Author: Tom Koor

Tom Koor

What is the value and role of a lead investor?

You may download a PDF of this article from: What is the value and role of a lead investor

How do you read this article?

  • This article is written for startup founders.
  • There are two examples of a lead investor.
  • Then there is a generic description of a lead investor. The lead investor in your specific situation will likely be different.

Two examples of a lead investor:

The lead investor in an angel investor organization

  • Produces the due diligence report. Consultants and other angels may have provided input to the report and carried out specific due diligence task.
  • Negotiates with the founders on behalf of all the angels.
  • Manages angels’ lawyers.
  • Manages the angel close including getting the money into escrow.

The lead investor of a syndicate:

  • Has prepared a due diligence report, completed a term sheet after negotiations with the founders.
  • Then begins to actively recruit more investors to the deal.

What is the value of a lead investor?

  • Without a lead investor, you may fail to raise capital.
  • The reputation and network of the lead investor will attract other investors.
  • Many VCs, angels, and angel groups will not invest until there is a lead investor.
  • Including the name of the lead investor and terms in your pitch deck greatly improves your chance of success.
  • Having a lead investor reduces the overall time and effort to raise capital.
  • The lead investor will make a major investment, at least 15% of the round and sometime up to 50% of the round.

What may the lead investor do?

  • Prepare a due diligence report. Subsequent investors may still decide to conduce their own due diligence.
  • Negotiate the term sheet.
  • Hire a law firm to handle the investors paperwork. Sometimes the startup will pay for some or all of the lead investors out-of-pocket costs.
  • Sit on your advisory board.
  • Sit on your board of directors.
  • Make introductions to potential investors, customers, partners, suppliers, employees, and others.
  • Help manage the other investors.
  • Help structure future fund raising rounds.
  • Participate in future fundraising rounds.

What are the characteristics of a lead investor?

  • They passionately believe in you and your startup. They are not going to try to force you out and take control.
  • You’ll be able to work with them for the long term. Divorce from a spouse is often easier than divorce from a lead investor.  Do you actually like the lead investor?
  • Consider the investor’s values, morals, and ethics.
  • They are respected in your industry and/or in the startup financing world.
  • It’s helpful if the lead has been a lead before.
  • They have invested before and those investments have done well.
  • They have lots of funds for follow on investments and investments in other startups.
  • They are not in any kind of financial distress.
  • The investors have diverse portfolios so that market problems in one sector will not result in pressure on your startup to perform.

Look for the lead investor before you look for the follow-on investors.

  • This can take a long time.
  • You may make hundreds of phone calls and emails, meet with over a hundred people, and spend over 20 hours a week for three to nine months to find a lead investor.
  • You need to build relationships with investors over time. You’ll need a plan, and a CRM, to stay in touch with them.

How do you find a lead investor?

Your next steps

  • Define what you are looking for in a lead investor.
  • Set out you plan to find a lead investor and to stay in contact with the investors you have met.
Tom Koor

How do you understand potential investors?

You can download a PDF of this article from: How do you understand potential investors?

Why understand potential investors?

You will fail to raise capital if you:

  • Don’t understand the investors needs.
  • Don’t understand how the investors perceives how you meet their needs.
  • Don’t understand how the investors perceive that you meet their needs better than others asking for capital.
  • Spend time on investors who will never invest with you rather than spending time on investors who have needs you might be able to meet.

Or, as Karen Kelly of K2 Performance Consulting told me, “Don’t try to sell steak to vegetarians.”

The overall process is to:

  • Document some hypotheses: What are the characteristics of a potential investor? What are their problems and needs?
  • Document your hypotheses in the business model canvas1. This framework ties together investors, their needs, your solution, and what’s required to build your solution.  Your business model canvas will change as your hypotheses change, are validated, or are invalidated.
  • Test the hypotheses by interviewing potential customers. These are not sales calls.
  • The interview process will either validate or disprove your hypotheses.
  • During the interview process you will likely revise some hypotheses, as well as set down some facts (i.e. validated hypotheses).

Key Hypothesis for the rest of this article:

Let’s assume your target investor is the individual investor who makes decisions regarding some or all of their investable assets.  There would be different needs if your target was: the Chief Investment Officer of family office; the financial advisor who makes investment decisions for clients; or an institution investing capital.

 Why is a business model canvas critical?

Let’s pick a simple example to illustrate:

  • You want to raise $10 million and you plan to do $25,000 asks from investor with investable assets of $3 -$5 million. You’ll need have 400 investors.  OR are you planning to do $1,000,000 asks from investors with investable assets of $100,000,000+? You’ll need 10 investors.
  • Your channels, partners, resources, activities, etc. will be radically different for each of the above two examples.

A business model canvas will help you think this through.

What are some aspects of the target investor profile?

  • Age?
  • Gender?
  • Location?
  • Where born and where living now?
  • Current income and occupation?
  • Current net worth?
  • Part of a high net-worth family?
  • Supported by a family office, shared or dedicated to one family?
  • % of assets managed (i.e. investment decisions made) by third parties vs made directly by the investor
  • Associations membership e.g. Tiger 21 or Family Enterprise Xchange?
  • Yearly living expenses – e.g. some potential investors may have fractional jet ownership?
  • Future major expenses – this could range from several hundred thousand dollars to support a child in a foreign university, to a $100 million+ for their next yacht?
  • Do they have a documented investment thesis?
  • Do they have little time to manage their investments, are they devoting significant time to manage their investments?
  • What is their asset allocation mix? Specifically, what % of assets are they allocating to the asset class you are part of?  Two examples:  1) You’re a fintech company using AI to analyze home mortgage approvals.  2) You’re an early stage Venture Capital fund investing in companies with women founders.

What are potential investor needs?

