EUVC #266: Tom McGinn, General Counsel at Northzone on building high-functioning startup boards

0:00Hi, everyone. Welcome to this episode of the UVC podcast. I'm David Am joined by Andreas. Today, we're welcoming Tom McChin with us. Tom is the general counsel of North Zone. And in case you're living under a rock, that is a multi-stage venture fund with offices in London, Stockholm, New York City, Amsterdam, and Berlin that invests from seed to growth across Europe and the US. You may recall seeing the news about Northzone closing a 1 billion fund last year, and it has backed over 100 companies, including names like Spotify, Personio, and Spring Health. Tom joined Northzone in 21, straight from Cooley, where he helped get the emerging companies team in Europe off the ground.

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1:40Join the Peak Show instead at EU.VC. This show is not investment advice and the hosts of this episode may be invested in the funds and companies featured. So, Tom, I met you down in Bucharest and I'm very happy that I did because now we're going to be interviewing about all the topics that we tried to talk about in a bar that was far too loud for that to be a really productive conversation. So, Tom, let's start where every conversation here on EUBC starts. How did you break into venture? So I think the long version of the story probably starts off with the movie Jerry Maguire. I don't know if you guys are familiar with that 90s classic.

2:20Beautiful work that everyone should watch around December every year. There are a few things I'll agree with more than that statement. I totally agree. I watched it as like a six, seven-year-old when it came out, and it just had like a super profound impact on me. You know, kind of the relationship that Jerry Maguire, for those that don't know, he's basically a sports agent. And, you know, the relationship he had with his clients, kind of how it goes beyond just the transactional, just had a huge impact on me. And he was a law student slash lawyer. So as a six, seven-year-old, I'm like, that's what I'm going to model my life after.

3:02I'm going to go to law school. And that's what I ended up doing. So yeah, Jerry Maguire had a huge, huge impact on me. And then when I was in law school, I started working with a startup. So this is 2011, so just over 10 years ago now, an online dispute resolution startup in Washington, D.C. And that was a very good experience. It was a super small team. It's basically a retired judge, myself and a couple of engineers. And the company, you know, it's not really operating anymore, but it was a great experience. And I learned a lot, including a couple of important lessons. One is a big market doesn't necessarily mean a valuable market.

3:53I think WeWork is a good reminder of that. I literally have a friend that's building a business doing exactly that right now.

4:07Let's just copy-paste this little bit of the episode and send it to him. Doing an online dispute resolution startup. Yeah. So I'd love to speak with him. Because I think it's such an interesting space and you can definitely do it right. So maybe... How cute. I'll shoot this. We can think about that. So this was one of the first ever online dispute resolution startups or companies. And again, run out of D.C., great guy, the founder, a retired circuit court judge in the U.S. But yeah, it kind of printed on me two lessons. One is big market doesn't necessarily equal a valuable market. And the other lesson really was you need people who understand how to build businesses around you in order to build and scale a high growth business.

4:59So I said, well, how can I kind of become a person like that? I'll go back to London and join a law firm called Osborne Clark, which at the time had a top rated venture practice in the UK. So, yeah, that's kind of the long version of the story. You shared the Jerry Maguire inspiration, which felt like a pivotal moment, but I'm going to ask the question again, hoping there's another one in there. Share what's a pivotal moment in your life and how it has shaped you today as someone working in venture. I guess let me start off by saying that maybe an obvious statement to you and the listeners, which is that lawyers are known as being very risk averse, risk averse naysayers who don't really speak like humans.

5:42and a pivotal moment in my life was when I realized it didn't really have to be that way. So I was working with a company called Panacea on their seed round and one of the investors was represented by a guy called Ryan Naftalin who was a partner at Cooley and he just moved to London from the US. For those that don't know, Cooley is a big West Coast law firm, probably the most active firm when it comes to venture investments globally. And one of our core sponsors. No, wait, they're not, Tom. They need to do venture out there. They should be. I was going to say, they actually have great, it's mostly for founders.

6:25I don't know if they have stuff for fund managers as well, but they have great playbooks and resources and a bunch of stuff available. So one thing that I recommend to a ton of people is their kind of online document automation service. It's totally free, totally open sourced. And if you're in the UK or the US and Singapore, I think, you can create a whole suite of incorporation documents when you're starting your company, but also kind of employment agreements. And we can get into this sort of stuff later, but... I'll be sharing everything about it in two months on the podcast when they're sponsored.

7:00Yeah. Yeah, let's do a combination for them. But yeah, it was a great experience working with Ryan on that deal. And he convinced me to join his team as one of the first employees of Cooley in Europe. And working there was a great experience. And it really kind of underlined two things for me. One is that in order to become a good advisor to high growth companies, whether you're a lawyer or investor or another advisor, I think you really need a lot of experience across a lot of companies, across a lot of different stages, and across a lot of different cycles. So that sort of experience basically takes time to develop.

