Think & Grow partner, Vinisha, chats to Chris Flavell, Managing Partner of Second Sphere Partners, who is sharing the need-to-know information for start-up founders who are building and selecting their boards.
What are the key market trends you’ve been seeing over the past 6-12 months from a board perspective?
The major issue has been with the pressure on early-stage valuations and therefore fundraising which has been impacted hugely with capital raised running at 50% of historic levels and with that being allocated to existing deals, new deals are finding it extremely challenging. Usually, when management or shareholder employees look at their remuneration package options they want to see that their good work has been recognized and as the business grows, the company valuation and therefore their option value goes up as well. But, in the situation where the value of the company has been significantly reduced, their options can become a disincentive.
So, as part of the packaging that’s often done in start-ups, early-stage founders and management teams are taking discounted cash salaries for upside and equity. And where the value has dropped significantly, this creates an issue in terms of how to incentivize and retain staff and how to keep the best long-term teams together.
However, the Board only really concentrates on the CEO and founder remuneration, perhaps the CTO and CMO as well. They leave the rest of the packaging to the CEO/founder and senior management team. So we have also come to recognize that the way a CEO sets their own remuneration and salary sets a precedent for all the rest of the senior staff.
Corporate executives often have inflated expectations of what they should earn in an early-stage start-up or in growth companies. This is one reason why I believe neobanks have had so much trouble. With very high-cost structures imported from executive expectations from banks, in contrast to smaller fintech companies with lower cost structures and tend to be a lot more focused on getting market traction with a narrow focus.
Talk us through examples of what you’ve seen go well and not so well in terms of founder and board relationships.
Where I see it working well is when a founder is able to leverage and grow the board as the company grows and matures. The types of directors and the level of advice you need at each growth stage are very different.
During early-stage, the founder is doing all the fundraising themselves and it tends to only be supporters and immediate contacts such as family and friends. However, getting input from an advisor at an early stage is beneficial because while the founder is the best person to sell the business to investors, they might not be the best person to go through the shaping of their share register for future capital raising. It’s a very heavy time commitment, so passing it onto a trusted advisor who is familiar with fundraising and shareholder management means the founder can focus on business success and achieving operating targets.
Where it’s not gone so well is when there’s a clash between investors and founder. The founder wants to go in one direction and it’s been too common for the outcome to be the founder losing control of the business. We’ve seen several Australian businesses failing or falling over due to dysfunctional relationships with between the founder, investors, board and management team.
It’s hard for a founder to know when to make that shift away from a certain board or make any changes regarding the company’s future. What’s your advice for knowing when it’s time to make that change and how to navigate it?
Growth stages are becoming a lot more defined. There are also mechanisms in place like incubators where people can work together in smaller groups with founding teams working with other complementary founding teams. Learning from others, modeling and taking on mentors for different stages are important.
As an example, we’re investors in Energy Lab or Startmate or Taronga - any of these early-stage incubator groups. That can be incredibly helpful for founders to find out from other founders what they’re doing and how to take things forward. In the next stage, it’s more individually driven with the early-stage investors coming in. And then you’ve got onto Series A or B. All of these are different in terms of what board composition looks like, what you need in and from the management team and the maturity of the founder.
What kind of skills are complementary to a start-up board?
It depends on the stage. Traditional mid-market firms will typically have a lawyer and accountant and an old business head. But, for growth and start-up companies, the change in what’s required happens very quickly as the company matures.
With the early rounds of friends and family, you’ve got relations potentially coming on board. You’ll be bringing on all those early investors – people who have put money in and believes in the Founder and their idea and may want to be on the board. These parties usually aren’t the best long-term Directors.
The best roles that I see for very early-stage is that a pseudo board through an advisory board is far more effective to bring advisers in early and test their chemistry and value add. There are quite a few people who just want to give back to industry or founders and they want an opportunity to want to invest early on.
Do you have any advice for founders with regard to building or selecting their board?
Map out a capital plan as clearly as possible so that you know how much dilution you’re going through as you navigate each stage and understand how to chunk that out. Have a clear view of milestones to hit and value parameters that somebody might put around that – both high and low.
The last thing is the current environment. All investors are looking for a clearer path to cash flow breakeven rather than continuing to source capital from round to round without clarity of whether the business model is actually working.
Thanks to Chris Flavell, Managing Partner of Second Sphere Partners and Vinisha Rathod, partner at Think & Grow.