent and open with my investors”, do a reality check on what you actually mean. Remember, the simplest way not to get tangled up in communication is just to be blunt, open, and honest all the time – that way you never have to figure out what you said. If you don’t believe your board members are mature enough to engage in this level of interaction on a continual basis, reconsider whether they should be on your board.
3. “I’m afraid it will stifle communication within the company.” If this is the case, reconsider your relationship between your board members and your company. Are you anthropomorphizing your board? Are you shifting blame, or responsibility to them (as in “the board made me do this?”) Are you creating, or do you have, a contentious relationship between your team and the board? All of these things are problems and lead to ineffective board / company / CEO interactions so use that as a signal that something is wrong in relationship.
Notice that I didn’t say “all investors” – I explicitly said board members. As in my post recently about board observers, I believe that board members have a very specific responsibility to the company that is unique and not shared by “board observers” or other investors. There are plenty of other communication mechanisms for these folks. But, for board members, add them to you email@example.com list today.