Investor needs can include social, emotional, and financial needs.  These needs may include:

  • Being perceived by others as: a sophisticated investor, someone making a positive impact on society or a specific cause.
  • Having the satisfaction of knowing they are doing good.
  • Being actively involved and devoting time to managing their investment. They value the social interaction with other investors.  They value being a coach or mentor to the CEO, being on the advisory board, or being on the board of directors.
  • This type of investment is a hobby.
  • They are seeking a xx% probability of achieving YY% cash-on-cash return within ZZ years?
  • They are seeking wealth transfer to their children and grandchildren.
  • IRR is of little interest.

What value will the investor provide to you and your company?

Investors can provide value in many ways.  Some of the hypotheses in your business model canvas may include:

  • Providing capital both in the short- and long-term.
  • Enabling your capital raising by drawing upon their network of investors.
  • Providing access to their network of potential channels, partners, suppliers, customers, and employees.
  • Enabling your success based on the reputation of the investor.
  • Being a coach or advisor to you.
  • Serving on your advisory board or board of directors.

What are the dos and donts?

  • Do document and execute a structured process.
  • Do define your target investors and select potential investors who are representative. For example, if you are creating a venture capital fund which will focus on providing investor exits within 3 years, do not interview potential investors who seek a 20+ year exit in order to facilitate inter-generational wealth transfer.
  • Do face-to-face interviews. Video calls are a distant second best.  Phone calls are a very distant third best.  Don’t do emails or surveys because those do not allow interactive dialogue and understanding.
  • Do get out and interview lots of investors. The absolute minimum number of investor interviews is 10.  50 interviews are a better number.  You will have to contact many people to get the necessary interviews because most people will decline.  They are strangers with busy lives.
  • Do ask potential investors if it’s OK to record the interview for later analysis. If not, have a second person take detailed notes.  Do not conduct a non-recorded interview by yourself.
  • Do document the criteria for assessing the answers. This will avoid confirmation bias, in which you’ll ignore information which invalidates your hypotheses.
  • Do not interview friends, family, or those you have a personal connection with. You need brutal honesty, rather than hearing from people who do not want to hurt your feelings.
  • Do focus on the people who actually have the problem or need for which you are creating the solution.
  • Do create questions which require quantitative answers or specific descriptions. Don’t ask for subjective or hypothetical feedback.
  • Do create questions which help you understand how investors think, and why they take the actions they do.
  • Do not talk about your company in your initial meeting.
  • Do not use or send a survey form. These tend to ask closed-ended questions, while you want open-ended responses to open-ended questions.
  • Do finish each interview with two questions: “Who else would you recommend I interview?”, and “What should I have asked but did not ask?”
  • Do create a data collection form for each interview. This will contain things such as: the description of the investor profile, your open-ended questions, which hypotheses were confirmed and why, which hypotheses were invalidated and why, which hypotheses you gained no insight into and why, what changes you should make for the next interview (target customer profile, hypotheses, questions to ask).
  • Do review and update your business model canvas as you validate your hypotheses regarding target customers and their needs.

Other ways to understand investors:

  • Read research reports e.g. Tiger 21 reports.
  • Document and analyze sales calls on investors.
  • Interview your existing investors.

What are the challenges in interviewing potential customers?

  • The FEC (Founders, or Existing Companies), passionately believe they have created right solution. They believe there is no reason to interview potential investors. They are focused on building the solution and selling it. Their passion results in them being unable to listen to, and understand, what the investors are saying.
  • The FEC believe any sales and marketing problems can be fixed by changing the sales deck and changing the website.
  • The FEC are passionate they have the right solution. Hearing brutal feedback from potential investors requires founders who are self-confident, self-aware that they don’t have all the answers, and have the ability to learn and adapt.  I’ve observed many people who are not able to learn and adapt.
  • The FEC lack the personality and skills to contact a large number of strangers to setup and conduct interviews.
  • Doing interviews appears to be lack of progress. Building a solution is more fun and appears to be progress.

Conclusion

You will fail if your investors do not believe your solution addresses their individual key needs.

 Footnotes:

1 “What is a business model canvas?”  The following is a link to my article https://koorandassociates.org/tools/what-is-a-business-model/

 

 

Tom Koor

How do you determine employee talent requirements?

If you don’t have the right talent, your company cannot survive or prosper.  You cannot put in place talent recruitment, development, compensation, and exit plans until you know what the talent requirements are.

This document focuses on management and staff, excluding the board of directors, founders/C-Suite, and advisory board. The following is a broad framework.  You need to customize it for your specific situation.

To succeed, a company’s target customers must perceive they are obtaining competitively differentiated value over time.

The four 4 questions you must answer are:

#1 What is that competitively differentiated value?

#2 Which components of the business framework1 are required to deliver that value?

#3 What roles are required, and how will each role help deliver that value?

#4 What are the characteristics of the person in that role?

The answers to the 4 key questions depend upon the specific situation of the company.

Where is the company now, what’s the future direction, and what are the upcoming challenges? Some of the possible situations include:

Startup has no MVP2 (Minimum Viable Product) yet, is targeting a major market, and hopes to grow to 100+ employees.

#1 What is that competitively differentiated value?

At this point the founders are still figuring this out.

#2 Which components of the business framework1 are required to deliver that value?

The startup is focused on just a few components of business framework, and only a few pieces of the business model – who are target customers, what are their needs?

#3 What roles are required, and how will each role help deliver that value?

There are no detailed role descriptions. Everyone working on everything.

#4 What are the characteristics of the person in that role?

Everyone must be comfortable in chaos, dealing with daily new problems, have the ability to make rapid personal changes, and be relentless in overcoming obstacles.

Startup, has Product/Market Fit3, a small niche market, and will grow to a handful of employees.

#1 What is that competitively differentiated value?

The founders have determined this.

#2 Which components of the business framework1 are required to deliver that value?

