Startup Board Stress Remains Prevalent

A recent study by the NVCA and Dow Jones VentureSource reveals valuable metrics on VC board behavior, composition and dynamics. In the area of board conflict, one observation from the study begs to be discussed further in the context of the current operating environment: A suggestion that there is strong agreement between VCs and CEOs regarding the key challenges and sources of conflict in the boardroom.

I don’t believe this reflects the reality of the situation because my continuing personal experience and other anecdotal experience from the field shows very little progress in this area.

The level of personality conflicts and stress are unprecedented in the venture-backed company boardroom today. I do not believe that much progress has been made in defining more constructive board dynamics over the past three years. The picture of the VC boardroom in 2009 — forced to cope with a systemic liquidity crisis for VC-backed companies compounded by a sharp recession for these resource-constrained start-ups — is not harmonious.

What the study labels “Executive Management Search/Change” — remains the chief reason for lingering stress. And there IS a lot of stress in these boardrooms.

The fact is that underlying conflicts of interest among VCs, due to economic and strategic misalignments, are now rising to the surface and causing tremendous pressure in the boardroom. The survey reveals that personality conflicts also rank highly when CEOs comment about the sources of conflict with the VCs on their boards. Protecting the management team from further dilution, always high on the agenda of the CEO, often clashes with the agenda of VC backers, especially when a company does not meet its projections and more capital is needed than was originally anticipated. This scenario is repeating itself among venture-backed companies not only in America, but globally, due to the severe impact of the financial crisis on emerging growth companies that lack scale and therefore cannot sustain themselves on internally generated cash flow.

Independent research by Noam Wasserman of the Harvard Business School has documented that approximately two thirds of venture-backed CEOs are replaced before a liquidity event. Consequently, VCs could mitigate the negative impact of board conflict on company harmony by managing expectations between CEOs and VC’s more effectively.

Here are five common early warning signs of trouble in the corner office that I first noted in my 2006 white paper, “Rites of Passage: Managing CEO Transitions in Venture-Backed Technology Companies.”

  • A CEO does not react constructively to board member suggestions, is increasingly inflexible in considering strategic board changes, or stubbornly clings to a plan that is not working.
  • Significant company problems are obvious but the CEO goes into denial, sometimes by seeking seats on outside boards, scheduling frequent vacations, or getting involved in political, community or charitable endeavors. A CEO often missing-in-action because of these activities has usually lost the requisite “fire in the belly” that a venture-backed startup CEO needs.
  • The CEO cuts off the flow of information to the board and typically initiates few calls to board members. Typically, every director should hear from a CEO in advance of board meetings, as well as once or twice a month to celebrate good news, discuss a setback, or simply discuss a basic management issue.
  • A CEO increasingly pleads ignorance of a problem, complaining that other executives did not inform him/her. But the CEO doesn’t present a clear case and a plan to remedy the situation or tries to throw problems back in the board’s lap.
  • A CEO starts referring inquiries from board members to other executives as a loyalty test, putting out the word that no executive is to communicate with a board member without first getting approval from the CEO. It’s a red flag when subordinate executives give board members scripted, vague answers when asked questions.

One reason these red flags crop up relatively often is that interests among venture capitalists on the board and other directors are often misaligned. Frequently, the seed round VC who recruits or makes a bet on the founding management team, a bet often forged in friendship and loyalty, has an interest in maintaining his or her relationship with the CEO. Unfortunately, these relationships are different from those between top management and independent directors and other VCs who join the board in later rounds. During stressful times, CEO’s are even more protective of their “turf” as they see the anxiety coming from the investors and don’t want to provoke intrusions into what they feel is their domain as CEO. This is a common CEO response – and it is rooted in distrusting that the board will really make the right decision for the company.

Conflict also emerges between the investors and the CEO because the board will tend to focus on achieving immediate results rather than a deeper understanding of the fundamentals of the organization. Boards often lack clarity in answering a fundamental question: “Do we have the right strategy?” Why? Because the CEO wants “hands-off”, and the board doesn’t have time to do the deep dive.

This problem can be resolved. First, VC boards must become more involved and more challenging in the way they address the longer-range view of the company’s strategy. This can start by having the board ask a different question of the CEO: “Where will our actions today lead us tomorrow, and what are the implications of those actions?” In order to do this, VCs have to first learn to work better together through more frequent communication, both in and out of the boardroom. Venture capitalists must master the art of compromise in the boardroom and focus on the real goal – maximizing the odds of success of their startups. This is especially true in today’s difficult environment and is imperative as VCs face another difficult year in 2010. I continue to encourage all of the board members with whom I work to do this, and I hope my peers on other boards will do the same.

Pascal Levensohn is the Founder & Managing Partner of Levensohn Venture Partners (LVP). Founded in 1996, LVP manages $200 million and invests in emerging companies in the area of Intelligent Infrastructure, specializing in Security, Cleantech, and Digital Media. Mr. Levensohn currently serves on five portfolio company boards, including one NASDAQ public company. Read his past peHUB posts here