Why Startups Should Embrace Radical Transparency

After large-scale startup failures 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 join the list: it’s in their best interest to accept transparency and accountability, especially with their investors. This advice goes against some of the misconceptions that have become popular in startups, namely that it is in the founder’s best interest to accept as little oversight as possible. In fact, to increase the growth and impact of a startup, founders should take on the responsibility that comes with raising external funding. This will make their company stronger and more reliable.

Lots of hand wringing and navel gazing going on starting land ended two of the biggest scandals the industry has ever seen: Theranos’ Elizabeth Holmes (sentenced to 11 years in prison for fraud) and FTX’s Sam Bankman-Fried ($32 billion in value evaporated due to mismanagement and fraudulent accounting).

Yes, investors should do more due diligence. Yes, new recruits should be more careful about blowing the whistle when they see bad behavior. Yes, founders who violate the constraints of a permissive culture of “fake it until you make it” and “move fast and break things” should be held more accountable.

But here’s what’s not being talked about: founders are actually the ones who should be taking on more transparency and accountability. It is in their interest. And the sooner founders realize this 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. Specifically:

  • Increase “party rounds” where no investor is the lead and thus founders can be held accountable.
  • Maintain tight control over your board of directors. In fact, ideally don’t allow any investors on your board.
  • Insist on “founder-friendly” rules that would reduce investors’ rights to information 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 this information against you in future funding rounds.
Also Read :  Let youth create wealth | Inquirer Opinion

Each of these choices can increase the founder’s control, but at the expense of long-term value potential and ultimately success.

Many years ago, my former Harvard Business School colleague, Professor Noam Wasserman, articulated the “Rich vs. King/Queen” trade-off, where founders had a fundamental choice between being big but giving up control (wealthy) or staying in control but aiming. smaller (remains king/queen). Wasserman argued, “The choice for founders is simple: do they want to be rich or a king? Few have been both.

But when money is cheap and the competition to invest in new companies is fierce, founders suddenly had the opportunity to be both. Many of them seized this opportunity and in doing so harmed themselves by abandoning a fundamental principle of capitalism: agency theory.

Entrepreneurs as agents of their shareholders

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

This principle has been weaponized and politicized in recent times due to tensions between purely defined shareholder capitalists (see Milton Friedman’s performance in 1970 New York Times Magazine script) and a more progressive view known as stakeholder capitalism (see BlackRock CEO Larry Fink 2022 letter).

But wherever you fall on this debate, the fact is that once a founder raises one dollar of funding in exchange for one claim on their cash flow, they are accountable to someone other than themselves. Whether you believe their duty is solely to investors or to multiple stakeholders, at that point they become agents acting on behalf of their shareholders. In other words, they can no longer make decisions based solely on their own interests, but must now also work on behalf of their investors and act in accordance with this fiduciary duty.

Also Read :  15 Wanita Paling Kuat di Startup Tahun 2022

The flip side of accountability and transparency

Some founders see only the negative aspects of accountability and transparency that are imposed on them once they take outside money. And frankly, 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, these stories are in the minority among the thousands and thousands of positive investor-founder relationship case studies. Many founders realize the huge upside that comes with accountability.

Accountability is an important part of the startup maturation process. How else can employees, customers, and partners trust a startup to deliver on its promises? Top talent wants to work for startups and leaders they can trust, and transparency in all communications and all-hands meetings is a critical part of building and maintaining that trust. Customers want to buy products from companies they can trust – ideally ones that publish and adhere to their product guides. Partners want to work with startups that actually do what they say they will do.

The implications of accountability and transparency for future investors are obvious: Investors want to invest in companies they understand and have visibility into the inner workings and drivers of value, good or bad. When US regulators made visible the fact that Chinese companies were not as open as their US counterparts before public listings on the NASDAQ or NYSE, this naturally reduced the valuation of those companies.

There is an equally compelling reason for good accounting practice. It provides reliability and control. Researchers have often shown that greater transparency—both between countries and between companies—leads to greater trust and thus value. For example, the IMF concluded a 2005 research paper that countries with more transparent fiscal practices have more credibility in the market, better fiscal discipline and less corruption.

Also Read :  Team Cleaningly mengakhiri Sesi Pendidikan Eksekutif Wharton baru-baru ini tentang Program Akselerasi Kewirausahaan

Triple A rubric

In addition to improved evaluations and greater trust among partners, there is another advantage of increased accountability. My partner Chip Hazard recently wrote a blog post on the importance of monthly investor updates and formulated a “Triple-A Rubric” for alignment, accountability and access. Founders report that external accountability and the habit of sending detailed monthly updates can be a positive coercive feature. As one of our founders said, “The practice of sitting down to send 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 able to be useful. If you’re open with your investors about the situation and your “staying awake” issues, you’ll have a better chance of accessing their help—whether it’s strategic advice, sales leads, talent, or partnership opportunities.

Founders and Radical Transparency

Ray Dalio of Bridgewater famously coined the phrase “radical transparency” as a philosophy to describe his operating model at a company that practices a culture of directness and honesty in all communications. his book, Principlesextends radical transparency and this general philosophy of business and life.

Founders should take a page from Dalio’s book and practice radical transparency with all stakeholders, especially investors. Some defenders of Theranos and FTX founders argue that they may have been in over their heads and not corrupt. Regardless, today’s founders can not only avoid similar pitfalls, but more importantly, foster greater alignment, opportunity, and superior value if they simply embrace accountability and transparency as stewards of others’ capital. By doing so, they will put themselves in a better position to build valuable, sustainable businesses that positively impact the world.

Source

Leave a Reply

Your email address will not be published.