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July 02, 2005

TWO MYTHS IN ONE: Founder Control is Healthy and Investor Control is Healthy

MYTH: [Founder or Investor] Control is Healthy

REALITY: [Founder or Investor] Control is called [Founder-itis or Investor-itis]

We VCs often use the term “Founderitis” and, according to Google, we appear to be winning the war for hearts and minds of most, since an equally serious, but rarely admitted to malady, called “investoritis” isn’t even mentioned once. 

Google Search Results (06/30/05)

• Founderitis  =  111
• Investoritis  =  0

So I’d like to help set the record straight and add a few Google hits under “investoritis” — if only to level the playing field a bit — since “investoritis” is simply the complementary extreme of “founderitis” and is just as life threatening to any enterprise.

It is always important to remember, whether you are on the management side or the investor side, that health, vitality, and growth of a successful enterprise requires delicate balance or homeostasis on numerous fronts.  One of the hallmarks of a successful Board of Directors is the constant vigilance to preserve and protect the optimum growth conditions required for their company.

One of these key areas of homeostasis is governance and control. 

An essential balance must be always be maintained — first between “founders” and “investors” — and later — between “management” and “investors (including founders)”.

Key Principle: IF EITHER WINS — BOTH LOSE

Hence, the terms: “Founder-itis” and “Investor-itis”

This point shouldn’t require much elaboration — as recent history provides a boat-loads of examples on point. 

During the rise of the “Dot Coms,” we had all of the stigmata of rampant “Founder-itis” and then, during the crash of the “Dot Bombs,” we had all of the stigmata of rampant “Investor-itis”.  There is plenty of blame to go around on this one.  Yes the founders were incredibly greedy and stupidly ran up valuations — leaving investors with too little upside incentive to help out in a crisis.  But the investors were equally stupid and unsophisticated in how they greedily handled “down rounds” and “cram downs” — and then wondered why they are being sued and why their companies continued to perform so poorly and management teams seemed so “un-incented” to change their situations.

Again, a true partnership between management and investors works both in good times and in bad times.  No matter how arrogant as either side can get or how indispensable either side feels they are to the success of the company, the truth has always been that neither-side can go it alone.  Neither side can ever allow the other side to win — or they will both lose.  

It is in the checks and balances that the true genius of their tortured relationship lies.  Only when held together by appropriate checks and balances can the constant strain of their tenuous relationship be transformed into —

1) focused creative power and 

2) unleashed potential to maximise the performance of its growth engine.

[BTW, Control is not the same as ownership interest.  There are many examples where companies are structured so that management retains control even if they own much less of the economic interests (famous example: Brain McCaw needed millions to build his first cellular network but realized he needed to retain control for the enterprise to succeed — even if he owned less than 10% of the company it would still make sense for investors to grant him control.  In this case, a healthy balance was struck by issuing Brian a class of “super-voting” shares which would eventually dilute out his control when his ownership stake dropped below a critical level which was much less than the normal 50%.  There are many other ways to accomplish this and, to some degree, this is part of routine venture financings when people talk about liquidation preferences, and other standard terms as well as super-majority voting, covenants, etc.  These are all ways to effectively grant more economics than governance, to the investors.  — cgm]

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Posted by cmayaud at 02:47 PM | Permalink| Comments (0)
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