After high-profile startup failures like FTX or Theranos, investors, employees, customers, and policymakers all ask what might have been done differently to ensure accountability and prevent mismanagement. But startup founders should join that list: It’s in their interest to accept transparency and accountability, especially with regard to their investors. This advice runs counter to some misguided ideas that have become popular within startups — namely, that it’s in a founder’s interest to accept as little oversight as possible. In fact, to maximize the growth and impact of a startup, founders should embrace the accountability that comes from raising outside financing. It will make their company stronger and more trusted.
There is a lot of handwringing and navel-gazing going on in startup land with the denouement of two of the largest scandals the industry has ever seen: Theranos’ Elizabeth Holmes (sentenced to 11 years in prison for fraud) and FTX’s Sam Bankman-Fried (vaporized $32 billion of value through mismanagement and fraudulent accounting).
Yes, investors should be doing more careful due diligence. Yes, startup employees should be more vigilant about blowing the whistle when they see bad behavior. Yes, founders who push the limits — egged on by 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 isn’t being talked about: Founders are actually the ones who should be embracing more transparency and accountability. It is in their interests. And the sooner founders grasp this reality, the better off all of us will be.
Rich and King/Queen?
Unfortunately, during the boom times of the last few years, founders received some pretty bad advice regarding fundraising and investor relations. Specifically:
Raise “party rounds” where no one investor is the lead and thus in a position to hold founders accountable.
Maintain strict control of their board of directors. In fact, ideally, don’t allow any investors on your board.
Insist on “founder friendly” terms that would reduce investor information rights and weaken controls and protective provisions.
Avoid sharing information with your investors for fear of it leaking out to your competitors or the press. Further, your investors might use the information against you in future financing rounds.
Each of these choices may maximize founder 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 a “Rich vs. King/Queen tradeoff,” where founders had a fundamental choice between going big, but giving up control (rich), or maintaining control but aiming smaller (staying king/queen). Wasserman asserted, “Founders’ choices are straightforward: Do they want to be rich or king? Few have been both.”
But when money is cheap and competition to invest in their startups is fierce, founders suddenly had the option to be both. Many of them seized this opportunity and, in doing so, inflicted self-harm by abandoning a fundamental principle of capitalism: agency theory.
Entrepreneurs as Agents for their Shareholders
Managers of a corporation are agents for their shareholders. In Michael Jensen and William Meckling’s famous 1976 scholarly article, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” they point out that corporations are legal fictions that define contractual relationships between the owners of the firm (shareholders) and the managers of the firm regarding decision making and cash-flow allocation.
This principle has been more recently weaponized and politicized due to the tension between purely defined shareholder capitalist (see Milton Friedman’s seminal 1970 New York Times Magazine article) and a more progressive viewpoint known as stakeholder capitalism (see BlackRock CEO Larry Fink’s 2022 Annual Letter).
But wherever you fall in this debate, the fact is that as soon as a founder raises one dollar in financing 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 instead to multiple stakeholders, at that moment they become agents acting on behalf of their shareholders. In other words, they are no longer able to make decisions based solely on their own interests but must now work on behalf of their investors as well and need to act in accordance with this fiduciary duty.
The Upside of Accountability and Transparency
Some founders only see the downside of the accountability and transparency imposed upon them as soon as they take outside money. And, to be fair, there are plenty of horror stories of bad investor behavior and incompetent boards that ruin companies. Fortunately, in my experience, just as fraud in startup land is very rare, those stories are in the vast minority of the thousands and thousands of positive case studies of investor-founder relations. Many founders are realizing the tremendous upside that accountability brings.
Accountability is an important part of a startup’s maturation process. How else can employees, customers, and partners trust a startup to deliver on their promises? The most talented employees want to work for startups and leaders that they can trust, and transparency in all communications and all-hands meetings are a critical component of building and maintaining that trust. Customers want to purchase products from companies that they can rely on — ideally ones that publish and stick to their product roadmaps. Partners want to collaborate with startups that actually do what they say they will do.
The impact of accountability and transparency on future investors is obvious: Investors want to invest in companies they understand and where they have visibility into the inside operations and value drivers, both good and bad. When U.S. regulators made visible the fact that Chinese companies were not as disclosive as their U.S. counterparts before public listings on the NASDAQ or NYSE, it naturally deflated the valuation of those companies.
There is an equally compelling reason for good accounting practices. It provides reliability and control. Researchers have frequently demonstrated that greater transparency — whether amongst countries or companies — leads to greater credibility and thus value. For example, the IMF concluded in a 2005 research paper that countries with more transparent fiscal practices have more credibility in the market, better fiscal discipline, and less corruption.
The Triple-A Rubric
Beyond improved valuations and greater confidence amongst partners, there is an additional upside to being more accountable. My partner, Chip Hazard, recently wrote a blog post on the importance of monthly investor updates and articulated the “Triple-A rubric” of alignment, accountability, and access. Founders report that outside accountability, and the habit of sending out detailed monthly updates, can be a positive forcing function. As one of our founders put it, “The practice of sitting down to send an update builds in internal accountability.”
By being more transparent and accountable, founders can ensure that their employees and investors are fully aligned and in a position to be helpful. If you are candid with your investors on where things stand and your “stay-awake issues,” you will be in a better position to access their help — whether for strategic advice, sales leads, referrals to 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 the firm where a direct and honest culture is practiced in all communications. His book, Principles, expands on radical transparency and this overall business and life philosophy.
Founders should take a page from Dalio’s book and embrace radical transparency with all of their stakeholders, especially their investors. Some defenders of the founders of Theranos and FTX claim that they were perhaps over their heads and inept rather than corrupt. Whatever the case, today’s founders can not only avoid similar pitfalls, but more importantly drive greater alignment, opportunity, and ultimate value if they were to simply embrace accountability and transparency as stewards of others’ capital. In doing so, they will put themselves in a better position to build valuable, enduring companies that make a positive impact on the world.