The founders have identified and documented this.

#3 What roles are required, and how will each role help deliver that value?

There must be clearly defined roles for a stable business. The days of chaos should be over.

#4 What are the characteristics of the person in that role?

What are the necessary skills, experience, values, morals, and ethics to carry out that role?  Each person must have the ability to learn and change over time as the company continues to evolve.

Large company, with Product/Market Fit.

#1 What is that competitively differentiated value?

This must be documented.

#2 Which components of the business framework1 are required to deliver that value?

All the components are required for continued success.

#3 What roles are required and how will each role help deliver that value?

For each role, there must be a clear definition of the future challenges, issues, changes, obstacles to overcome and expected outcomes for that role.

#4 What are the characteristics of the person in that role?

Focus on the skills, experience, values, morals, and ethics to carry out the role.  Every company has a small number of roles that enable the bulk of competitively differentiated value. These roles are not based on management hierarchy.  You must identify and target these roles.

Large company that has lost Product/Market Fit, the market is shrinking, there is intense competition, and the company must be transformed.

#1 What is that competitively differentiated value?

At this point the company does not have competitively differentiated value with a large percentage of customers recommending the company to others. The leadership must rethink who the target customers are, what their problems are, and how the company can provide a solution which solves those problems.   In some cases, such as many paper-based publications, there is no future value and the company will disappear at some point.

#2 Which components of the business framework1 are required to deliver that value?

All components are required. It’s likely all components will undergo major changes.

#3 What roles are required, and how will each role help deliver that value?

First there must be the right board of directors and CEO.  The current board and directors got the company into this situation.  Leadership transformation begins at the top.

#4 What are the characteristics of the person in that role?

The board of directors and CEO are dealing with the same issues as an early stage startup.  Everyone must be comfortable in chaos, dealing with daily new problems, have the ability to make rapid personal changes, and be relentless in overcoming obstacles.

Some of the challenges in determining talent requirements include:

#A Many large companies do not realize they no longer have Product/Market Fit, and are hiring the talent based on invalid historical requirements.

#B Many startups attempting to scale don’t understand that the talent that got the company to this point is not what is going to help them create a successful future

#C Many startups simply do not have the CEO and founder talent to succeed. There is some combination of the founders: not understanding the customers problems, not understanding what solution is required, and not able to attract the necessary talent and help that talent work together.

Your next steps:

Define your current situation, based upon facts.  Your advisory board can challenge your thinking and help you understand your company’s situation.

Footnotes

1 Business Framework has inter-related 10 components:

#1 What can only the CEO do

#2 Company purpose

#3 Values, morals, and ethics

#4 Customer perceived value proposition

#5 Business model

#6 Talent management

#7 Capital and cash management

#8 Investor management

#9 Exit management

#10 Governance

2 A product or service with just enough features to delight early customers, and to provide feedback for future development.

3 Product/Market Fit.  Marc Andreessen’s definition of product/market fit:

“The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can.” On product/market fit for startups

 

 

 

Tom Koor

How to assess director and CEO candidates – regarding values, morals, and ethics. (V2)

There have been numerous corporate scandals, with questions as to “where were the directors?”  It is up to each board to establish a common understanding of, and commitment to, what they mean by values, morals, and ethics.  Based on this common understanding, the board can then assess director and CEO candidates. This document is a tool designed to enable discussion leading to that common understanding

This tool does not provide any recommendations or advice as to what are appropriate values, morals, and ethics. The focus on possible behavioural questions (i.e., can be confirmed via reference checking) to ask director and CEO candidates.  Skills or functional competencies are not addressed.  Each board should identify additional questions.  This tool is illustrative and not intended to be a comprehensive set of questions.

The nomination committee/board should have a discussion on each question and document:

  • What might be good, OK, or unacceptable answers.
  • Which answers would eliminate the candidate from further consideration.

Directors and the CEO should be passionately committed to the purpose of the company

What is the purpose of the company? Why does the company exist? The description of the purpose of the company should be positive and outwardly focused on how you benefit customers and society.  For example, Nike’s “authentic athletic performance,” rather than “sell lots of shoes made in China.”  Is the purpose of the corporation to make as much money as possible? How should the company benefit society?  Or, should it?

Larry Fink, in his 2018 letter to CEOs, said “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate…..Without a sense of purpose, no company, either public or private, can achieve its full potential…..And ultimately, that company will provide subpar returns to the investors.”1

The passionate commitment to purpose will set the tone from the top and quickly percolate throughout the company.  The purpose is the foundation upon which values, morals, and ethics are based.

I do not have any suggestions as to how to assess a candidate’s passionate commitment to purpose.  It will be clear within a year if a director or CEO doesn’t have passionate commitment to the purpose – which presents a major decision for the board to make.

Which director decision has the greatest impact on long-term corporate value?

Many would advocate this decision is the appointment (or termination) of the CEO.  Let’s first consider some possible questions to ask each director candidate who would have to vote on CEO appointment or termination.

  • What is the most senior level position you have terminated?
    1. Why? Performance (i.e. impact on profit or value creation and preservation)? Non-compliance with laws, regulations or company policies? Ethics or values?
  • Looking back over your career, what’s an example of person you decided not to hire or promote, due to ethics or values?
    1. What were the ethics and values issues?
  • What is the most senior level person you either appointed or recommended for appointment?
    1. What were the three most important reasons for that decision?
  • As you look back over the people you have appointed or recommended for appointment, what was your greatest mistake? How did you determine it was a mistake?  How did your correct your mistake? What have you done differently since then, when appointing people, or recommending appointments?

