Stanford Law’s Joe Grundfest and Mike Callahan Correct Common Misconceptions about Corporate Governance in the Venture Capital Arena

Corporate governance encompasses almost every aspect of management, but it’s often misunderstood, especially in the VC space. In the discussion that follows, two experts in corporate governance, Stanford Law Professor Joe Grundfest and Mike Callahan, executive director of the Rock Center, challenge a few common misconceptions.

Misconception #1. A startup isn’t complicated enough to need corporate governance.

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Joe Grundfest, JD ’78, W.A. Franke Professor of law and business

Grundfest: Every business needs a governance structure. Every VC will tell you that when they negotiate terms with their portfolio companies, the negotiation is about economics and control. Control is just another word for governance, and experience suggests that even the savviest of VCs can be badly burned by unfortunate governance structures. Also, even when an investment has a responsible structure, it’s easy for start-ups not to pay attention to important legal formalities and for oversights in this area to blow up in investors’ faces. And, to make the situation more complex, optimal governance structures can vary dramatically from firm to firm and over time. They can depend on founder and investor personalities, industry sector, size of the business, and myriad other factors. There are no off-the-shelf formulas here.

Callahan: I agree. Governance structures should be malleable to fit the current needs and situation of the company at the time — and be flexible to grow with the business and its scale and objectives. Putting into place a static structure to check a box is a waste of valuable time and resources for a startup. Done properly, good governance processes and procedures can help a startup be more successful by optimizing information flow, thereby increasing the quality and timeliness of decision making and enabling boardroom time to be spent on the issues that truly matter for success.

Misconception #2. Investors don’t care about corporate governance. They only care about the bottom line and their exit ramp.

Grundfest: VCs rationally focus on economic returns, and not on governance for the sake of governance. But many VCs have learned an expensive lesson: bad governance and poor attention to basic corporate hygiene can lead to expensive litigation and depress returns for VCs and fund investors alike. Put another way, even if a VC is focused exclusively on the bottom line — and many VCs are — ignoring governance issues often isn’t the smartest way to maximize your bottom line. Bad governance can also make life hell for a VC even separate and apart from a hit to the bottom line. I don’t know of many VCs who like spending days in depositions, prepping with attorneys, testifying in court, paying legal bills, and being away from life as an investor. Bad governance imposes a life-style cost in addition to an economic burden.

Callahan: Given the recent high-profile governance failures at some prominent venture-backed firms, my sense is that governance is no longer far down the list for most investors and, importantly, for the leaders of startups. Whether it is reinforcing a company’s culture and values, maintaining an environment that enables success for everyone regardless of gender or background, or building a reputation in the marketplace that will accrue returns in both business development and recruitment and retention, I think the tide is changing to embrace solid approaches to governance. Smart corporate governance provides confidence and reassurance for investors. A very clear approach to accountability, responsibility, and timing of decisions between shareholders, boards of directors and the CEO provides current and future investors’ confidence in the structure of your venture.

Michael Callahan
Michael Callahan, Professor of the Practice of Law and executive director of the Arthur and Toni Rembe Rock Center for Corporate Governance

Misconception #3. VCs and investors know a lot about corporate governance.

Grundfest: Corporate governance, particularly in the VC space, is an under-researched and under-taught field. Recent governance failures at Uber, Theranos, Zenefits, and other firms have attracted VC attention to governance practices, but much more work remains to be done. For example, courts are becoming more aggressive in demanding that VCs make available copies of their emails, text messages, and other forms of communication when shareholders simply make a books and records demand on the corporation. A very recent Delaware decision requires that Palantir’s directors and officers make their electronic communication available to a shareholder with whom the company is having a rather heated dispute. As we all know, some people say intemperate things in emails and text messages. Even emojis count in court. Greater attention to email and other forms of electronic communication hygiene is likely part of the wave of the future.

The Stanford/NVCA Venture Capital Symposium seeks to correct the governance deficit by giving investors, startup executives and directors of venture-backed companies the skills to respond effectively to real-world governance challenges such as culture and inclusion, board-founder relationships, crisis management and boardroom mechanics.

Joe Grundfest, the W. A. Franke Professor of Law and Business and Senior Faculty, Rock Center for Corporate Governance, is a former commissioner of the Securities and Exchange Commission and a nationally prominent expert on capital markets, corporate governance, and securities litigation.

Mike Callahan, Professor of the Practice of Law, is the executive director of the Arthur and Toni Rembe Rock Center for Corporate Governance and was senior vice president and general counsel at LinkedIn and Yahoo, Inc., where he had global responsibility for legal, regulatory and public policy matters, including corporate governance.