VC Guidance Note #3

How can investors retain influence as startups scale and their shareholding and related rights are diluted? This is a key question that the majority of Venture Capital (“VC”) investors, especially those with an ESG or impact mandate, face during the startup life cycle.

Early-stage investors may initially hold significant shareholding in startups, giving them substantial leverage and hard rights (e.g. to appoint a director or to approve business plan changes). However, as startups fundraise, early investors’ shareholding may be diluted, leading to reduced influence and hard rights, and limited access to information. This may hinder investors’ ability to monitor governance and manage related risks such as fraud and regulatory non-compliance that can undermine commercial and impact outcomes and damage reputations.

This Guidance Note presents proactive approaches for investors in startups, including VC Fund Managers, to continue to ensure appropriate oversight and shape good governance even when as their influence wanes. It provides guidance on the following;

• Actively planning at the pre-investment stage for the scenarios in which investors’ influence and governance rights may be weakened;
• Identifying strategies for continuing to exercise leverage and oversight on startups post-dilution, using hard rights, soft power or engaging with the ecosystem to ensure appropriate monitoring;
• Design a governance monitoring approach across the portfolio using a risk-based approach, taking into account dilution challenges and resources.

This Guidance Note is the third and last of a series that shares actionable advice - including easy-to-use tools and case studies – on ensuring good governance in startups, particularly in emerging market contexts.

This Note builds on a First Note on how to identify and proactively manage governance risks, and Second Note on how to develop phased and proportionate governance frameworks for startups, published in November 2023 and January 2024 respectively.

This Guidance Note series was jointly supported by British International Investment and FMO, the Dutch Entreprenurial Development Bank.

You can access the note through this interactive version or the PDF document.