Why Startups Should Embrace Radical Transparency

After the failure of a high-profile startup like FTX or Theranos, investors, employees, customers, and policymakers ask what could have been done differently to ensure accountability and prevent mismanagement. But startup founders should be on that list: it’s in their best interest to accept transparency and accountability, especially when it comes to investors. This advice goes against a common misconception within startups, namely that it’s in the founder’s best interest to accept as little oversight as possible. In fact, to maximize a startup’s growth and impact, founders should embrace the responsibility that comes with raising external funding. Their company will be stronger and more reliable.

They are looking at the hands and navel the starting ground with the end of two of the biggest scandals the industry has ever seen: Theranos’ Elizabeth Holmes (11 years in prison for fraud) and FTX’s Sam Bankman-Fried (who evaporated $32 trillion in value through mismanagement and fraudulent accounting).

Yes, investors should do more careful due diligence. Yes, startup employees should be vigilant enough to blow the whistle when they see bad behavior. Yes, creators who push boundaries – encouraged by a permissive culture of “fake it ’til you make it” and “move fast and break things” – should be held more accountable.

But here’s what is not being talked about: creators are precisely the ones who should take more transparency and responsibility. It is in their interest. And the sooner creators understand that reality, the better off we’ll all be.

Rich and king/queen?

Unfortunately, during the boom of the past few years, founders received some pretty bad advice on fundraising and investor relations. Exactly:

  • Raise “party rounds” where no one investor is the lead and thus hold the founders accountable.
  • Maintain strict control of their board of directors. In fact, ideally, leave no investors on your board.
  • Insist on “creator-friendly” terms that will curtail investors’ information rights and weaken controls and safeguards.
  • Avoid sharing information with your investors for fear of leaking it to your competitors or the press. Additionally, your investors may use the information against you in future funding rounds.
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Each of these options can maximize creator control, but at the expense of long-term value potential and, ultimately, success.

Many years ago, my former colleague at Harvard Business School, Professor Noam Wasserman, articulated a “Rich vs. King/Queen trade-off,” where founders had a key choice between going big but giving up control (wealthy), or keeping control but having purpose. . smaller (remain king/queen). Wasserman said: “The founders’ choices are straightforward: do they want to be rich or king? There have been few of both.”

But when money is cheap and the competition to invest in startups is fierce, founders suddenly had the opportunity to be both. Many of them seized this opportunity and thereby caused self-harm by abandoning a fundamental principle of capitalism: agency theory.

Entrepreneurs as agents for their shareholders

The managers of a corporation are agents of the shareholders. In the famous 1976 scholarly article by Michael Jensen and William Meckling, “The Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” point out that corporations are legal fictions that define the contractual relationship between the company’s owners (shareholders) and the company’s managers regarding decision-making and the allocation of cash flows.

This principle has recently been weaponized and politicized due to the tension between the pure shareholder capitalist (cf Milton Friedman’s 1970 New York Times The magazine article) and a more progressive perspective known as stakeholder capitalism (see BlackRock CEO Larry Fink Letter of the year 2022).

But wherever you fall on this debate, the point is that as soon as a founder raises a dollar of funding for a claim on their cash flow, they become accountable to someone other than themselves. Whether you think their duty is only to investors or instead to multiple stakeholders, at that point they become agents acting on behalf of shareholders. In other words, they are no longer able to make decisions based solely on their own interests, but must now also work on behalf of their investors and act according to that fiduciary duty.

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For responsibility and transparency

Some founders only see the downside of the imposed accountability and transparency 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, just as fraud is extremely rare in startup land, those stories are in the vast minority of the thousands and thousands of positive case studies of relationships between investors and founders. Many creators are realizing the enormous benefit that accounts bring.

Accountability is an important part of a startup’s maturation process. How else can employees, customers, and partners trust a startup to deliver on its promises? Top talent employees want to work for startups and leaders they can trust, and transparency in all communications and all-hands meetings is a critical component to building and maintaining that trust. Customers want to buy products from companies they can trust, preferably ones that post and stick to product roadmaps. Partners want to collaborate with startups that actually do what they say.

The impact of accountability and transparency on future investors is obvious: investors want to invest in companies they understand and where they can see the inner workings and value drivers, both good and bad. When US regulators made it visible to Chinese companies they were not as informative as their US counterparts Before the public listings of NASDAQ or NYSE, it naturally deflated the valuation of these companies.

There is a similar reason for good accounting practices. It offers reliability and control. Researchers have often demonstrated that greater transparency—between countries or companies—leads to greater credibility and therefore value. For example, the IMF a 2005 research work Countries with more transparent fiscal practices are known to have more credibility in the market, better fiscal discipline and less corruption.

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Triple-A rubric

In addition to improving ratings and greater trust between partners, having more responsibility has the added benefit of being more accountable. My partner, Chip Hazard, recently wrote one blog post He articulated the importance of monthly investor updates and the “triple A rubric” of alignment, accountability and access. According to the founders, it can be a positive function to enforce external accountability and the habit of sending detailed monthly updates. As one of our founders said, “The practice of sitting down to post an update is based on internal accountability.”

By being more transparent and accountable, founders can ensure that their employees and investors are fully aligned and in a position to help. If you’re clear with your investors about where things stand and your “waking issues,” you’ll be in a better position to get their help, whether it’s for strategic advice, sales pipelines, talent referrals, or partnership opportunities.

Creators and Radical Transparency

Bridgewater’s Ray Dalio coined the phrase “radical transparency” as a philosophy to describe his operating model at the company, which cultivates a culture of fairness and honesty in all communications. His book, The principlesIt spreads that radical transparency and general philosophy of business and life.

Founders should take a page from Dalio’s book and embrace radical transparency with all of their stakeholders, especially investors. Some defenders of Theranos and FTX’s founders say that maybe they were just in over their heads and corrupt. In any case, today’s founders cannot avoid similar pitfalls, but more importantly, drive greater alignment, opportunity, and ultimate value if they must embrace accountability and transparency as stewards of others’ capital. In this way, they will be in a better position to build valuable and sustainable companies that have a positive impact on the world.

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