Now, let’s look at the values, morals, and ethics questions that you could ask of both director and CEO candidates:

  • What is the most courageous business action you’ve taken, and what was the impact on company profit, your career, and your family’s financial situation?
  • What was the most difficult ethical business decision you have made, and what was the impact on company profit? What definition of ethics did you have in this situation?
  • What has been the greatest crisis you have had to resolve? What was your role?
  • When dealing with an issue, what is an example of how your probed deeper into the company to understand the causes of the issue?
  • What is the biggest issue or problem you’ve encountered where you wished you’d informed the board earlier?
  • What was the most significant issue regarding ethics, values or morals, which a subordinate or colleague brought to your attention? How did you deal with it?

The following questions address the beliefs a candidate has:

  • Should a company invest in a country, or have operations in a country, in which:
    1. Child labour is common.
    2. The rule of law does not apply i.e., the government or highly placed individual are not subject to the laws, and the judiciary is not independent.
    3. The press is not free.
    4. Doing business requires payments to government officials or other highly placed individuals.
    5. The government is not elected in a freely democratic process.
  • Should the company arrange its legal structure to minimize taxes, ideally to pay no taxes?
  • Should the company lobby governments to change laws to reduce company taxation?
  • What would be your answers for the first three questions if the country in question was your home country, such as Canada? If your answers differ, why do they differ?

 Footnotes:

1 https://corpgov.law.harvard.edu/2018/01/17/a-sense-of-purpose/

Tom Koor

Leadership talent is the underlying cause of startup failure.

There is some debate regarding the relative importance of the idea vs talent.  Talent is the most critical.  It is the talent which: comes up with the idea, changes the idea as learning more about the customers, and successfully grows a profitable company.  Lots of people have ideas.  Few people can successfully achieve results.

 Founders are often the cause of start-up failures:1

65% of the failures of high-potential start-ups are due to people problems: relationships, roles and decision-making, and splitting the income. More than 50% of founders are replaced as CEO by the third round of financing.  In 73% of these founder replacements, the CEO is fired rather than voluntarily stepping down. The founder’s passion, confidence, and attachment to the start-up is initially a great strength. Founders often refuse to revise their strategy and business model, underestimate and misjudge the need for additional skills, and make decisions that don’t reflect the current situation.

 The top nine reasons for start-up failures were identified by CB Insight:2

( I’ve shown below my point-of-view as to why leaders and leadership were the root cause.)

  • 42% no market need – not obtaining facts as to customers and their needs.
  • 29% ran out of cash – poor management of cash flow and poor reputations with investors.
  • 23% not the right team – unable or unwilling to assemble the right team.
  • 19% get outcompeted – not aware of the competition and customer needs.
  • 18% pricing/cost issues – not aware of customer needs and the competition.
  • 17% poor product – poor ability to design and build a product meeting customer needs.
  • 17% need/lack business model – not understanding a business model is needed, or unable to define one.
  • 14% poor marketing – poor marketing skills.
  • 14% ignore customers – clearly a leadership problem.

 Why do companies find themselves in crisis?

“The assumptions on which the company has been built and is being run no longer fit reality.”3

 Major business changes almost always fail:4

  • Major changes almost always fail. 12% of change programs succeed.
  • 38% produced less than half the expected results.
  • 50% diluted the value of the company.

Most venture capital backed start-ups will fail5.

  • Three quarters of VC backed firms in the U.S. don’t even return all the investors capital..

Your next steps

To enable discussion with your board of directors, C-Suite, and advisory board, download the following one-page slide:

Leadership talent is the underlying cause of startup failure

Footnotes:

1 “The venture capital secret: 3 out of 4 start-ups fail”, Deborah Gage, Wall Street Journal Small Business, September 19, 2012  discusses research by Shikhar Ghosh, Harvard Business School

2 “Top 20 reasons start-ups fail”, CB Insights, Oct 7, 2014

3 Peter Drucker, Harvard Business Review, November 2009, Page 90

4 “It’s 8-to-1 against Your Change Program”, Bain website, Managing Change Blog, 2017 June 23

5 “The Founder’s Dilemmas”, by Noah Wasserman

Tom Koor

Startups often fail in the transition to scaling.

Startups often fail in the transition from product/market fit to successful scaling, because the talent requirements are different.  The problems faced by leaders in those two situations are very different.  Many leaders are not able to transition.

Getting to product/market fit requires a small team making constant changes to build a product which delightfully solves urgent customer problems:

  • CEO focus on building a delightful product.
  • Everyone does everything. There are no full-time managers.
  • Doing things that don’t scale and are inefficient.
  • Limited management processes.
  • Key metric is customer satisfaction.
  • Heavy investment in engineering.
  • With an engineering team of less than 6 people, the CTO (Chief Technology Officer) spends most of their time coding.
  • There are lots of coding, technical, architectural issues and decisions.

 Being ready to scale requires an architected business and suite of with supporting processes and technology, able to efficient roll out an evolving solutions which will change the world:

  • CEO focus on building talent and a company.
  • Management structure in place. Roles and responsibilities defined.  Fewer generalists, and more specialists.  Full-time managers.
  • Focus on efficiency in order to profitably scale.
  • Management processes and supporting technology in place, especially for talent acquisition, development, and retention.
  • Decision-making drive by several key metrics.
  • Heavy investment in marketing and sales.
  • CTO no longer coding most of the time – may be a full-time manager.
  • Broad set of issues and decisions.

The CEO must do what only the CEO can do, and must not delegate:

  • Creating and maintaining purpose and alignment.
  • Hiring a leadership team and making sure they work well together.
  • Nurturing the company culture.

 Your next steps

To enable discussion with your board of directors, C-Suite, and advisory board, download the following one-page slide.

https://koorandassociates.org/points-of-view/startups-often-fail-in-the-transition-to-scaling/

Tom Koor

When do startup get capital from outside investors? (V2)

This is an update to my 2019 Feb 22 survey, with additional findings and insights.

