The Bad Marriage Problem

Over the last 18 months, the early-stage financing market has seen dramatic changes characterized by these three things:

• A shift from in-person fundraising to virtual fundraising
• A reduction in financing process timelines from months to weeks
• A continued increase in the amount of capital available for early stage companies

I believe that for the most part, these changes will be permanent.

And I believe that for the most part, these changes are good for early-stage company formation and innovation.

However, there will be some negative side effects from these changes and one that I worry about is the “bad marriage problem.” Unlike public markets, private market investments are held for many years, often a decade or more. If an investor and an entrepreneur find each other difficult to work with, there is no easy solution. There is no divorce court for startups. And so the result is likely to be entrepreneurs and investors getting stuck in bad marriages.

There are a few opportunities to address this issue. There is a vibrant secondary market for private investments and while it is mostly limited today to well-known later-stage companies, it could develop into a broader market as the capital seeking to get invested in early-stage innovation continues to grow unabated. It is unlikely that founders will be able to force investors out of their cap tables via the secondary markets, but a voluntary separation via the secondary market seems more likely to me.

I also think startup boards need to evolve. There should be many more independent directors and many fewer investor directors on startup boards. Investors should be more open to observer seats and founders should have more say in which investors sit on their boards. I am not arguing that founders should control their boards, but I am arguing that investors should not control the boards. I think independent control is the most sustainable solution.

We know that bad marriages are hurtful to everyone, not just the spouses. Companies that have dysfunctional founder/investor relationships suffer from them. And the shotgun marriage environment we are operating in right now (and for the foreseeable future) will likely create more of them. So we should be thinking about solutions to end these bad marriages and let everyone move on to better ones.