After high-profile startup failures like FTX or Theranos, investors, employees, customers, and policymakers ask what could have been done differently to ensure accountability and prevent mismanagement. However, startup founders should join this list: It is in their interest to embrace transparency and accountability, especially with respect to their investors. This advice goes against some of the misguided ideas that have become popular among startups—namely, that it’s in the founder’s best interest to accept as little oversight as possible. To maximize a startup’s growth and impact, founders should embrace the responsibility that comes with raising external funding. This will make their company stronger and more trustworthy.
There’s a lot of hand squeezing and navel gazing going on starting country with the unraveling of two of the biggest scandals the industry has ever seen: Elizabeth Holmes of Theranos (sentenced to 11 years in prison for fraud) and Sam Bankman-Fried of FTX (wiping out $32 billion in value through mismanagement and fraudulent accounting).
Yes, investors should do more careful due diligence. Yes, entry-level employees should be more cautious when they see bad behavior. Yes, founders who push the limits—enforced by a permissive “fake it ’til you make it” and “move fast and break things” culture—should be held more accountable.
But here’s what’s not being talked about: Founders are actually the ones who should be accepting more transparency and accountability. It’s in their interest. And the sooner founders understand this reality, the better off we’ll all be.
Rich and King/Queen?
Unfortunately, during the boom times of the last few years, founders were given some pretty bad advice on fundraising and investor relations. Specifically:
- Have “party rounds” where no investor is in the lead and therefore in a position to hold the founders accountable.
- Maintain tight control over their board of directors. In fact, ideally, don’t let any investors on your board.
- Insist on “founder-friendly” terms that would limit investors’ information rights and weaken controls and safeguards.
- Avoid sharing information with your investors for fear that it might be leaked to your competitors or the press. Furthermore, your investors may use the information against you in future funding rounds.
Each of these options can maximize founder control, but at the expense of long-term value potential and ultimately success.
Many years ago, my former colleague at Harvard Business School, Professor Noam Wasserman, formulated the “rich vs. kings and queens trade-off,” where founders had a crucial choice between becoming big but giving up control (the rich) or staying in control , but will focus on smaller ones (remain king/queen). Wasserman argued, “The choice for founders is straightforward: Do they want to be rich or kings? Few were both.”
But when money is cheap and the competition to invest in their startups is fierce, founders suddenly have the opportunity to be both. Many of them took this opportunity to self-harm by abandoning the basic tenet of capitalism: agency theory.
Entrepreneurs as proxies for their shareholders
The managers of a corporation are agents for their shareholders. In a famous 1976 scholarly paper by Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” point out that corporations are legal fictions that define contractual relationships between the firm’s owners (shareholders) and the firm’s managers regarding decision-making and the allocation of cash flows.
This principle has recently been rearmed and politicized due to the tension between the purely defined shareholder capitalist (see Milton Friedman’s Key Year 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 on this debate, the fact is that once a founder receives one dollar of funding in exchange for one claim to their cash flow, they are accountable to someone other than themselves. Whether you believe their duty is solely to investors or instead to multiple shareholders, at that point they become agents acting on behalf of their shareholders. In other words, they can no longer make decisions solely based on their own interests, but must now also work on behalf of their investors and act in accordance with this fiduciary duty.
The advantage of accountability and transparency
Some founders only see the downside of accountability and transparency imposed on them once they take 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 scams are very rare in startup land, these stories are in the absolute minority of the thousands and thousands of positive case studies of investor-founder relationships. Many founders realize the huge advantage that accountability brings.
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? The most talented employees want to work for startups and leaders they can trust, and transparency in all communications and all 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 stick to their product plans. Partners want to work with startups that actually do what they say they will do.
The impact of accountability and transparency on future investors is clear: Investors want to invest in companies they understand and where they have visibility into the internal operations and values, both good and bad. When US regulators made visible the fact that Chinese companies they were not as open as their American counterparts prior to public listings on the NASDAQ or NYSE naturally reduced the valuations of these companies.
There is an equally compelling reason for good accounting practices. It provides reliability and control. Researchers have often shown that greater transparency—whether between countries or companies—leads to greater trust and, therefore, value. For example, the IMF concluded va 2005 research paper that countries with more transparent fiscal practices have greater market credibility, better fiscal discipline and less corruption.
In addition to better appreciation and greater trust between partners, there is another benefit to greater accountability. My partner, Chip Hazard, recently wrote a blog post on the importance of monthly updates to investors and the formulation of a “Triple-A rubric” on compliance, accountability and access. Founders report that external accountability and the habit of sending detailed monthly updates can be a positive enforcement function. As one of our founders said, “The practice of sitting down and submitting an update creates internal accountability.”
With more transparency and accountability, founders can ensure that their employees and investors are fully compliant and able to be helpful. If you’re honest with your investors about where things stand and your “trouble staying up,” you’ll be in a better position to access their help—whether it’s strategic advice, leads, talent referrals, or partnership opportunities.
Founders and radical transparency
Bridgewater’s Ray Dalio famously coined the phrase “radical transparency” as a philosophy to describe his operating model at a firm where a culture of directness and honesty applies to all communications. his book Principlesextends radical transparency and this overall business and life philosophy.
Founders should take a page from Dali’s book and embrace radical transparency with all their stakeholders, especially their investors. Some defenders of the founders of Theranos and FTX say they may have been in over their heads and more inept than corrupt. Be that as it may, today’s founders can not only avoid similar pitfalls, but more importantly, achieve greater alignment, opportunity, and bottom line value if they simply embrace accountability and transparency as stewards of foreign capital. This puts them in a better position to build valuable and lasting companies that have a positive impact on the world.