I did a survey of founders and CEOs of  startup software companies.  I asked them the question: When did you get outside investors, excluding friends and family?  After you had some satisfied customers who provided some revenue?  Before?  At some later stage of your company?

The key learning is that there are many paths to growing a software company

There were a total of 17 responses.  11 raided money from outside investors once they had a MVP (Minimum Viable Product) with some satisfied customers and some revenue, 3 never raised capital from 3rd party investors to grow into significant sized companies.  3 raised money before they had any customers. Two of these conducted large numbers of interviews of potential customers (in one case, 300 individual documented interviews in one year).

Investors told me that they did invest in pre-revenue and pre-customer companies.  These were clean technology, medical technology, pharma, quantum computing, etc. i.e. not software companies.

Every investor told me that they don’t invest in the idea.  They invest in the people.  i.e. The world is filled with people with ideas, but there are few people that can actually create something.

Tom Koor

What are the decision-making challenges faced by directors? (V2)

Directors face five challenges in making decisions:

#1 Have the directors agreed upon which decisions are most critical, and agreed upon the criteria for selecting those decisions?

  • Is the criterion: what has the greatest impact on long-term value creation and preservation?
  • Are the critical decisions: setting the strategy; hiring/terminating CEO; approving CEOs strategic implementation plan; monitoring results of executing the CEOs plan?

#2 Do the directors understand the company?

A McKinsey survey of directors1 revealed:

  • 34% agreed their board fully comprehended strategies.
  • 22% said boards completely aware of how firms created value.
  • 16% said boards had strong understanding of industry dynamics.

#3 Does each individual director have the qualifications to make each critical decision?

  • What have been each director’s past experiences in making each critical decision?
  • What is each director’s relevant knowledge and experience regarding the industry, company strategy, and how the company creates value?
  • What have been the past outcomes of each director assessing and selecting advisors?
  • What are the value, morals, and ethics of each director?
  • Do the directors have the interest, ability, and commitment to understand the company and its industry?

#4 Is there an effective board decision-making process?

  • A McKinsey survey of executives2 revealed 28% of executives thought good strategic decisions were frequent.
  • Critical decisions are complex emotional, social, and political processes. Do the directors understand the typical flaws, and take mitigating actions?

#5 The director selection process is almost always flawed.

  • Directors are ultimately responsible for the long-term success of the corporation.3
  • The vast majority of public company directors fail to achieve long-term success.

Mark Leonard, CEO of Constellation Software, in his final annual CEO letter said:  “Qualified and competent Directors are very rare, and not surprisingly, the track record of most boards is awful. According to the 2017 Hendrik Bessembinder study of approximately 26,000 stocks in the CRSP database, only 4% of the stocks generated all of the stock market’s return in excess of one-month T-Bills during the last 90 years. The other 96% of the stocks generated, in aggregate, the T-Bill rate over that period. This means that 4% of boards oversaw all the long-term wealth creation by markets during that period. Even more disturbing, the boards for over 50% of public companies saw their businesses generate negative returns during their entire existence as public companies.”    http://www.csisoftware.com/wp-content/uploads/2018/04/Presidents-Letter-April-2018-Final.pdf

Few major companies survive for the long-term:

  • 16% of major companies in 1962 survived until 1998.4
  • Of the 500 companies in the S&P 500 in 1957, only 74 remained on the list in 1997. Only 12 of those 74 outperformed the 1957-1997 S&P index.  An investor who put money into the survivors would have done worse than someone who invested only in the index.4
  • 31% of Fortune 500 companies went bankrupt or were acquired from 1995 to 2004.5
  • 52% of Fortune 500 companies went bankrupt, were acquired, or disappeared between 2000-2015.6
  • 50% of the S&P 500 will not be on the list in 10 years’ time.7
  • Three-quarters of VC-backed firms do not even return all of the investors’ capital. Over 95% do not meet initial projections.8

Why are there so few qualified directors?

The background of many directors does not qualify them to make board-level decisions in today’s rapidly changing world.

  • Many directors are business executive who were not CEOs or members of the C-suite. They were successful because they rose through the ranks of existing companies.  They never had to make company-wide decisions.
  • Some directors are consultants, academics, and others who have never had major P&L or operational accountability.
  • I wonder about why directors who are not qualified to occupy C-suite positions are qualified to make decisions such as whether to: hire a CEO or fire a CEO; sell the company; approve or reject the CEO’s strategy or budget, etc.

Your next steps:

  • To enable discussion with your board and management, download the following one-page PDF.

What are the decision-making challenges faced by directors?

  • Does each director state the board is ultimately responsible for the long-term success of the company? If the board does not agree on this, proceed no further.
  • Document which are the critical board decisions.
  • Define the value creation matrix: what skills, experience, values, morals, and ethics are required to make each of those decisions.
  • Assess each director and remove the unqualified directors immediately, or at the next annual general meeting.
  • Assess future director candidates using the value creation matrix.

This process must be repeated yearly.  In today’s fast-changing world, yesterday’s solutions are not always appropriate for tomorrow’s problems.  Remember: innovation, agility, and transformation start at the top – at the board.

 Footnotes

1 “Corporate Boards need a facelift”, Eric Kutcher, McKinsey, May 04, 2018

2 “The case for behavioural strategy”, McKinsey Quarterly, 2010 Number 2

3 Professor Didier and Estelle Metayer, “Does your board really add value to strategy?”, IMD, Global Board Center, https://www.imd.org/research-knowledge/articles/board-strategy/

4 “Creative Destruction – why companies that are built to last, underperform the market”, by Richard Foster & Sarah Kaplan

5 “Unstoppable” by Chris Zook, 2007, page 7

6 Accenture 2016

7 “2018 Longevity Report” by Innosight Consulting

8  Deborah Gage, “The venture capital secret: 3 out of 4 start-ups fail”, Wall Street Journal,  https://www.wsj.com/articles/SB10000872396390443720204578004980476429190, September 19, 2012

Tom Koor

Successfully scaling startups are different from public companies. V2

I observe major differences between long established public companies and successfully scaling startups.  The two major things that strike me are:  the startups have an in depth understanding of the customer; and the startups are incredibly focused on having the right talent: talent in management, on the board, on the advisory board, as well as talented investors.

