Startups, think twice about paying investors to sit on your board
05.10.2023
The current funding slowdown means startup founders must be more flexible in their search for investors. But should that stretch to compensating investors for taking a board seat?
It’s tough out there for many startups, as venture investors take a more cautious approach to writing cheques. UK tech venture capital funding was down 57% in H1 compared to last year, and that could translate into a nerve-wracking time for those founders whose runway is nearing an end.
Deals are still happening, but they are taking a lot longer, and founders have to be more flexible about valuations and terms. That’s to be expected given the riskier landscape. However, founders must be careful they don’t give away too much as they push to close a deal.
One request that we’ve seen increasingly as part of the deal process is venture investors wanting to be compensated for sitting on the board of their portfolio companies. This feels particularly short-sighted, unproductive, and even unethical.
At a time when startups should be looking to minimise costs and maximise every penny for the growth of the business, it seems counter-intuitive that investors are asking them to shell out thousands of pounds for board involvement.
This should be expected as a standard practice from any venture investor. Founders can’t very well refuse them a seat, so the request puts them in a very difficult position.
Venture capital is a hands-on business, particularly at an early stage, and building value and exiting successfully means putting the time into supporting portfolio companies in any way you can, including nurturing founders, providing guidance, and sharing contacts.
Any work that investors do with their portfolio companies, including board involvement, should be treated as investment time, and be baked into the existing charging structure.
The downside of paying investors to sit on your board
Venture funds already have well-established and often lucrative revenue streams, including charging annual percentage fees to LPs, and carried interest on exit profits, which can be substantial.
On top of that, some also charge fees during the deal process, and the combination of additional costs can leave a bad taste for founders, meaning relationships begin on the wrong foot and feel more transactional, rather than being based on an aligned set of collaborative objectives.
The practice can also have a knock-on effect on other investors, sparking further requests for a board salary, which can result in startups paying hundreds of thousands of pounds every year on board compensation.
While that might be affordable for a more established business, it is a lot of expense for an early-stage startup, and money that could be much better spent on activities and resources that will directly impact growth, such as product development, sales, or marketing.
Compensating investors for their board work could also reduce the financial capacity of startups to bring on independent executives, such as a chair or non-executive director, who would nearly always expect to be paid for their services.
This would be a great shame, as relevant independent board members have the potential to add direct value, offering an objective perspective on the business, vital experience, and contacts that can deliver tangible business progression.
In the current climate, founders might feel like they can’t say ‘no’, for fear of losing a potential investor, but my advice would be to push back and try to negotiate, to avoid adding substantial additional overheads to your business.
If the investor won’t back down, then consider whether alternative compensation could work, for example offering options on future equity instead of a salary, to avoid the immediate hit on your cash flow.
If an investor is really committed to your business, then they should be willing to listen to your arguments and do the right thing for its future success.
Denis Shafranik is the managing partner of Concentric.
