How it works in practice
In this short series we’ve looked at various aspects of investor controls in venture funded companies – what they are, why they’re needed, who gets to have them, and how they’re shared between investors. We’re going to close off this topic, for the moment at least, by considering how the board and its investors work together in practice.
Despite the forbidding legal agreements, management and investors tend to work together in harmony. Most of the time, at least.
So, exactly who does run the company?
The chair at one of our portfolio companies asked this question a few weeks ago. We were not exactly daggers drawn, but the investors on one side and management on the other had very divergent views on a strategically important decision. (As it happens, it was about marketing, a subject on which everyone has an opinion. When it comes to accounting policies, oddly, we get the field to ourselves).
Back to the chair’s remark. It was a good question, and there isn’t an easy answer. Of course, there’s the pat answer: management manage, investors invest. Yes, of course, but……… and the “but” is two-fold:
- Some decisions are just so fundamental that the major investors must be involved. They backed a particular team, business, and plan, so when that changes (like pivoting SaaSco into a fashion business) they get a say. Unless the founder is called Elon, Mark, or Sergei, this isn’t a contentious position.
- Other decisions may be important, but not existential. Even the hands-on investor will appreciate the luxury of just sitting back and watching, just so long as SaaSco is thriving, and management’s choices seem smart.
And there lies the problem, and the source of disagreement – sometimes the cumulative effect of a bunch of poor operational decisions means that SaaSco is struggling. And other choices made by management maybe just don’t seem to stack up.
So, at what point should the investors become more involved?
Time to roll your sleeves up
Every investor will have their own views on this topic, but for DSW Ventures, this is our take on when it’s reasonable to get closely involved in a management decision.
- The issue is so fundamental that it’s actually in the first category above, like agreeing to sell the company.
- It’s important and either irreversible or takes virtually forever to correct. Signing a multi-territory multi-year exclusive distribution agreement is an example of the former. Some hires are examples of the latter. SaaSco’s first six-figure employee will probably take months to scope and identify, months to serve notice, and months till management find out if they’re any good. Life moves fast for a scale-up: that hiring decision has to be right. The investors have good cause to get involved – and may well make the process better in any case.
- Management are raw – especially if they’re new-ish, first time entrepreneurs – and doubly so if the subject is outside their core competency. And double again if they have a history of making bad calls.
- The investors have got reasonable experience on the subject, either directly or through their network of contacts. Of course, we investors all think we’re experts in everything, so a period of introspection might help before we wade into a complex debate based on some semi-relevant parallel from the 1990s.
- Management can’t explain their decision. The investor may not be the expert, but even so, they ought to be able to follow management’s assumptions and logic flow.
The more hits in this checklist, the more likely is the investor to sit up and pay attention in a board meeting.
Day to day working
The DSW Ventures team are an organised bunch. For each portfolio company, we have a folder, and somewhere within lurks a sub-folder marked Consents. You might imagine, if you’ve read through this series of posts, that we have to tidily file away a signed PDF every week, authorising management pay rises, an issue of options, or a major commercial agreement.
In fact, in most cases, it’s empty. That’s maybe embarrassing (surely there out to be something in there: where do we put these things?). Mainly, though, it’s because there’s rarely a debate about what needs our input – we work together closely with management, we sort-of get on pretty well most of the time, and we each instinctively know what’s important, what would benefit from investor input, and when management should just be allowed to get on with it. To the extent that formal consent is given, it’s a call, or an email, or a note in some board minutes. You wouldn’t run Unilever like this, but pace matters.
Difficult cases and tough choices
SaaSco’s management may have tried and failed to hire a commercial financial director several times. It’s a key hire. The investors, on the other hand, have made this kind of hire repeatedly. They know the job description, the agencies, the market rate, and plenty of candidates. Management finds a candidate they love to bits, based on chemistry and a reference from a mutual contact that worked with the candidate years back. This decision ticks a few boxes in our checklist above. So, the investors barge into the process and, having insisted on meeting the candidate, can’t see why they were ever considered. Management wants to follow their gut and see the investors as interfering. They can’t reconcile their views through discussion.
Who backs down?
This position is pretty rare, so let’s not over-dramatise it. When it does occasionally happen, the investor and management could dig in for a long period of trench warfare (not recommended). Better is to find a different solution. In this case, bin the candidate, and start the search afresh and find someone mutually acceptable.
That may not always be possible, and, in that case, the investors may choose to back down for two reasons.
- The first is: the investor may be wrong, and management may be right. Even if just through serendipity.
- The second reason is that, unlike private equity, a venture investor doesn’t own the company, they don’t ultimately run it, they backed a management team, and short of replacing the team, they’re stuck with them. So, to preserve goodwill and the working relationship, maybe it’s better to accept that SaaSco will never break any records, and to just let management make their own choices and do the best they can.
Designing the board to avoid conflict
DSW Ventures always insist on good non-executive representation. Not our people. Not the founders’ people. Instead: the Company’s people. Good people with the skills to guide SaaSco to avoid the obvious mistakes (the ones they made when they were first time round entrepreneurs), to help management make better choices, to comfort and mentor stressed out managers and founders, and to act as respected arbiters.
The very fact of their independence makes their opinion carry weight and reduces the chance of an impasse between investors and management.
Well, that’s enough for a while on investor protections and sharing control. To my mind, considering the high stakes, the disparate personalities, and the conflicting agenda, the most amazing thing about the investor-management relationship is how rarely it founders.
If there’s one single piece of advice on the subject, however, it would be to founders: choose your investors carefully. Choose people who will get to know you and your business, who will support it, will support you, and who are decent people to work with.
Maybe, someone like DSW Ventures…
Partner, DSW Ventures