This version 2 of my document includes 3 key concepts:

  • Startup board of directors are focused on creating value. Public company boards often focus on “oversight”
  • Startups make 5-10 minute “pitches” for investments, focused on “What is the customer problem” and “What is the solution the customer will pay for” Public companies often have very long presentations regarding “business cases”.
  • Startups are constantly re-inventing themselves and transforming. Public companies often view transformation as a one time event and create temporary organizations such as “The Transformation Office” and “The Chief Transformation Officer”.
Successfully scaling startups Long established public company
Planning driven by: what is the customer problem or need; how does the customer perceive that the solution is significantly differentiated. Planning driven by vision and mission statements.  Often little differentiation among competitors.
Often clarity as to the beneficial impacts on society. Beneficial impact on society is not a consideration.
Focus on meeting the needs of customers Focus on growing shareholder value
Every member of the board of director is focused on growing company value.  They have previous experience in growing value. Board of directors has an “oversight” role.  There often the concept of “noses in, fingers out”.
Investors make decisions based on talent: talent of the founders and management team, talent on the board, talent on the advisory board, and talent of the other investors. Talent does not play a major role in deciding on whether to invest or divest.
Most things are broken most of the time.  The focus is on solving the daily issues which arise from scaling and meeting evolving customer needs. Risk management and Enterprise Risk Management play a major role.  Focus on “mitigating risk”.
Transformation is an ongoing and integral part of the business. As the company grows from a few co-founders to 10 people to 50 people to 150 people to 500 people, the company re-invents itself every 6 months.  Everything changes: the role of the CEO, who you hire and how you hire, how internal meetings are structured and organized, the technology, the business processes, etc.

There are no such things are “Chief Pivot Officer” or “The Pivot Office”.

 Companies launch stand-alone transformation initiatives.

The is a Chief Transformation Officer and a Transformation Office.

Transformation is views as a focused one-time event,
The start-up is the disrupter due to deep understanding of the customer and providing solutions which the customer sees as very superior and different. Companies are “disrupted” because they no longer understand customer problems, needs, and why the customer should buy from them.
Uses advisors and experts who can help invent (and re-invent) and create what will be successful in a future which is very different from what was successful in the past. Use advisors and experts who understand in detail what has been successful in the past in the industry, with other companies.  The phrase “best practices” is often used.
Pitches to justify investments are often 5-10 minutes long.  The focus is on:

One-on-one interviews with potential customers have validated that there is a problem and customers would consider for a solution.

Minimum Viable Products are piloted until the there’s validation that customers will actually pay for the solution.

Then major investors are made in growth

 Business cases to justify  are built, with long and detailed presentations.

Often years pass in building a solution before launching to initial customers.

 

 

Tom Koor

How can founders and investors create a shareholders agreement?

How can founders and investors create a Unanimous Shareholders Agreement?

1      Purpose of this document

2      How to read and use this document

3      What is a Founders Agreement?

4      What is a USA  (Unanimous Shareholders Agreement)?

4.1       What are the benefits of a USA?

5      How does a USA fit into the overall governance structure?

6      What are the stakeholder expectations?

7      What questions does the founders agreement address?

8      How does the term sheet reflect stakeholder expectations?

8.1       Questions to consider in the term sheet include:

9      How does the USA reflect stakeholder expectations?

9.1       Generic contents

9.2       Decision Making.

9.2.1        Shareholders.

9.2.2        Board of Directors.

9.3       Sale or transfer of shares

9.3.1        Forced shareholder exit

9.3.2        Shotgun provision.

9.3.3        Right of first refusal

9.3.4        Tag-a-long or piggyback.

9.3.5        Drag-along rights.

9.3.6        Option to purchase/call rights.

9.3.7        Option to sell/put right

9.3.8        Auction.

9.4       Issuing additional stock or options

9.5       Dispute resolution.

9.6       Information Rights

9.7       Amending the shareholders agreement.

 

1       Purpose of this document

This document is a tool to help the founders and shareholders of a private corporation develop a common understanding of expectations and objectives.  This common understanding can then enable lawyers to craft a USA (Unanimous Shareholders Agreement).  This tool can be used to both review an existing USA as well as craft a new or revised USA.

The critical action is to document the expectations of the founders and shareholders before starting to spend money on lawyers to develop a USA.  Once the expectations are documented, then any issue can be discussed and resolved, leading to a set of common expectations which can guide the lawyers.

This document poses a series of questions, to stimulate thinking and discussion.  This is not a comprehensive list of questions. It is up to the founders and shareholders to make decisions.  This document does not make recommendation nor does it provide legal advice.  Legal advice must be obtained from qualified lawyers.  A Strategic Advisor can help you think through your answers to the questions.

 

2       How to read and use this document

The co-founders and shareholders will be referred to as “stakeholders”.

The document is organized to 6 groups:

  • What is a USA and what are the benefits?
  • How does the USA fit into the overall governance structure?
  • What are the stakeholder expectations?
  • What is a founders agreement?
  • How does the term sheet reflect stakeholder expectations?
  • How does the USA reflect stakeholder expectations?

The point of view of each stakeholder should be documented for each question.

