The Founder/Investor Honeymoon

When an investor and founder first start working together, both sides have high hopes about how the relationship will unfold. There is at least a bit of a honeymoon period in the early months when both parties are getting to know each other better and are hopefully confirming why they chose to work together.

Usually, the honeymoon doesn’t last forever. Reality soon starts to sink in. Both parties know that this phase cannot last forever. Companies don’t crush their plan every quarter, markets change and unexpected challenges will be faced. Inevitably, situations will arise where the interests of the investors and founders are not aligned, and even if that doesn’t happen, strong differences of opinion and style will create conflict. Despite the end of the honeymoon, these challenges can actual strengthen a relationship, much like an actual marriage is strengthened through the realities of living life together.

But sometimes, the honeymoon ends and devolves into a bit of a nightmare. All the high hopes for a great collaboration are dashed, and the founder/investor relationship becomes dysfunctional. Why does this happen and how does one avoid it? Generally, I find that it comes down to one of two things: A communication breakdown or misaligned expectations.

Communication Breakdown:

A breakdown in communication tends to sneak up on you. It starts with something small, then slowly expands to become a real problem.

The starting point for a communication breakdown comes from insufficient information. This is the beginning of a downward spiral, because without enough information, investors feel out of the loop and are unable to effectively engage, which makes it seem less important to keep them in the loop.

I’m a fan of being pretty religious around setting and sticking to a regular cadence of investor updates. Usually, I recommend a board meeting (or the equivalent to a board meeting with major investors) once every 6–8 weeks, along with a regular monthly email update to all investors. There are a lot of good posts on how to structure these, so I won’t go into it at this point.

Even with regular information flow, the next challenge is being transparent about what’s going on. Sometimes, board meetings or updates end up being superficial window-dressing vs. an honest discussion about what’s working and what’s not. This is something that I think investors need to help founders work on, given the power dynamic the often exists. Investors need to make sure they seek out a complete picture of what’s going on in the company, and prove to founders that they can be trusted to respond productively to less-than-stellar news.

This is why it pays to build some personal rapport with your lead investors. This isn’t purely a transactional relationship, and having some personal foundation helps grease the wheels for honest conversations.

The point of these efforts is to avoid the situation where an investor feels blindsided by bad news that they should have seen coming. As an investor, there is nothing that creates more angst than feeling like a major problem was brewing under their nose. And it’s even worse if they feel like a founder was deliberately hiding information. I find that most investors go into a relationship with a fair bit of tolerance and willingness to give founders the benefit of the doubt. But once that trust is breached, it’s almost impossible to restore.

Misaligned Expectations:

The other source of broken relationships with investors tends to be around misaligned expectations. There are a couple flavors of this.

First, is misaligned expectations early on around the status of the company. With most financing rounds, there is some level of “first board meeting blues” where the external picture of a company that is developed by an investor gets compared to reality once you are under the tent. The bigger the delta between expectations and reality, the more the relationship is on shaky ground. Of course, assuming the founder has been transparent and honest during their fundraising process, it’s the job of the investor to do proper due diligence to make sure they know what kind of situation they are getting into.

The next misalignment ends up being around the engagement model between investors and founders. Investors will say a lot of things to try to “win” a deal, but they may or may not actually follow-through. I’m increasingly seeing a weird trend where founders choose a fund because of a particular partner or lead, but then get their board seat staffed by a junior investment professional that is just there to monitor progress. The worst scenario is when a lead investor leaves the firm shortly after investment, which is pretty terrible behavior, IMHO.

Sometimes, founder/investor engagement just gets off to a weak start because everyone gets distracted. I think that both investors and founders should prioritize creating a good onramp with each other in the first 4–8 weeks post investment. This should include setting up the next several months of checkins or board meetings, establishing some communication rhythm, and some plan to work together towards at least one important near-term goal for the company.

The toughest misalignment ends up being around follow-on financing strategy. It’s tough to arrive at the moment of a follow-on round and then be surprised by the way an investor is behaving in that situation. Different investors are entitled to different strategies around their follow-on rounds. What’s important is to understand the bounds of their strategy, and to consider how that may help or hamper your fundraising. A lot of posts have been written about this. But in general:

• If an investor owns less than their target ownership, they have an incentive to buy up to their target ownership at the next round if they are excited about the company and the pricing is reasonable.
• If an investor owns their target ownership, their bias will be to write a check to maintain their ownership or step back, but they will rarely want to lead the next round.
• Most investors would almost always prefer to see a new lead in a round. The only exception are if you are absolutely knocking the cover off the ball. And even if that is true, few funds have the size, credibility, and attitude to just double down and convince founders that they are better off just working with them.
• Some syndicates will support a company if things go ok, but not great. But it’s hard to know for sure up front. Fred Wilson wrote a great post on this recently.

The way to address misaligned expectations is to do a good job doing your references on investors. All investors should give you time to conduct these references in a respectful, but thorough way. Ask explicit questions around things like follow-on financing, the fund’s engagement model, and how investors behave when things go sideways. Try to find off-list references as well. If you have multiple, well known institutional investors in your syndicate, try to find deals where your investors have collaborated together to see what their joint behavior might look like.

In many cases, the success or failure of a business probably doesn’t hinge on having a great founder/investor relationship. But having a productive relationship at minimum will make your life much more pleasant, and sometimes make or break things in moments of crisis. Some conflict is unavoidable and healthy. But everyone goes into an investment hoping that the relationship will be effective, so it’s worth doing the work up front to prevent the honeymoon from turning into a nightmare.