Why boards (should) want founders/CEOs to be happy

And we’re back! Before we dive into this next edition… we want to wish you a happy holidays from Above Board! We’ll be in your inbox one more time next week before it’s a new year.

In the past two editions, we talked about term sheets and liquidation preferences. In this edition, our scope broadens and we dive into the dynamics related to an investor-company/founder relationship. We’re back with interviewee Jim Armstrong, Managing Director of Composite Ventures and Forbes Midas List investor.

Want to give Above Board a holiday gift? Tell your friends/colleagues to subscribe. Thank you!

AB: Welcome back, Jim. Thanks for being with us. Why should a VC want to work hard to keep a founder happy?

JA: Many reasons. And I think it’s the right thing to do. For one, as a VC, I want to work with the founder(s) again; if they don’t have a positive experience with me, they’re not going to want to have me as an investor in the future. Secondly, whether I like it or not, they're my reference— whatever I do with them can affect my ability to win future deals. Relatedly, other VC’s on the deal will see how I work. If they badmouth me, it will make my future tougher. And it goes the same the other way.

AB: Should investors allow founders to take chips off the table as their company grows?

JA: I don't insist because it's not my place, but I strongly urge founders to take chips off the table and put some money in their pocket, such as $5 million. As an example, let’s say the founder is 35 years old. Would they like to buy a house? Taking a bit of their equity off their table could allow them to buy that house and feel a little more secure. 

Let’s say a founder owns 25% of a company and they might be able to sell the company for $200 million. They might be looking longingly at their $50 million they'll make on a $200 million exit. While this exit might sound great to a founder, this is a worrisome situation for investors, which is why an investor wants a founder to get some wealth along the way, enjoy the ride and, most importantly, stay long term focused at the company and be willing to say no to more acquisition offers.

As an investor, my fund is designed economically and structurally with carry, such that I can't make a living selling companies for $200 million [editor’s note: this depends on fund size, a topic to be explored in greater depth in a future edition.] Example: if I own 20% (fully diluted) of a company with a $200 million exit, I get a $40 million return. If I have a $400 million dollar fund, I have to do 10 of those deals just to return capital; and the reality is that having 10 exits of this size out of a fund is extremely unlikely.

Rather, what I need is one of my companies to be worth $4 billion. To get to this stage, the founders and board had to say no to acquisition offers dozens of times on the way up to this point. Whenever a company is succeeding in their industry, acquirers are going to want to take it off the table. So, if funds can all agree that they need super unicorns to create meaningful returns, then they need really happy founders that are loving their day job and want to keep going for the brass ring— allowing a founder to take a small portion of their chips of the table can be an effective method to making this happen.

AB: What do you think about founder vesting?

JA: I understand why it exists. I try to avoid it personally. As an early stage investor, it exists for protection. Example: let’s say there are no founder vesting rules. Melissa starts her company on Monday and I call Tuesday after wiring the money on Monday and ask how the company is doing? She says, ‘oh, I quit.’ And I hope they do well, of course, because I'd like to see my investment be worth something. Despite Melissa leaving the company, she still owns part of the company. In other words, other people are working for her, despite her not being there.

Founder vesting makes it such that, as the founder, you only get your full allocation of shares if you stay there for a set period of time, such as four years.

The reason that I’m not very concerned about founder vesting is that a founder is usually so invested in the company that they have their own money, capital of friends and family, relationships, and recruiting contacts all on the line. If they were to leave, it would have serious impacts on their reputation and future career which is why I’m not very focused on founder vesting. I'm not saying it's not valid, but I think it gets overused to be honest.

AB: Do I need to raise money to have a board?

JA: You can recreate all the good of a board or 90% of it on your own, without raising money, if you need to. Let’s say your company, for whatever reason, is cash flow positive from day one and doesn’t need to raise money. You could— and should— go create those great external pressures that come from a board.

You can create a board with all independent directors, and you can also establish advisory boards. I think people should have a technical advisory board, a product market fit advisory board, a go to market advisory board, a capital advisory board, and an exit advisory board. Because they don't have legal liability, you can get people to serve on these boards who just want to be involved for 0.1% to 0.25% equity.

As an early stage company, you likely have little or no cash to give to advisors. But you do have this one thing: equity. So, print it and give it out. You use it to trade for money, but you can also use it to recruit a team, expertise, advisors, and so on.

The key to boards (both management and advisory) is you need to use your most powerful pieces. You don't want your most important pieces stuck in a corner— you have to deploy them and use them. I’ve seen the Elon Musk’s, the Naval Ravikant’s, the Peter Thiel’s— they weaponize their equity rapidly and get everyone helping them. 

So, the key thing is: a money board is a preferred stock board— it’s a powerful, dangerous board. It can be a great board, but you can still go create a lot of that on your own if you ever want to. So, you should never raise money just to get the board.

AB: We hope you enjoyed this edition. Wishing you a wonderful holidays and we’ll see you again next week. In the meanhwhile, don’t forget to share Above Board with those who you think may find it helpful. Thank you.