 

3       What is a USA  (Unanimous Shareholders Agreement)?

The Canada Business Corporations Act defines a USA as “…written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that restricts, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation.”  All shareholders must sign and be part of the USA

3.1      What are the benefits of a USA?

The USA typically contains provisions in two main areas: decision making and share transfers, which are particularly helpful in the case of deadlocks or an unexpected shift in share ownership as a result, for example, of the bankruptcy or death of a shareholder. A USA is generally recommended whenever there are two or more shareholders in a closely held corporation.

The process of establishing a USA defines expectations and creates provisions which will ideally prevent lengthy, expensive, and potentially damaging disputes in the future.

 

4       How does a USA fit into the overall governance structure?

Governance is simply the definition of who makes what company decisions and the process for making those decisions.

  • The founders agreement may be used before there is any legal entity in order to define key decision making roles.
  • The articles of incorporation may limit the actions and decision of stakeholders.
  • The by-laws, which are approved by shareholders, limit the decisions and actions of the board of directors and management.
  • The board of directors, according to the Canada Business Corporations Act “…shall manage, or supervise the management of, the business and affairs of a corporation.” The board of directors mandate may specify which decisions are reserved for the board
  • Board of directors approved policies may constrain the decisions of management and the board. The board of course can approve an exception to any constraints it has placed on itself.  The Board of Directors committee mandates may specify which decisions are made by the committee.
  • The Delegation of Authority to the CEO may specify that the CEO may make all decisions, subject to board of directors approved policies, and except those decisions specifically reserved for the board or shareholders. The Board of Directors and stakeholders still have the authority to veto any decision made by the CEO as well as make any decision which may have been delegated to the CEO.
  • Loans, other financing, and other corporate agreements with third parties may have covenants which in specific situations may provide decision rights to third parties or limit the decision rights of the stakeholders.
  • The USA may specify which decisions are reserved for shareholders and which for the board of directors. The USA takes precedence over any by-laws, board of directors decisions, board approved policies, and management decisions. A unanimous shareholders resolution may be able to make any legal decision, regardless of bylaws, existing unanimous shareholders agreement, or other governance documents, except for the articles of incorporation.  The company must file with Corporations Canada (if federally incorporated) to amend the articles of incorporation.
  • Decision making authority and constraints may also be defined in other documents such as: Share Purchase Agreement or Investor Rights Agreement. Seek to reduce the number of documents which define decision making authority or constraints. Simplicity enables greater common understanding and reduces the costs of creating and maintaining legal documents.

 

 

5       What are the stakeholder expectations?

You should document the stakeholder expectations, which may include the following questions.  The intent is to identify where there are common expectations as well as disagreements. As the stakeholders review and discuss their expectations, they may revise their expectations.

The stakeholder expectations are the foundation for preparing the founders agreement, term sheet and USA.  When issues arise with the founders agreement, term sheet or USA, revisit and revise if necessary, the documented expectations. Do not attempt to come to agreement on expectations by spending large legal fee to revised term sheets and USAs.

In my experience, the agreement on stakeholder expectations may take several months.

  • Why does the company exist?
  • Why is the stakeholder involved?
    1. Make a positive impact on society?
    2. Have a positive impact on stakeholders reputation?
    3. Make money?
    4. Some other reason?
  • What are the stakeholders’ specific objectives?
    1. Realize x times return on investment within y years?
    2. Sell the business within x years?
    3. Growing the value of the company year over year?
    4. What are the key milestones?
  • What is the scope of the business?
    1. Geography?
    2. Nature of the business?
    3. What the business cannot do?
  • What contribution will each stakeholder make?
    1. Capital?
    2. Introductions to potential customers?
    3. Introductions to potential employees?
    4. Introductions to potential suppliers?
    5. Expertise relevant to the business?
    6. Time devoted to the business?
  • How will the stakeholder realize financial value from the business?
    1. Sale of equity?
    2. Sale of business, followed by cash to shareholders?
    3. Dividends?
    4. Fees, salary, or other compensation?
    5. Products and services provided by the business, perhaps at cost?
    6. Other ways?

 

6       What is a Founders Agreement?

The founders of a company may have an agreement before the company is incorporated and a shareholders agreement put into place.  This agreement may or may not be a legal document signed by the founders.  Even if signed, it may only be an intent rather than legally binding on future actions.

6.1      What questions does the founders agreement address?

The following are some of the questions a founders agreement may address.

  • What objectives and timelines does each founder have for the startup and for themselves?
  • Who gets what percentage of the company?
    1. Will the percentage depend upon vesting over time and continued involvement in the company?
  • What will each founder contribute?
    1. Number of hours?
    2. Capital?
    3. Finding customers?
    4. Finding capital?
    5. Creating the product or service?
  • How are key decisions made?
    1. Who will be the CEO?
    2. Unanimous? Majority? CEO only?
    3. What will be the founders salaries, if any?
  • What if a founder wants to leave? Can the other founders buy the equity? And at what price?
  • What happens if a founder becomes disabled or dies?
  • What happens if a founder wants to sell the company or kill the company?
  • What happens if it takes longer than expected to launch the company?
  • Can a founder work on other startups while launching this company?
  • What are reasons for removing a founder as an employee?
  • What happens if a founder does not fulfill the founders agreement?
  • If the business does not succeed, can a founder try again?
  • How much of the company are the founders willing to give up for how much capital?

 

7       How does the term sheet reflect stakeholder expectations?

  • Once the stakeholders have a set of shared expectations, with no fatal disagreements, a legal document know as the Term Sheet is prepared. The purpose of the term sheet is to outline the terms by which an investor will make a financial investment in company. The term sheet is not a legally binding document, with the exception of items such as confidentiality.
  • There may be a negotiation process around the term sheet.
  • Once the term sheet is signed, then the USA can be created (often with more negotiation) as well as the legal documents associated with funding and the other items in the term sheet.

