Do Your Board Members Represent Your Interests?

February 5, 2013 Whenever small-business owners and entrepreneurs come to me looking for capital, I encourage them to think about the trade-offs involved in choosing debt or equity. Sometimes there is no choice, and they have to pick one or the other. But often there is a choice, and that’s when it’s especially important to think things through.

The decision gets trickier when a company already has investors, particularly if they are venture capitalists. In these cases, there is often a board, and the directors get to vote on whether there will be additional rounds of financing. That vote can prompt some interesting questions.

When the board members are venture capitalists, the vote can create potential conflicts. Are they voting based on what’s best for their own investment in the company or what’s best for the company? If the company is doing well, the investors generally would prefer there to be another round of equity investing — at a higher valuation than when they first invested. This way, the investors can show a return, even though the entrepreneur faces further dilution of his or her ownership stake.

This is what I call the venture capital treadmill. Once you’re on it, the investors always want the next round completed and the round after that. There are times when debt financing may be better for the entrepreneur, but that won’t help the venture capitalists prove that their investment is growing. The board members have a fiduciary responsibility to represent the best interests of the company. But how can they do this if their jobs are ultimately measured by the success of their own investments? Should board members with financial stakes in the company be prohibited from making these votes?

Above all, this is another reason that, if you choose to take on equity investors, you should interview them carefully. It’s not just about the money. As much as possible, you want to try to make sure that your interests and the investors’ interests are as closely aligned as possible. It’s a lot like getting married — both parties need to understand each other very well.

What do you think?

Ami Kassar founded MultiFunding, which is based near Philadelphia and helps small businesses find the right sources of financing for their companies.