After high-profile startup failures like FTX or Theranos, investors, employees, customers, and policymakers are all asking what could have been done differently to secure accountability and prevent mismanagement. But startup founders should join this list: it’s in their interest to accept transparency and accountability, especially to their investors. This advice goes against some misconceptions that have become popular among startups, namely that it is in a founder’s interest to accept as little oversight as possible. In fact, to maximize a startup’s growth and impact, founders must embrace the responsibility that comes with raising outside funds. This will make their business stronger and more reliable.
There’s a lot of hand twisting and navel-gazing in starting ground with the unraveling of 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 (vaporized $32 billion in value through bad management and fraudulent accounting).
Yes, investors should do more careful due diligence. Yes, employees of startups should be more vigilant and not speak out when they see bad behavior. Yes, founders who push the envelope—encouraged by a permissive culture of “fake it until you get it” and “move fast and break things”—should be held more accountable.
But here’s what we’re not talking about: Founders are actually the ones who should embrace more transparency and accountability. It is in their interest. And the sooner the Founders grasp this reality, the better off we will all be.
Rich and King/Queen?
Unfortunately, during the boom times of the past few years, founders have received some very bad advice regarding fundraising and investor relations. Specifically:
- Organize “rounds” where no investor is the lead and therefore able to hold the founders accountable.
- Maintain strict control of their board of directors. In fact, ideally, don’t allow any investors to sit on your board.
- Insist on “founder-friendly” terms that would reduce investors’ rights to information and weaken controls and safeguards.
- Avoid sharing information with your investors lest it be leaked to your competitors or the press. Additionally, your investors could use the information against you in future funding rounds.
Each of these choices can maximize founder control, but at the expense of potential long-term value and, ultimately, success.
Many years ago, my former Harvard Business School colleague, Professor Noam Wasserman, articulated a “rich vs. king/queen trade-off,” where the founders had a fundamental choice between going big, but giving up control (rich ), or keep control but aim for smaller (remaining king/queen). Wasserman said, “The founders’ choices are simple: Do they want to be rich or kings? Few have been both.
But when money is cheap and the competition to invest in their startups is fierce, founders suddenly had the opportunity to be both. Many of them seized this opportunity and, in the process, inflicted self-harm on themselves by abandoning a fundamental principle of capitalism: the theory of agency.
Entrepreneurs as agents of their shareholders
The managers of a company are the agents of their shareholders. In the famous scientific paper by Michael Jensen and William Meckling from 1976, “Theory of the firm: managerial behavior, agency costs and ownership structure”, they point out that corporations are legal fictions that define the contractual relationships between the owners of the company (shareholders) and the managers of the company with regard to decision-making and the allocation of cash flows.
This principle has more recently been militarized and politicized due to the tension between purely defined capitalist ownership (see Milton Friedman’s seminal 1970 New York Times Magazine article) and a more progressive view known as stakeholder capitalism (see BlackRock CEO Larry Fink Annual letter 2022).
But wherever you are in this debate, the fact is that as soon as a founder raises a dollar of funding in exchange for a claim on their cash flow, they are accountable to someone other than them- same. Whether you think their duty is solely to investors or rather to multiple stakeholders, then 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 also work on behalf of their investors and must act in accordance with this fiduciary duty.
The benefits of accountability and transparency
Some founders only see the downside of the accountability and transparency imposed on them as soon as they take on outside money. And, to be fair, there are plenty of horror stories about bad investor behavior and incompetent boards ruining companies. Fortunately, in my experience, just as fraud in startups is very rare, these stories are in the vast minority of the thousands upon thousands of positive investor-founder relationship case studies. Many founders realize the huge benefit that accountability brings.
Accountability is an important part of a startup’s maturation process. Otherwise, how can employees, customers, and partners trust a startup to deliver on their promises? The most talented employees want to work for startups and leaders they can trust, and transparency in all communications and general meetings is an essential part of building and maintaining that trust. Customers want to buy products from companies 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 internal operations and drivers of value, good and bad. When US regulators made visible the fact that Chinese companies were not as revealing as their American counterparts before public listings on NASDAQ or NYSE, this naturally deflated the valuation of these companies.
There is an equally compelling reason for good accounting practices. It offers reliability and control. Researchers have often demonstrated that greater transparency, whether between countries or companies, leads to greater credibility and therefore greater value. For example, the IMF concluded in a research paper 2005 that countries with more transparent budget practices have more market credibility, better budget discipline and less corruption.
The Triple-A rubric
Beyond improved valuations and greater trust between partners, there is an added benefit to being more accountable. My partner, Chip Hazard, recently wrote a blog post on the importance of monthly updates for investors and articulated the “Triple-A Rubric” of alignment, accountability and access. The founders report that outside accountability and the habit of sending detailed monthly updates can be a positive forcing function. As one of our founders said, “The practice of sitting down to send an update builds internal accountability.”
By being more transparent and accountable, founders can ensure their employees and investors are fully aligned and able to help. If you’re upfront with your investors about the state of affairs and your “watch issues,” you’ll be in a better position to access their help – whether it’s for strategic advice, sales leads, talent referrals, or partnership opportunities.
Founders and radical transparency
Ray Dalio of Bridgewater coined the phrase “radical transparency” as a philosophy to describe his operating model within the company where a direct and honest culture is practiced in all communications. His book, Principlesdevelops radical transparency and this holistic philosophy of business and life.
Founders should take inspiration from Dalio’s book and embrace radical transparency with all their stakeholders, especially their investors. Some defenders of Theranos and FTX founders argue that they may have been in over their heads and incompetent rather than corrupt. Either way, today’s founders can not only avoid similar pitfalls, but more importantly foster greater alignment, opportunity, and ultimate value if they simply embrace accountability and transparency as stewards of the capital of others. By doing so, they will put themselves in a better position to build valuable and lasting businesses that have a positive impact on the world.
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