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What's New in the Expanded "A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors"?

Today the Working Group on Director Accountability and Board Effectiveness released an expanded version of "A Simple Guide...".  The new material covers three main areas--

Details on how to conduct a board peer review; a process outline for conducting an annual CEO review; and how and why you need to consider internal controls (particularly as an audit committe) at the same time that you are considering governance process implementation.

We also expanded the section on the importance of having aligned interests around the board table-- both economic and strategic, outlining some of the key questions that need to be discussed to get to the bottom of these thorny issues. 

If you've read the paper before, the bulk of the new material is on the following pages:

How to Achieve an Aligned and Effective Board-- page 4

Development Stage, Governance Process, and Internal Controls-- pages 6 -9

How to Evaluate Your Own Participation on the Board-- page 19

How to Conduct an Annual CEO Performance Review-- page 20

How to Conduct an Annual Board Peer Review-- page 21

Comfortably Numb? Death by Board Meeting

When I was a child I caught a fleeting glimpse,
Out of the corner of my eye.
I turned to look but it was gone.
I cannot put my finger on it now.
The child is grown, the dream is gone.
I have become comfortably numb.

Pink Floyd, Comfortably Numb, The Wall, 1979

In VentureBeat today, Nick Sturiale of Sevin Rosen writes an important editorial on ineffective board meetings.

"Death by Board Meeting" makes several important points about how to optimize board meetings-- the core link between all of them is the need for thoughtful process to be in place in order to make the board meeting valuable for all participants.

Defaulting to board meetings that emphasize form over substance-- allowing directors to  arrive unprepared and CEOs to emphasize operational reports as opposed to engaging in strategic discussions-- points to a deeper problem of failed communication.

If your board meeting turns into a waste of time, it is incumbent on both the management and the VCs to proactively change this dynamic.  Unfortunately the substance of this excellent editorial is unlikely to be a surprise to many VC company boards that are driven by inertia.  The question is, will they notice and do something about it?

New Podcast Program-- Masters of DLP (Data Loss Prevention)

One of our portfolio companies, Reconnex, which is one of the leading providers of DLP solutions, has launched a new podcast series, Masters of DLP, interviewing customers on the security challenges that they face from within their organizations.  Some of the questions addressed by the likes of Randy Barr, Webex CSO, and Tom Bowers of Security Constructs include:

What is Data Loss Prevention or Protection (DLP) and why do I need a DLP solution? What are some of the common problems when deploying a DLP solution? What business benefits will I experience from a DLP solution?

Reconnex tackles these and other important DLP questions head-on in this series of interviews and editorial commentary. Each episode makes clear recommendations about best practices that can be useful to anyone deploying or thinking about a DLP solution.

The content is worth listening to.

VCs Need to Focus on How the Jockey Rides the Horse

Last week in PE Hub Dan Primack reported on a recent white paper, “Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies”.  In this paper, Professors Steven N. Kaplan (University of Chicago), Berk A. Sensoy (USC), and Per Stromberg (Stockholm Institute of Financial Research) survey 50 VC-backed companies that completed IPO’s in 2004.  They conclude the following:

“The results call into question the claim that “a great management team can find a good opportunity even if they have to make a huge leap from the market they currently occupy. . . . firms that go public rarely change or make a huge leap from their initial business idea or line of business.  An initial strong business, therefore, may not be sufficient, but appears to be almost necessary for a company to succeed.  On the other hand, it is common for firms to replace their founders and initial managers with new ones and still be able to go public, suggesting that VCs are regularly able to find management replacements or improvements for good businesses.  We interpret our results as indicating that, on the margin, VCs should spend more time on due diligence of the business rather than management.”

The authors wisely note the limitations of their small sample size and that 44% of the companies in their survey were life sciences companies.  They also point out that they are unable to access data on companies that experienced exits through acquisition (the vast majority of VC-backed companies) because this data is unavailable.  It is unfortunate that the value of much of the academic research conducted on our field is severely limited by the lack of access to relevant data.  This is clearly the case when one reflects on the conclusions of this report.  In my view, debating this aspect of the Horse vs. Jockey argument isn’t particularly useful to VCs or to entrepreneurs.

A more interesting line of related questions could begin with “Why do so few VC-backed firms succeed, period?”  "Is it endemic to venture capital investing that roughly 10% of investments will account for the vast majority of returns?"  "Can VCs do something to improve these statistics and therefore increase the return profile of the entire industry?" 

As the authors point out, VCs do, indeed, know how to replace management teams, and this occurs quite regularly.  More importantly, the human capital side of founder and management transitions is by no means optimized in our industry. In my opinion, the absence of consistent processes in many VC-company management transitions is the Achilles heel that spells failure for many companies—and this suggests that dysfunctional personal dynamics between VCs and founders may actually lead companies with solid business models to fail.

Start-ups experience accelerating rates of change, both internally and externally, as they develop.  The convergence of changing markets, evolving product lines, and frequent employee hires and replacements in a resource-constrained environment leads to extraordinary and stress inducing rapid rates of change in fledgling companies.

Through collaborative work on identifying governance best practices, the group of VCs and other industry professionals who have formed the Working Group on Director Accountability and Board Effectiveness conclude that having process and internal controls in place allows investors and the senior management team to better identify and calibrate problems, to determine the next course of action, and to reposition the company for success.  The outcome may involve changes to the team, to the business model, or both.

Process and controls form an important framework for management self-help in decision making.  Without process, it’s much easier to flounder and get caught in sub-optimal decisionmaking.

While VCs should certainly avoid investing in weak business models, in contrast to Professors Kaplan, Sensoy, and Stromberg, I would suggest that, at the margin, we should spend more time identifying and applying best practices and processes to our companies to improve our set of potential outcomes.  Assuming that we can identify strong business models, we should focus on maximizing the potential for our management teams to succeed in order to boost the VC industry’s collective returns for our investors.