Why startups should embrace radical transparency

After the failure of high-profile startups like FTX or Theranos, investors, employees, customers and policymakers are wondering what could be done differently to ensure accountability and prevent mismanagement. But startup founders should join this list: It is in their interest to accept transparency and accountability, especially with regard to their investors. This advice goes against some of the misguided ideas that have become commonplace within startups — namely, that it is in the founder’s best interest to accept as little supervision as possible. Indeed, to maximize the growth and impact of a startup, founders must embrace the accountability that comes from external fundraising. It will make their company stronger and more confident.

There’s a lot of hand-to-hand fighting and navel-gazing Startup land With the conclusion of two of the biggest scandals the industry has ever seen: Elizabeth Holmes of Theranos (sentenced to 11 years in prison for fraud) and Sam Bankman-Fried of FTX (evaporated $32 billion in value through mismanagement and fraudulent accounting).

Yes, investors should do more due diligence. Yes, startup employees should be more vigilant about blowing the whistle when they see bad behaviour. Yes, founders who push boundaries — driven by a permissive culture of “fake it til you do it” and “move fast and break things” — should be held more accountable.

But here’s what’s not being talked about: It’s actually the founders who should embrace more transparency and accountability. It is in their interest. And the sooner the founders grasp this fact, the better for all of us.

Rich and King/Queen?

Unfortunately, during the boom times of the past few years, founders have received some bad advice in terms of fundraising and investor relations. especially:

  • Elevating “party rounds” where no single investor is at the forefront and therefore in a position to hold the founders accountable.
  • Maintain strict control over its boards of directors. In fact, ideally, you don’t allow any investors on your board.
  • Insisting on “founder-friendly” terms that would reduce investor information rights and weaken safeguards.
  • Avoid sharing information with your investors for fear of it leaking to your competitors or the press. Furthermore, investors may use the information against you in future funding rounds.

Each of these options may maximize founder control but at the cost of potential long-term value and ultimately success.

Several years ago, Professor Noam Wasserman, my former colleague at Harvard Business School, explained the “wealth trade-off for the king/queen,” in which the founders had a fundamental choice between going big, giving up control (getting rich), or maintaining control with a view to smaller (king/queen). Wasserman asserted, “The founders’ choices are straightforward: do they want to be rich or to own? Few have had both.”

But when money is cheap and competition to invest in their startups heats up, founders suddenly have the option to be both. Many of them seized this opportunity and inflicted self-harm by abandoning a fundamental tenet of capitalism: the theory of agency.

Entrepreneurs as agents for their shareholders

Company directors are agents for their shareholders. In Michael Jensen and William Mekling’s famous article in 1976, Firm theory: managerial behavior, agency costs, and ownership structure. They have pointed out that corporations are legal fictions that define the contractual relationships between the company’s owners (shareholders) and the company’s directors regarding decision making and cash flow allocation.

This principle has recently been weaponized and politicized by the tension between very specific equity capitalists (see Seminal Milton Friedman 1970 The New York Times magazine article) and a more progressive view known as stakeholder capitalism (see BlackRock CEO Larry Fink). 2022 Annual Message).

But wherever this controversy falls, the reality is that once a founder raises $1 in funding for a single claim on his cash flow, he is answerable to someone other than himself. Whether you believe their duty is to investors only or alternatively to many stakeholders, at this moment they become agents acting on behalf of their shareholders. In other words, they are no longer able to make decisions based solely on their own interests but must now act on behalf of their investors as well and need to act in accordance with this fiduciary duty.

The positive side of accountability and transparency

Some founders only see the downside of the accountability and transparency imposed on them by simply taking money from outside. And, to be fair, there are plenty of horror stories of bad investor behavior and incompetent boards destroying companies. Fortunately, in my experience, just as fraud in startup land is very rare, these stories are present in a significant minority of the thousands upon thousands of positive investor-founder relations case studies. Many founders understand the huge upside that accountability brings.

Accountability is an important part of a startup’s maturity process. How else can employees, customers, and partners trust a startup to deliver on their promises? The most talented employees want to work for startups and leaders they can trust, and transparency in all communications and meetings between hands is an important component of building and maintaining that trust. Customers want to buy products from companies they can rely on – ideally those that publish and adhere to their product roadmaps. Partners want to collaborate with startups that are already doing what they say they will do.

The impact of accountability and transparency on investors in the future is clear: Investors want to invest in companies they understand and where they have visibility into the internal operations and drivers of value, for good or bad. When US regulators explained the fact that Chinese companies They were not as outspoken as their US counterparts Before the public listing on the NASDAQ or the New York Stock Exchange, it naturally reduced the valuation of those companies.

There is an equally compelling reason for good accounting practices. Provides reliability and control. Researchers have repeatedly shown that greater transparency – whether between countries or companies – leads to more credibility and thus value. For example, the International Monetary Fund concluded in 2005 research paper That countries with more transparent financial practices have greater market credibility, better fiscal discipline, and less corruption.

The Triple-A Rubric

In addition to improved ratings and increased trust between partners, there is an added upside to being more accountable. My partner, Chip Hazzard, recently wrote an A.I blog post on the importance of monthly investor updates and articulating a “three-pronged rubric” for alignment, accountability, and access. Founders report that external accountability, and the habit of sending out detailed monthly updates, can be a positive enforcement function. As one of the company’s founders said, “The practice of sitting down to send an update builds in internal accountability.”

By being more transparent and accountable, founders can ensure that their employees and investors are fully aligned and in a position to provide assistance. If you’re upfront with your investors about where things stand and your “stay awake issues,” you’ll be in a better position to reach out to their help—whether for strategic advice, sales leads, talent referrals, or partnership opportunities.

Founders and Radical Transparency

Ray Dalio of Bridgewater famously coined the phrase “radical transparency” as a philosophy to describe his operating model at the company where a direct and honest culture is practiced in all communications. writing, principlesexpands on radical transparency and this inclusive work-life philosophy.

Founders should take a page from Dalio’s book and embrace radical transparency with all stakeholders, especially their investors. Some defenders of Theranos and FTX’s founders claim they may have been over their heads, incompetent, and not corrupt. Whatever the case, today’s founders can not only avoid similar pitfalls, but more importantly drive greater alignment, opportunity, and ultimate value if they are to simply embrace accountability and transparency as stewards of other people’s capital. By doing so, they will put themselves in a better position to build valuable and lasting companies that have a positive impact on the world.

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