November 7, 2023 • 1hr 11min

Elizabeth Zalman & Jerry Neumann - Founder vs Investor - [Invest Like the Best, EP.351]

Invest Like the Best with Patrick O'Shaughnessy

In this episode of Invest Like the Best, Patrick O'Shaughnessy interviews Elizabeth Zalman and Jerry Neumann about their new book "Founder vs Investor" and their perspectives on the venture capital ecosystem. Elizabeth is a two-time founder, most recently co-founding StrongDM. Jerry is an early-stage venture capitalist who was a seed investor in Elizabeth's company. Together, they provide an insider's view of the complex and often contentious relationship between startup founders and their investors.

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Key Takeaways

The book "Founder vs Investor" by Elizabeth Zalman and Jerry Neumann aims to provide an honest look at the founder-investor relationship, but has received some pushback from VCs who feel it portrays them negatively
There is often an inherent conflict between founders' desire to build something meaningful and investors' focus on financial returns
Clear communication and setting proper expectations between founders and investors is critical, especially around topics like board governance and company control
The fundraising process involves a lot of storytelling on both sides - founders need to articulate a compelling vision while investors often overpromise on how helpful they'll be
As companies grow, the founder-investor dynamic shifts and founders need to evolve from visionaries to professional managers
Building a sustainable competitive advantage or "moat" should be considered from the early stages, not just once a company finds product-market fit
Exits and liquidity events create tension between founders' and investors' interests, requiring careful navigation
The VC industry involves a lot of behind-the-scenes communication between investors that founders are often unaware of
Starting a company is less risky than many think - failure doesn't define you and the experience is valuable regardless of outcome

Introduction

In this episode of Invest Like the Best, Patrick O'Shaughnessy interviews Elizabeth Zalman and Jerry Neumann about their new book "Founder vs Investor" and their perspectives on the venture capital ecosystem. Elizabeth is a two-time founder, most recently co-founding StrongDM. Jerry is an early-stage venture capitalist who was a seed investor in Elizabeth's company. Together, they provide an insider's view of the complex and often contentious relationship between startup founders and their investors.

Topics Discussed

Reaction to "Founder vs Investor" Book (4:02)

The discussion begins with the strong reaction the book has received, particularly from some venture capitalists who feel it portrays them negatively. Jerry explains:

"I read Liz's sections, and some of them make me uncomfortable. Just as a venture capitalist, I don't see myself in what she writes. I don't see myself the same way that she sees me, or at least sees venture capitalists as a class."

However, Jerry insisted on maintaining this disagreement in the book to accurately reflect the tensions that exist. He notes that many VCs didn't want to be associated with the book or write a foreword supporting it.

Founder vs Investor Incentives (17:48)

The conversation explores the inherent conflict between founders' and investors' motivations. Elizabeth explains:

"In the most romantic version from a founder perspective, I start a company because I have a desire to birth this idea into the world and turn it into a big thing...And then the investor comes in, and investor's job is to return capital and more to their investors. And those two things, one is hyper pragmatic, and one is truly romantic at its heart."

This misalignment of incentives can lead to tension, especially as companies grow and evolve. Jerry notes that while he cares about founders succeeding personally, his primary duty is to the company's success.

The Fundraising Process (25:41)

The guests discuss the "kabuki dance" of startup fundraising, where both sides engage in storytelling and often overpromise. Elizabeth advises investors to really try to understand the core of what a founder is building, while Jerry argues he cares more about the long-term vision:

"I want to decide on what I'm going to exit. I'm not deciding on what I'm investing in today. I'm deciding on what I'm investing in ten years from now."

They debate the merits of focusing on present reality vs future potential during pitches.

Evolving Founder-Investor Dynamics (37:04)

As companies grow, the relationship between founders and investors changes. Elizabeth notes that founders need to transition from visionaries to professional managers:

"Nobody ever told me that that is the thing that you're going to need to do. You're going to need to enjoy people management, you're going to need to learn how to play politics at the highest level."

Jerry adds that investors need to help prepare founders for these transitions, but many don't do this effectively.

Board Meetings and Governance (41:44)

The guests discuss how to run effective board meetings and navigate governance issues. Elizabeth advocates for more direct, frank communication from investors:

"Tell me exactly what is on your mind all the time, in plain English. I will learn how to take it."

Jerry counters that complete honesty isn't always the best approach and that investors need to package feedback carefully. They agree that ideal board meetings involve honest discussion of hard problems and lead to clearer understanding of reality.

Investment Terms and Negotiations (48:13)

The conversation turns to negotiating investment terms. Elizabeth emphasizes focusing on board composition and option pools over valuation. Jerry warns about contracts not matching term sheets. Both have seen "shenanigans" pulled during negotiations and closings.

Managing Growth and Building Moats (51:18)

As companies enter high-growth phases, new challenges emerge in the founder-investor dynamic. Jerry pushes for continued risk-taking and aggressive growth, while Elizabeth notes the internal "mess" this often creates. They discuss the importance of building sustainable competitive advantages or "moats" from the early stages. Jerry explains:

"If you don't care about building businesses, it just seems like the wrong job to take."

Exits and Liquidity (59:08)

The guests share perspectives on company exits and founder liquidity. Jerry is generally skeptical of founders taking large secondary sales, seeing it as a potential red flag. Elizabeth argues for allowing founders to take some money off the table to reduce fatigue and maintain skin in the game. They debate the merits of different exit paths like IPOs vs acquisitions.

VC-to-VC Relationships (1:03:52)

The discussion touches on how VCs work together behind the scenes. Jerry notes that VCs talk constantly and need to maintain relationships for future deals. Elizabeth cautions that this puts founders at a disadvantage:

"I think a founder is always at a disadvantage in a board meeting or with investors on their cap table because they're always talking behind your back and they will never, ever, ever, ever vote against each other."

Reflections on Startup Careers (1:08:01)

To close, the guests reflect on startup careers more broadly. Jerry emphasizes that failure doesn't define you:

"Starting a company seems risky, but it's not that risky...In this world, having the experience of going through it is so valuable."

Elizabeth wishes more people knew about the creative opportunities in startups:

"There's so much possibility for it as a career path, and I wish more people knew that it existed. You don't even need to be a coder...You can be a marketer, be a storyteller, you can be a designer. It's just super cool."

Conclusion

This wide-ranging conversation provides a candid look at the complex, often fraught relationship between startup founders and venture capital investors. While their interests are theoretically aligned in building successful companies, the reality involves competing incentives, information asymmetries, and evolving dynamics as businesses grow. Both Elizabeth and Jerry advocate for more transparency and education to help founders and investors navigate these challenges. Ultimately, despite the difficulties, they remain passionate about the startup ecosystem as a driver of innovation and personal growth.