In about 50% of instances where an early stage company actually succeeds in raising venture capital, the founder CEO is fired within the first year and kisses most of his or her equity good-bye. Even the Wall Street Journal pointed this out in a article by Barnaby Federer from 09/30/02:

"If you ask a VC what value they add, and you get them after a few drinks, they'll say, 'We replace the CEO' ", he said. And that, he indicated, does not vary with the economic climate.

It usually occurs in this manner. The venture capitalist invites the founder out for a friendly lunch. During the meal the venture capitalist brings up a new person who would benefit the company greatly through his connections or industry experience. The venture capitalist explains that although this person is not available to serve on the management team, he could probably find the time to serve as a director. Yes, it would mean making the board larger than originally agreed to by everyone but this guy is a “star”. The founder wishing to please his venture capitalist reluctantly agrees to the change in board size.

The new face turns out to be the extra vote the venture capitalist needed to make wholesale management changes. Within a week the board has fired the founding team and replaced them with friends of the venture capitalist. Oftentimes the new board member assumes the CEO role.

Yes, this scenario happens often and has little to do with the founding team’s performance. Venture capitalists just prefer their friends at the helm.

Bottom Line: If you had the clout at the beginning to negotiate a board of directors balanced between management and venture capitalist, don't be a wimp and give it away for nothing. To do so only reinforces the venture capitalist's belief that he was right about replacing you.

The best tactic to employ when faced with this offer is tell the venture capitalist that you 1) can't recommend someone for a board seat until you are satisfied that they can make an actual contribution, and 2) that since the board is working well it would be preferable to compensate this person--once they have made a tangible contribution--with consulting fees instead of a board position.

Finally, if you sense a strong negative reaction from the venture capitalist you can be assured that there's trouble brewing in River City and it's spelled with a capital "T". He will always have a Plan B for pink-slipping you and it won't be pleasant. Call your lawyer immediately, and I mean your lawyer not the company's.

You're about to experience your own personal "Night of the Long Knives".

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