After high-profile startup failures like FTX or Theranos, investors, employees, customers, and policymakers are all asking what could have been done differently to ensure accountability and prevent wrongdoing. management. But startup founders should join that list: It’s in their interest to accept transparency and accountability, especially regarding their investors. This advice goes against some misconceptions that have become popular among startups — namely, that it’s in a founder’s best interest to accept as little oversight as possible. In fact, to maximize the growth and impact of a startup, founders must accept the responsibility that comes from raising external financing. This will make their company more stable and trustworthy.
There was a lot of hand writing and navel gazing going on ground of initiation in the denouement of two of the biggest scandals the industry has ever seen: Theranos’ Elizabeth Holmes (sentenced to 11 years in prison for fraud) and FTX’s Sam Bankman-Fried (vaporized $32 billion in value through mismanagement and fraudulent accounting).
Yes, investors should do more careful due diligence. Yes, startup employees should be more vigilant about blowing the whistle when they see bad behavior. Yes, founders who push the limits – fueled by a permissive culture of “fake it till you make it” and “move fast and break things” – should be held more accountable.
But here’s what’s not being discussed: The founders are really the ones who should receive more transparency and accountability. It is in their interests. And the sooner founders understand this truth, the better off we’ll all be.
Rich and King/Queen?
Unfortunately, during the boom of the last few years, founders received some pretty bad advice about fundraising and investor relations. Specifically:
- Raise “party rounds” where no investor leads and thus is in a position to hold the founders accountable.
- Maintain tight control over their board of directors. In fact, ideally, don’t allow any investors on your board.
- Insist on “founder-friendly” terms that would curtail investor information rights and weaken controls and protection provisions.
- Avoid sharing information with your investors for fear of it being leaked to your competitors or the press. Plus, your investors can use the information against you in future financing rounds.
Each of these options can maximize the founder’s control but at the expense of long-term potential value and ultimately success.
Many years ago, my former Harvard Business School colleague, Professor Noam Wasserman, posited a “Rich vs. King/Queen tradeoff,” in which founders have a fundamental choice between being big, but giving up control (wealthy), or maintaining control but aiming. smaller (remains king/queen). Wasserman asserts, “The founders’ choices were straightforward: Did they want to be rich or kings? Few were both.”
But when money is cheap and the competition to invest in their startups is fierce, founders suddenly have the option to be both. Many of them seized this opportunity and, in doing so, caused themselves harm by abandoning a fundamental tenet of capitalism: agency theory.
Entrepreneurs as Agents for their Shareholders
Managers of a corporation are agents for their shareholders. In the famous 1976 scholarly article by Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” they point out that corporations are legal fictions that define the contractual relationships between the firm’s owners (shareholders) and the firm’s managers regarding decision-making and cash-flow allocation.
This principle has more recently been weaponized and politicized due to the tension between the purely defined capitalist shareholder (see Milton Friedman’s seminal 1970 New York Times Magazine article) and a more progressive view known as stakeholder capitalism (see BlackRock CEO Larry Fink’s 2022 Annual Letter).
But wherever you fall on this debate, the fact is that once a founder raises a dollar in financing in exchange for a claim on their cash flow, they are accountable to someone other than themselves. Whether you believe their role is only to investors or rather to multiple stakeholders, at that moment they become agents acting on behalf of their shareholders. In other words, they can no longer make decisions based solely on their own interests but must work on behalf of their investors as well and must act in accordance with this fiduciary duty.
The Opposite of Accountability and Transparency
Some founders only see the downside of the accountability and transparency imposed on them once they take outside money. And, to be fair, there are plenty of horror stories of bad investor behavior and incompetent boards ruining companies. Fortunately, in my experience, just as fraud in startup land is extremely rare, those stories are in the vast minority of the thousands and thousands of positive case studies of investor-founder relationships. Many founders realize the enormous upside that comes with accountability.
Accountability is an important part of a startup’s maturation process. How else can employees, customers, and partners trust a startup to deliver on its promises? The best employees want to work for startups and leaders they can trust, and transparency in all communications and all-hands meetings is an important part of building and maintaining that trust. Customers want to buy products from companies they can trust — preferably ones that publish and stick to their product roadmaps. Partners want to work with startups that actually do what they say they will do.
The impact of accountability and transparency on future investors is obvious: Investors want to invest in companies they understand and where they have visibility into internal operations and value drivers, both good and bad. When US regulators make the fact that Chinese companies are not as obvious as their US counterparts prior to public listings on the NASDAQ or NYSE, this naturally reduced the valuation of those companies.
There are equally compelling reasons for good accounting practices. It provides reliability and control. Researchers have often shown that greater transparency — whether among countries or companies — leads to greater credibility and thus value. For example, the IMF concluded a 2005 research paper that countries with more transparent fiscal practices have more market credibility, better fiscal discipline, and less corruption.
The Triple-A Rubric
Beyond improved values and greater confidence in partners, there is the added advantage of being more accountable. My partner, Chip Hazard, recently wrote a blog post on the importance of monthly investor updates and expressed the “Triple-A rubric” of alignment, accountability, and access. Founders report that outside accountability, and the habit of sending detailed monthly updates, can be a positive feature. As one of our founders said, “The practice of sitting down to send an update builds internal accountability.”
By being more transparent and accountable, founders can ensure that their employees and investors are fully aligned and in a position to help. If you’re honest with your investors about where things stand and your “stay-awake issues,” you’ll be in a better position to access 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 firm where a direct and honest culture is practiced in all communications. His book, Principlesexpanding on radical transparency and this general philosophy of business and life.
Founders should take a page from Dalio’s book and embrace radical transparency with all their stakeholders, especially their investors. Some defenders of the founders of Theranos and FTX claim that they are probably in over their heads and incompetent rather than 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 simply embrace accountability and transparency as stewards of others’ capital. By doing so, they will put themselves in a better position to build valuable, sustainable companies that make a positive impact on the world.