Sections: The distinctiveness of startups and their life cycle

A framework of startup governance

• Source link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3352203
• TL;DR

Startups have a unique governance structure deriving from the fact that each stakeholder group has different interests. These diverging interests can cause conflicts and tensions that only in some cases are addressed by existing regulation.

• How helpful? Scale of 1 to 5

• Topic Tags

Fiduciary duties, shareholder conflicts, VC-founder conflicts, VC interests, founder-executives

• Relevant questions addressed

What are some typical conflicts that arise within a startup?

What leads to these conflicts?

• Summary bullet points
• Startups have a different focus than publicly owned companies and traditional closely held corporations, and they present different risks. This leads them to have different governance
• The different shareholders have overlapping roles and conflicting interests which create more and more tension as the company grows, driven by more complex capital structures
• Shareholders can have shifting roles or dual and conflicting roles, acting as role A in one context, but role B in another
• Shareholders in a startup are not a homogeneous group with the same interests and rights.
• The uniqueness of startups is driven by their goal of eventually being acquired or going public. The objective is for the startup to cease being a startup at some point
• Startups have two main areas of evolution determining issues in governance
  • The business
    • Many startups fail, and those that do not evolve in “recognizable patterns”
      • Early-stage, highly entrepreneurial and innovative
      • Mid-stage, refining product/service development, scale-up, revenues
      • Late-stage, manage more complexity, find exit opps to return liquidity
  • The capital structure, driven by the business
    • At founding, the company generally issues all stock to founders
      • Founders provide capital to the company through their funds and their personal networks
      • As the company needs more capital to grow, Angel Investors, and then VCs enter the scene
      • Angel Investors typically will get common stock or basic debt, leaving the capital structure simple in the early stages
      • VCs tend to require more complex debt or equity instruments and board seats. Employee compensation through stock options further complicates the capital structure
      • The more financing rounds a startup entertains, the more complex its cap structure