Ethics . . .

are critically important in venture capital transactions. The relationship of entrepreneur and venture investor is so intertwined that when one acts unfairly, the other almost always suffers. Even when the parties carefully document their agreements, either party can be ruined by the unethical behavior of the other.

Investors recognize the need to deal only with people they can trust and direct a good bit of their due diligence work toward determining whether an entrepreneur is honest and trustworthy. Entrepreneurs should be just as careful to examine their investors’ reputations.

An unfair or reluctant investor can cause real problems for a company. If he fails to provide funding or delays or reduces the funding he agreed to provide, he can steal a company’s promise and starve it for cash. This cash shortage can delay expansions and product developments. It can cause the collapse of companies that are not yet profitable. At the very least, it distracts management from the day-to-day management of the company and forces it to deal, instead, with the cash crisis created by the investor.

What is more, this same cash crisis often prevents the company from enforcing its contracts against its investor. Even if the company’s contracts require the investor to fund, the company may be unable to force the investor to live up to his bargain. This is because the investor’s unwillingness to fund takes away the two assets management needs most to force him to do so: money and time. In many cases, the company simply cannot afford to spend its money or time trying to force an unwilling investor to fund. Even if it could, the actions required to do so would be a serious drain on the company and might frighten other investors away. After all, how many investors want to put money into a company that is suing its prior investor?

At the same time, the investor may frustrate management further with new demands that make it difficult for the company to obtain money from other sources. As a result, just when management needs to concentrate its efforts on building its company, it is forced, instead, to find cash and deal with an uncooperative investor who has acquired significant rights in the company. The best way to avoid these problems is to be careful when selecting investors, to investigate their reputations, and to try, when possible, to deal only with people who are trustworthy. See: Adventure Capitalists, Cash Flow, Due Diligence, Stage Financing, Unlocking Provisions.