7.1      Questions to consider in the term sheet include:

  • What type of securities are being offered to investors? E.g. common stock? Class A preferred?
  • What happens to the investors investment in the event the company is liquidated?
  • What conversion rights, if any, will the security provide?
  • What are the voting rights?
  • What must be in the shareholders agreement?
    1. What will be the information rights?
    2. What key protections will the investor have?
    3. What pre-emptive rights will the investor have, to prevent dilution?
    4. What happens if any shareholder wished to sell?
    5. How are directors elected?
      1. Will the be a shareholder representative?
    6. How do you define “sale of the company”?
  • What will be the size of the option pool?
  • How many years will the share purchase agreement survive?
    1. Will there by any key representation and warranty items?
  • What will be the founders terms?
    1. What will the founders transfer to the company e.g. intellectual property?
    2. Will the founders have an employment agreement?
    3. What are the terms regarding founders vesting?
  • Will the company pay for investors legal fees?
  • How long is the term sheet valid for?
  • Will the founders be prohibited from soliciting other financing during the time the term sheet is valid?

 

8       How does the USA reflect stakeholder expectations?

8.1      Generic contents

Some of the generic contents include:

  • Is there a table of contents for the shareholders agreement?
  • Is there a statement that this is a unanimous shareholders agreement?
  • Does the shareholders agreement relieve directors of obligations and liabilities regarding decisions make by the shareholders?
  • Does the shareholders agreement prevail over articles of incorporation and by-laws?
  • Is the business defined?
  • Are the business objectives defined?
  • Are there definitions and principles of interpretation?
  • Confidentiality?
  • List of shareholders and shares owned?

8.2      Decision Making

Which decisions are reserved for shareholders and which for directors? The following illustrates some possible decision.  These are neither recommendations nor advice as to who makes the decisions.

8.2.1     Shareholders

  • Shareholder meetings
    1. How many shareholder meetings per year?
  • Are there shareholder representatives and can those representatives bind the shareholders?
  • What is quorum for shareholder meetings? Does the quorum consider any required representation from each shareholder?
  • Do decisions of the shareholder representatives need to be unanimous?
  • What decisions are reserved for shareholders?
    1. Changes to the shareholders agreement?
    2. Changes to capital?
    3. Changes to board size?
    4. Material changes to the business and business objectives?
    5. Mergers or acquisitions?
    6. Sale of the company or major assets?
    7. Going public via IPO or direct listing?
    8. Major financing?
    9. Approval of any contracts which limit the decision-making authority of the shareholders?
    10. Appointment of auditors?
    11. Appointment, termination, and compensation of CEO?

8.2.2     Board of Directors

  • What happens if one of the directors dies or is incapacitated?
  • Do specific stakeholders have the right to appoint a certain number of directors?
  • Do founders have certain rights to nominate certain number of directors?
  • Is the process for appointing board chair defined?
  • How is director compensation (if any) set?
  • What is the minimum number of yearly board meetings?
  • What is the process for calling an emergency board meeting?
  • What is board meeting quorum? What quorum requirements exist regarding director(s) nominated by each stakeholder?
  • How many directors are required to approve a resolution?
  • What are the specific decisions reserved for the board of directors, if any?
    1. Approval of strategic/business pans and related budgets? If so, what must be in these documents?
    2. Approval of material modifications to strategic/business plans and budgets?
    3. Appointment, termination, and compensation of all officers, other than the CEO?
    4. Financing?
    5. Capital expenditures?
    6. Dividends or other return of capital?
    7. Material accounting or tax policies?
    8. What committees, if any, of the board exist?
    9. What are the key responsibilities of each committee?
    10. How is the composition of each committee determined?
    11. Will the committees have any decision-making authority?
    12. What are the minimum number of yearly committee meetings?

8.3      Sale or transfer of shares

  • What is the process?
  • What are the restrictions?

8.3.1     Forced shareholder exit

  • If a shareholder is an individual, what happens if: shareholder dies, is incapacitated, declares bankruptcy, divorces, etc.
  • If a shareholder is a company, trust, etc. what happens if: there is a change of control, bankruptcy, change in leadership of the other company, etc.

8.3.2     Shotgun provision

  • Is there a shotgun provision? (Usually only for a 50/50 two shareholder situation. Allows shareholder A to buy out shareholder B. After A makes the offer, then shareholder B can buy out shareholder A at the same price.)

8.3.3     Right of first refusal

  • Is there a right of first refusal? (This gives a shareholder the option to purchase the shares of another shareholder before they are sold to a third party.)

8.3.4     Tag-a-long or piggyback

  • Is there a tag-a-long right? (The minority shareholder has the option to block the sale of the majority shareholders, unless minority can sell at the same terms.)

8.3.5     Drag-along rights

  • Are there drag-along rights? (The major shareholder has the option to force the minority shareholders to sell at the same terms)

8.3.6     Option to purchase/call rights

  • Does a shareholder have the option to purchase the shares of another shareholder?
  • What are the terms and conditions?

8.3.7     Option to sell/put right

  • Does a shareholder have the right to force another shareholder to purchase the right holder’s shares?
  • What are the terms and conditions?

8.3.8     Auction

  • If there is a fundamental disagreement among the shareholders, is there an auction process. (Each shareholder would submit sealed bids for the shares in question. The highest bid wins the auction.

8.4      Issuing additional stock or options

  • Who makes decisions regarding the size of the stock option pool and issues of stock options?
  • Do existing shareholders have pre-emptive rights to purchase new shares issued?

8.5      Dispute resolution

  • Is there a dispute resolution process?
  • Is there binding arbitration?
  • How is the arbitrator selected?

8.6      Information Rights

  • What information must the corporation deliver to shareholders by what time?
  • Must the corporation provide to shareholders other financial and business information requested by the shareholders?

8.7      Amending the shareholders agreement

  • Is unanimous shareholder agreement required to amend the shareholders agreement or some percentage of the shareholders?