Understanding Your Legal Risks

> Please read this unit before watching the video.

Scott Kupor, a former lawyer and now managing partner of star VC firm Andreessen Horowitz, published a widely acclaimed book in 2019 to help Founders and junior Venture Capitalists better understand the asset class. 

He lists the duties that any Board member, but even more so VCs, need to comply with:

• Duty of Care: make sure you know what is happening in the Company. Read Board packs, ask relevant questions (even if they are sometimes hard ones), and pay attention to the discussions
• Duty of Loyalty: a Board Director must act in the best interest of the Company and its common shareholders. It can be challenging especially when VCs need to recoup their money and sell the startup at a distressed price: they generally benefit from liquidation preference that wipes out the common stock’s proceeds. the sale process must be run fairly, as the Trados case clearly showed (see the link below)
• Duty of Confidentiality: this one is self-explanatory, but potential issues arise when a startup in the VC’s portfolio pivots and becomes a direct competitor to another portfolio company. Go back to “Managing Conflicts of Interest” for more
• Duty of Candor: Board members are obliged to disclose all the relevant information on corporate actions to shareholders 

Why VCs Have A Harder Time Managing Their Obligations

Institutional Investors who raised funds with external parties (also called Limited Partners or LPs, as we covered in our live session “How Do VC Funds Work“) have two sets of duties:

• To the Company and its common stockholders when they are also Directors on the Board
• To their LPs

These duties may find themselves in conflict, as highlighted by the Trados case, and as Scott Kupor explains in the video (watch from 6’00 – we thought we’d feature the whole video as Kupor touches upon many notions we cover in this module.)

Because of the way VC funds are formed and capital is deployed, Investors may have an incentive to sell their shares, which often translates into pushing for the sale of the whole company, earlier than when Founders want. Since they are invested in Preferred Shares, VCs can recoup their investment faster than Founders.

Another famous illustration is the Zappos case. A year after he sold his company for $1.2 billion to Amazon, Zappos Founder Tony Hsieh explained in his book that the sale process started when Sequoia Capital announced they wanted out. Although there was no improper conduct by the Sequoia Board members, the story highlights how Founders’ and VCs’ interests may be misaligned.

Which of the duties mentioned by Scott Kupor seem the most important to you? Can you think of situations where VCs are at risk of not complying with them?

Let us know in the Comment section below.

• Secrets of Sand Hill Road, by Scott Kupor (1999) > Chapter 13: In Trados We Trust
• When Exits Go Wrong: The Trados Case Study, on our blog
• Tony Hsieh explains why he sold Zappos to Amazon under pressure from Sequoia, on Techcrunch (2010)