Several more real costs of taking outsider investments.

Let’s talk about the reality of taking money from professional investors.  It is not the first time we’ve covered this general subject nor the last. But this time, we concentrate upon governance changes.

Once a company founder has tapped the funds available from his or her resources and from friends and family, if the company needs more cash for growth, the most obvious next step is to look for money from angel investors and venture capitalists, typically in the $300,000 TO $3,000,000 range.

This money comes with restrictions a founder may not expect, including restrictions upon the sale of founder stock, clauses that require the investor be allowed to sell an equal proportion of stock upon any other person’s sale of stock, anti-dilution provisions that protect the investor from a subsequent offer of stock at a lower price, and much more.

Almost always, professional investors, including angel groups and venture capitalists, also require at least one seat on the corporate board.  The investor organization is granted the seat as long as the investment remains, and the documents often name the first representative assigned by the investor group to the position.

[Email readers, continue here…] In later insights, we will explore the legal and ethical responsibilities of board members.  But the intent of these “forced” placements of a representative on the board is obviously to watch over the company’s use of invested funds and to help grow the company in value.  The combination of restrictive covenants in the investor documents and the new dynamic of board members with an agenda make for a change in the culture of the corporation, certainly one for the CEO.

However, outside professional investor board members can be a very good asset to the corporation with the skills, experience and broad relationships many bring to the boardroom table.

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5 Responses to Several more real costs of taking outsider investments.

  1. Michael O'Daniel says:

    They can also force the company into directions that are counterproductive to its growth and its financial health. I’ve worked in two companies that were leaders in their market space until investor board members insisted that they pursue “opportunities” that turned out to be pipe dreams. Cautionary tale: the agenda the investor brings to the boardroom is not necessarily the one you’ll wind up with once that investor begins influencing corporate decisions, compounded by the fact that said investor may not really be all that knowledgeable about the market.

  2. Michael O'Daniel says:

    And, I should add, knowledgeable about the company’s capabilities to follow the path the investor thinks it should take.

  3. Dave Berkus says:

    Michael,

    I have had the identical experience with a VC investor dictating the direction of a company that was profitable and growing, but not enough for the fund he represented. His “suggestions” turned out to be received by the board and CEO as “orders” and ultimately killed a good company that could have continued it growth profitably for years. I am sure many readers have similart stories. Thanks for yours. – Dave

  4. Michael O'Daniel says:

    One of the points at which companies are most vulnerable is when another round of funding is required to keep the company afloat, and in particular when original investors are being asked to take a cram-down in their valuations.

  5. Michael O'Daniel says:

    However, none of these considerations can compare with doing marketing for a CEO who thought our primary marketing strategy should be delivering baskets of fruit to neighboring businesses. I am not making this up. Happy New Year!

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