When bad news is good news.

When a founder comes with bad news, to me that’s good news. Not that I want things to go wrong at our portfolio companies… quite the contrary! But it means that I have established a level of trust with the entrepreneur so that they actively seek out my help and advice. To me that’s one of the final levels to reach as an investor.

I want to worry. I want to know the large problems that keep a founder up at night and the smaller ones too that might become big ones. It is a proven value driver for our fund to help entrepreneurs in the Heartcore portfolio remove roadblocks that limit their companies’ growth paths. I also believe that for an entrepreneur, the best strategy is to establish a culture of honesty with your investors. Flag issues as they arise. Big problems appear gradually, then suddenly. If untreated they only get worse.

This is why great investors value honesty. An example: recently one of our portfolio companies had a major internal fuckup happen in the middle of raising a large round, term sheet already signed and all. They missed the sales forecast for the latest month by a LOT. The founders then did two things. They first identified the root cause and swiftly prepared measures to fix the problem. Then they called the investor to communicate the forecast miss, together with a thorough analysis and action plan. Being fully transparent was potentially a risk, since it could have caused the investor to drop out of the process or at least re-negotiate on valuation. The opposite happened: said investor announced right in the call that this would conclude their due-diligence and they would now be ready to move to signing. While surprising in its clarity, in my book this was actually a rational move. As a VC you always stand on the side line. Never able to see the complexities of the day to day business, so we appreciate if founders are fully transparent and it is a great signal for a successful working relationship.

Over the years I have observed three beliefs that make it difficult for founders to be transparent with their investors and the board. Ultimately, these beliefs reduce the probability of building a large company.

Firstly, founders believe in their own abilities to solve a problem before it hits the board room. And quite often they are right. However, it is hard to know whether that will be the case every time, before the fact.

Secondly, founders might be very aware of the principal agent problems that are embedded in a founder-investor relationship. If all information is laid open, will existing investors invest again, support, or make adverse board and shareholder decisions? Due to uncertainty in predicting future behavior, it can feel like the smartest strategy to only highlight the wins and sweep any issues under the rug. Long term though, the consequences of “selective” information sharing and “window dressing” will depress enterprise value. Not only will this erode trust with shareholders, but it is simply harder for your investors to help and make the best board decisions without seeing the full picture.

As an investor I am also quite aware that an entrepreneur’s trust has to be earned over time. The faster we overcome the uncertainty about how I act on information the faster we can work on building a category defining company together. For those moments when there are different hats to wear I try to state clearly who I am representing right now. Board member, advisor, coach or investor.

Lastly founders might believe that VCs only want to hear the good news and can only stomach graphs that point up to the right. It is true that some investors are opportunistic or fearful characters, sometimes internal fund dynamics don’t allow them to really act on being a conviction investor. These investors you should treat cautiously and be strategic in what you share, as you don’t want to have panic and pessimism spread through the board room like the flu in playschool. The real question here is however if you should have let them invest in your company in the first place.

On the flipside, no investor wants to be surprised by bad news when it’s too late to act. The worst bad news I get are those I did not see coming and have to report back to my partners. “I just got a call from the founder, they are running out of cash this week.” But when things go really wrong and everyone has been part of the ride and fully informed, the propensity to help a company out of difficult times is full on. We’re truly in it together.

Reaching a level of transparency and trust that leads to truth and ultimately a better outcome is a process. Let’s work together on getting better with this. It is worth it.

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