Venture capitalists often say that they don’t just back a company because of its vision, but also because they believe in the founder or founding team and think they’re the right people to execute the startup’s goals.
However, being the right person to bring an idea to fruition has no correlation with being a good CEO or manager of a resulting startup, and investors may find themselves tied into a yearslong relationship with someone who turns out to be problematic.
Though it’s impossible to predict whether someone will make a good CEO, Cameron Newton, a founder and general partner at Relevance Ventures, told TechCrunch that a good indicator of how a founder will act in the future can be how they interact with you throughout the pitch process.
“Those sorts of things you pick up on right away,” he said. “Do they like constructive criticism or are they defensive? How are they responding to your criticism or the holes you are trying to punch in their pitch?”
Eric Bahn, a co-founder and general partner at Hustle Fund, said that you don’t always see a founder’s true colors until they start to come under stress or enter personally uncharted territory, like managing a growing staff.
So, when one slips through the cracks even after performing due diligence, what can you do?
Angela Lee, a Columbia business school professor and venture partner, said that if you don’t catch this during the due diligence process, investors should be checking in with their portfolio companies frequently enough to catch issues early. She recommends asking founders about how things are going beyond just how the business itself is doing.
“When founding teams implode, it is not like it happens overnight; there are cracks,” Lee said. “If we get ahead of these cracks, we can help.”
It’s not one-size-fits-all
How a VC responds to these instances of problematic startup leadership varies greatly depending on what kind of stake they have in a company, what stage the startup is at and the exact dynamics of the problems. For example, a CEO who is fostering a toxic culture should be treated differently than, say, a founder who committed sexual harassment or assault.
Dealing with a bad CEO is easier for late-stage companies; more mature startups tend to have more governance structure and a board of directors that can be involved with the process.
“If we are making an investment, we are getting a board seat so we can address some of those issues from a perspective of having regular scheduled meetings,” Newton said. “Our role as an investor is to coach, teach and mentor, not just invest dollars.”
It’s also important for a board to send a founder unified messaging or a unified plan when they are looking to address problematic behavior, Newton said. That can help mitigate any confusion.
For early-stage founders, a VC’s role is a little trickier, Bahn said, because you as an investor may not be able to make changes. He said that Hustle Fund makes a lot of early investments through a SAFE model — simple agreement for future equity — which means if that stake hasn’t converted to equity, they don’t have much say if things start to go wrong.
Of course, that shouldn’t stop these investors from talking to the founder and brainstorming ways to address the issues, but there aren’t as many options for investors who have a small stake.
Be transparent
It’s always important to be upfront with future investors about the state of things, Bahn said. “Let’s say that a downstream investor said, ‘I’m interested in investing in X company, what do you think?’ and we tell the truth,” he said. Otherwise, it could come back to bite you, he said.
Both Bahn and Newton agreed that, for the most part, regardless of stage, it’s better for a CEO to stay in their role if possible, considering they are the driving force behind the startup’s vision. “You also don’t want to be known as the VC who invests and then fires the founder,” Bahn added.
But for that to happen at any level, Lee said what’s most important is for the founder or leader to be self-aware. Founders need to be able to recognize the problems, respond to feedback and actually want to improve, she said.
But founders should also be flexible. “One of the most important things for an entrepreneur is to be malleable,” Newton said. “You tell someone and fix this pitch and come back and give it to us again. If this person is not going to work with constructive direction, the red flags start to go up.”
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