When investors look into potential investment targets, they assess whether they’ll need to waste time and energy on fixing problems caused by someone else. Any team hurdles or discord between the core employees? Those need to be resolved at all costs before the situation escalates.
“The longer founders wait to resolve their mess, the bigger the issue. It improves their position at a roundtable if that table is clean and any issues are mitigated,” says Vit Hanus, Partner at
ZGC.
Bad leavers
In our previous blog, we’ve talked about contractual precautions that discourage the so-called “bad leavers”. These are the key people who leave startups in a damaging way, which could be anything from breaching their contract to fraud, poor results, or misconduct.
Whether a company has strict contracts in place or not, all imminent threats should be resolved before investors join the conversation. A problematic founder or a core employee should be already out of the door; otherwise, they are a possibly unacceptable risk for the investor.
“Defining decisions about the team should be made before investors join the negotiations, not after. If any doubts arise later in the process, the damage is done, and it might be too late to believe in strong and decisive founders,” Hanus explains.
Free-riders
Free-riders are a burden that no company should carry, let alone startups with limited resources. Remember the high school projects where everyone got an A, but one of the kids barely lifted a finger? The startup equivalent is a free-rider – a team member who initially contributes to the venture’s success but gradually loses interest or capacity. There’s nowhere to hide in a small team, and a free-rider quickly becomes a blatant dead weight.
That’s especially tricky if they already have equity despite their progressing lack of added value, and their contract doesn’t allow an elegant way out. That’s why founders should always have reverse vesting in place. In that case, shareholders can only continue holding their shares in specified proportions over a specific period of time. In other words, free-riders need to return the portion of shares which they do not deserve, as they had not served the expected value over the expected duration of time. To sum it up: a free-rider is a severe red flag for any investor.
“Investors invest money into founders – into their time and effort. Not into their original idea and remaining share value,” reminds Dusan Duffek, Partner at ZGC.
Buy-outs
Suppose co-founders get along well and can “break up” amicably through a buyout – great! But more often than not, it’s not that simple. If the two parties can’t reach a mutually satisfactory agreement, things can get ugly and very, very expensive.
“No investor wants to deal with eventual buy-outs of founders on behalf of an arguing or a fragmented team. Investors invest into the growth of the company, development of product, expansion and contributing team members, not into buy-outs or leavers,” says Duffek.
Such a situation would be a headache, especially if the person planning to say goodbye were instrumental to the team. Sometimes the leavers don’t care about the financial blow they’ll cause to the company and push for cashing in as much as possible. This behavior will not convince the investor to invest, but rather motivate them to walk out and let both company and founders fall. We’ve said it once, and we’ll say it again: the clearer the contracts, the less trouble along the way. Both for the startup and (potential) investors.