Thirty-eighth in a series of weekly posts by myself and Nicholas Lovell of Gamesbrief which answer the fifty questions you should ask before raising venture capital. We expect the series to run for a year after which we will collate the posts into a book. You can find the rationale behind the series here, and the list of questions here. We welcome your comments on any and every aspect of what we are doing.
The first thing to say here is that experienced investors rarely plan on bringing in a pro-CEO when they invest. It has become something of a cliche now, but backing good teams is probably the single biggest driver of returns for a VC fund, and if the CEO of a company isn’t good, then the team isn’t good. So rather than invest and plan to make a change most VCs would decline to invest.
However, companies change as they grow, and the requirements to manage them change as well, and the right person to run a company at the early stage isn’t always the right person to run it once it gets to 50 or 100 people, and other companies don’t perform and bringing in someone at the top with some new ideas can be the best way forward. If the VC and founder are experienced they will probably have prepared themselves for these moments and jointly decide to bring in someone new to lead the business. In this situation it is not the VC bringing in a pro-CEO. Rather it is everyone collectively deciding to make a change.
There are, however, situations where the founder and investors don’t agree on this decision and sometimes the VC will find a way to insist that a change is made (more on that below). It is important to note that forcing a change like this generates an awful lot of upheaval within a company and is not something that anyone would undertake lightly. However, if a VC is convinced that without a change the company is unlikely to succeed she is duty bound to try and make it happen – that is her obligation to her investors.
The underlying context here is by taking investment from a VC the founders agree that the goal for the company going forward is to maximise value for the shareholders, and that is more important than any individual holding any particular role. Founders who are uncomfortable with that should think long and hard about raising venture capital.
Good VCs will talk all of this through with founders before they invest in a company. It is tough to have a conversation along the lines of ‘I believe in you as CEO now, but even though I see no reason why that might change, experience tells that it might, and if it does I need to know what your attitude will be, will you think first as a shareholder, or will you think first as an individual/employee?’, and the reason it is tough is that many founders find it hard to visualise the scenario in which they are not the best person to run the company. it is a tough conversation, but it is an important one.
I said I would come back to the ways in which VCs can force a change. The most obvious is when they have control of the board (hiring and firing of the CEO is a board decision). Also, when VCs control over half the equity then (absent clauses in the company docs to the contrary) they have the potential to change the board composition so they do control it and hence the board will likely follow their wishes. Finally, if the company is out of cash, or likely to be out of cash at some point in the future, then the VC is typically in a sufficiently powerful position to force the change through.
I want to finish by saying that in the best investments the VC and founders have a strong relationship based on trust and mutual respect. Having such a relationship should be the goal of anyone raising money, and once you have that you will know where you are and there should be few surprises.