Why Startups Should Embrace Radical Transparency

After major startup failures like FTX or Theranos, investors, employees, customers, and policymakers all ask what could be done differently to ensure accountability and prevent mismanagement. But startup founders should join the list: it’s in their best interests to embrace transparency and accountability, especially when it comes to investors. This advice goes against some of the misconceptions that have become common in startups—that it’s in the 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 of external financing. This makes their company stronger and more reliable.

There is a lot of handwriting and cursive writing going on Launch ground By dismissing two of the biggest scandals the industry has ever seen: Elizabeth Holmes of Theranos (sentenced to 11 years in prison for fraud) and Sam Benkman-Fried of FTX ($32 billion in value evaporated through mismanagement and fraudulent accounting became).

Yes, investors should do more due diligence. Yes, startup employees should be careful to blow the whistle when they see bad behavior. Yes, founders who push the envelope—with a lax 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 talked about: founders are actually the ones who need to accept more transparency and accountability. It is for their benefit. And the sooner founders realize this fact, the better off we all will be.

Rich and king/queen?

Unfortunately, during the boom of the last few years, founders received very bad advice on fundraising and investor relations. specifically:

  • Raise the “party round” where no venture capital is leading and therefore in a position to hold the founders accountable.
  • Maintain strict control of their board of directors. In fact, ideally, don’t let any investments be on your board.
  • Insist on “founder-friendly” terms that reduce investors’ information rights and weaken controls and safeguards.
  • Avoid sharing information with your investors for fear of leaking it to competitors or the press. Additionally, your investors may use the information against you in future financing rounds.
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Each of these choices may maximize the founder’s control, but at the expense of the potential for long-term value and, ultimately, success.

Years ago, my former colleague at Harvard Business School, Professor Noam Wasserman, described the “rich vs. king/queen equation,” where founders have a fundamental choice between getting big but giving up control (wealthy), or staying in control. But they had a goal. Smaller (remaining king/queen). “The founders’ choices are simple: do they want to be rich or king,” Wasserman said. A few have been both.”

But when money is cheap and the competition to invest in their startups is fierce, founders suddenly have the option of being both. Many of them seized this opportunity, and in doing so, did themselves a disservice by abandoning a fundamental principle of capitalism: agency theory.

Entrepreneurs as representatives of their shareholders

The managers of a company are the representatives of their shareholders. In the famous scientific paper of Michael Jensen and William Meckling in 1976, Theory of the firm: managerial behavior, agency costs and ownership structure. They point out that corporations are legal fictions that define contractual relationships between corporate owners (shareholders) and corporate managers regarding decision-making and cash flow allocation.

This principle has recently become weaponized and politicized due to the tension between the well-defined shareholder capitalist. Important work by Milton Friedman in 1970 New York Times Magazine Article) and a more progressive view known as crony capitalism (see BlackRock CEO Larry Fink 2022 Annual Letter).

But wherever you stand on this debate, the reality is that as soon as a founder raises a dollar in funding in return for a claim on their cash flow, they are accountable to someone other than themselves. It doesn’t matter whether their duty is solely to investors or instead to multiple shareholders, at that point they become their shareholder’s representatives. In other words, they are no longer able to make decisions solely based on their own interests, but must now also work on behalf of their investors and must act in accordance with this fiduciary duty.

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The positive aspect of accountability and transparency

Some founders only see the negative side of accountability and transparency imposed on them as soon as 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, as rare as scams are in startup land, these stories are in the vast minority of the thousands and thousands of positive case studies of investor-founder relationships. Many founders realize the tremendous progress that accountability brings.

Accountability is an important part of a startup’s maturation process. How 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 public meetings is a critical component to building and maintaining that trust. Customers want to buy products from companies they can trust – ideally ones that publish and stick to their product roadmaps. Partners want to work with startups that will 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 can see into the internal operations and drivers of value, good or bad. to invest When US regulators exposed the fact that Chinese companies They were not as revealing as their American counterparts Before public listings on NASDAQ or NYSE, it naturally reduced the value of those companies.

There is an equally compelling reason for good accounting practices. Provides reliability and control. Researchers have repeatedly shown that greater transparency—both among countries and firms—leads to greater credibility and thus value. For example, the International Monetary Fund in A 2005 research paper Countries with more transparent fiscal procedures have more credit in the market, better fiscal discipline, and less corruption.

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Triple-A rubric

Beyond improved evaluations and greater trust among partners, greater accountability has another positive side. My partner, Chip Hazard, wrote recently blog post On the importance of monthly investor updates and articulating the “Triple-A rubric” of alignment, accountability and accessibility. Founders report that external accountability, and the habit of sending accurate monthly updates, can be a positive enforcement practice. As one of our founders says, “The act of sitting down to post an update creates internal accountability.”

By being more transparent and accountable, founders can ensure that their employees and investors are fully aligned and in a position to be useful. If you’re honest with your investors about the state of your situation and your “stay awake issues,” you’ll be in a better position to reach out for their help—whether it’s for strategic advice, sales, talent referrals, or partnership opportunities.

Founders and Radical Transparency

Bridgewater’s Ray Dalio famously coined the phrase “radical transparency” as a philosophy to describe his operating model at a company where a culture of directness and honesty applies to all communications. His book, PrinciplesRadical transparency and this general philosophy expands business and life.

Founders should take a page from Dalio’s book and embrace radical transparency with all of their stakeholders, especially their investors. Some defenders of the founders of Theranos and FTX claim that they may have been more incompetent than corrupt. After all, today’s founders can not only avoid similar pitfalls, but more importantly, bring greater alignment, opportunity, and bottom-line value if they simply embrace accountability and transparency as stewards of other people’s capital. By doing so, they better position themselves to build valuable and sustainable companies that positively impact the world.

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