A couple weeks ago I was contacted by a recent graduate of Duke’s Fuqua School of Business, Gabby Bashist, who is advising founder of MomBox, Kate Westervelt, on a fundraising strategy for the early-stage venture. They wanted to know if there was a way to include a code of conduct clause requirement for their investors. The question sparked a lot of dialogue, including a conversation with integrity and ethics expert Robert Chesnut, author of Intentional Integrity: How Smart Companies Can Lead An Ethical Revolution. The fact there was no quick and simple resolution for this question indicated to me that it merits more discussion.
Publicly traded companies are required to have a code of conduct. And those companies have been requiring employees to sign a code of contact clauses for decades; however, no such requirement exists for investors in startups despite the important role they may play as board members. Not only do board members make important strategic decisions that dictate the future of the startup, they are often a visible embodiment of that startup’s brand. Given this important bilateral relationship, why is it that they are not held to the same basic standard as the CEO of a publicly traded company?
In short, it’s complicated. But mostly, it’s because such a code of conduct clause is not “the norm.”
Let’s start with why it’s complicated. Even if you were to find individual investors, e.g. angel investors, that were willing to sign a code of conduct agreement, challenges emerge when you consider how to structure it. For example, using a stock buy-back clause that is triggered by bad-behavior runs the risk of rewarding a poorly-behaving investor with early liquidity at the expense of the well-behaved investors and the determent of the startup.
What about for institutional investor like venture funds? Given the fact this clause is not part of what have become the “industry standards,” it is likely that the startup will face an uphill battle to get any firm to agree to such a clause. After all, who is really in power in this scenario?
Additionally, for both individual investors and institutional investors, the addition of a code of conduct agreement or clause introduces a slew of follow on questions including: Who gets to decide what is morally in and out of bounds? What does the moral clause state and what conduct triggers it? Who decides if the moral clause has been violated?
Given this, what options do founder have to avoid being affiliated with bad actors?
Start by being extremely careful from whom you take money. Make certain you, the founder, are conducting reserve due diligence on your investors. Most founders are so anxious to get the money that they don’t think about what happens if this person ends up being a bad actor and quickly accepts any investment offer. Instead, as a founder you should slow down and understand if the investor is aligned with your vision and values. In the long run you and your startup will be better off accepting a lower valuation with a better investor than taking a higher valuation with a bad investors; this is true regardless of a code of conduct clause.
Second, it has been suggested that founders conduct formal background checks on their investors. If you are considering accepting an investment from anyone outside of your network or someone that you feel unease about, then this may be an option to consider.
But, if you want to start driving change, after all, change has to start with somewhere, then consider introducing a narrowly defined code of conduct clause, such as requiring any board member that is convicted of a felony to be removed and replaced. I would hope that we could all agree that in such a case it would be in the best interest of the startup not to have an active affiliation with that investor. In the case of an institutional investor, the board member could be replaced with a representative from the same investment firm. In the case of an individual investor, the replacement mechanism would need to be outlined in the agreement, but options exist, including:
a) The remaining board members identify and appoint an unaffiliated representative;
b) The individual who is removed proposes three names with the final decision being voted on by the remaining board members; or
c) The two parties use a third-party arbitrator to identify a replacement.
While none of the outlined options are simple, the only way the norm will change is if founders take a stand and demand more from their investors. I dare you to join Gabby and Kate of MomBox and change the rules! Let your investors know that you and your startup demand better — it’s not just about money but about the relationship you are forming to build a company that expects more from every member of the team.