7:51In Europe, we're obviously getting there in terms of people that have that kind of holistic view. But compared to the US, it's still pretty nascent just because our industry is a bit more nascent. And we haven't had as many companies as the US that have gone public, for example. So that was one thing, having the right level of experience, which he and Cooley more generally certainly have. And the other was having a mindset of, hey, I'm really going to try to help this person in a proactive way when you're dealing with founders. So I think there is a difference between kind of the US approach to being an advisor slash lawyer to high growth companies and the European one.

8:37I feel like the UK, like with many things, is kind of a bit of a halfway house. But I think generally speaking, and it's, you know, it's tough to kind of generalisms are always dangerous. But generally speaking, I think that European lawyers in our industry, so when you're advising high growth companies and their founders and investors, European lawyers tend to be a little bit more reactive as opposed to proactive. Also more risk averse, a bit more kind of black letter, let's stick to the letter of the law sort of thinking. whereas in the US they're just more business advisors which is why in the US the general counsel will typically attend board meetings whereas in Europe that's not typically the case.

9:26I'd love to go super off script and put you on the spot but I have to ask this because like two weeks ago I was in an event where there was a legal tech entrepreneur talking about AI and this is not the topic of today's conversation so let's make this a small side comment I'd love to ask you what in your worldview what's the future of AI within the legal space uh what role can it play uh and let's try and keep it short I know it's a really tough question I'm putting you on the spot here but I'd love to have your quick thoughts so it's something I've thought about a lot uh and this is also informed by kind of my experiences with that online dispute resolution startup I mentioned at the top of the show I think the potential is huge um because so much of what lawyers do in big law firms can be commoditized.

10:16So the potential is huge. I think the barrier are lawyers and are the incentives that drive big law firms. And again, lawyers tend to be very risk averse. It's only until fairly recently that big law firms have started using Google Drive to share documents as opposed to pinging Word docs to each other over email. Now, Slack, I know, you know, is also not a common kind of tool within law firms. So I think generally speaking, lawyers are very risk averse when it comes to new technology, particularly if there's kind of no human to oversee it. So the potential is massive, but I think it will take a long time for it to filter through to the way bigger law firms operate.

11:02I'm going to take us through the script so that we actually manage to get through everything. Because as you just said just before, and that was what I was about to say, Tom, you are not the average lawyer. So I'm really excited about this. And we're going to get knee deep into some of the company building stuff that you normally don't get the advice from from general counsel in Europe on. So I'm really excited about this. But first, let's go to the Take a Stand section.

11:30Take a start.

11:39Now, Tom, I would love to ask you to comment on this quote from Sean O'Sullivan from SOSV. Entrepreneurship, it's a blood sport. The founders are constantly battling in the arena and ultimately the majority of them are not going to be successful. I think there are a couple of ways to interpret this. One is less controversial, the other more controversial. So I'll focus on the more controversial interpretation. And, you know, the less controversial one is a very obvious one, which is that it's super hard to build and scale a business. And there are going to be people on the show who can speak to this way better than I can.

12:14But, you know, going from, you know, zero to one million ARR is one thing, but it's super hard to go from one million to 10 million ARR. And that's when most companies fail because you need to shift your mindset from let's hustle and build some traction to we really need to win. And the best founders are obviously able to do this. So building a company, super hard, very uncontroversial statement. The more controversial statement is that or interpretation is that it's super hard to turn a company that's developing negatively. So once the rod has started, it's just very difficult to reverse. You know, if an investor asks for a multiple liquidation preference when they put together a round, you know, like a 2x preference, say, the next investor is probably going to ask for that too.

13:07And before you know it, your employees are going to be totally out of the money. And they know that. Negative emotions will seep in. Investors, the seed investors will be upset. that they'll start losing trust. And once trust starts to break down, it's very difficult to reverse. It's really a vicious cycle. I was about to say on that note, we've just seen Cruz pausing their stock auction program just this morning after having a major blow up, of course, or rundown, if I should call it that. Yeah, probably the latter. It's interesting though, because I've seen companies that are profitable or near profitable who are trying to build around, but where the stakeholders around the table have just lost trust in each other.

13:56And the result is a very complex funding round with a very complex capitalization structure, which is going to lead to more complexity and more negative emotions and those sorts of companies dying. I've seen that a number of times. Whereas conversely, I've seen companies that have worse performance metrics, same stage, same economic environment, that, you know, where the stakeholders do have trust in each other and they're able to build a good round and live to fight another day. And I think like the difference between the two is really the founder and how he's able to manage or how she's able to manage their stakeholders and build a high functioning board and keep everyone happy and everyone aligned.

14:40So a founder, you know, really plays like they're the difference between those two outcomes.

14:50So Tom, you just hinted, just made my life super easy. You just hinted to the main topic that we want to deep dive into, which is high-functioning boards. And I think I'd start with a very macro question to kind of set the stage for everyone listening in, which is, you know, from where you're standing, what is an effective board? What does it look like? And then we can deep dive on, okay, as an operator, as a founder, as an entrepreneur, Or how the hell can you go around building that? Sure. So I think this is a super important topic. And I think there's a real lack of understanding among founders and also investors around what an effective board should look like, let alone how to build it.

15:32You know, many founders, I'm sure this chimes with your experience, see board meetings as a massive time sink. You know, they treat meetings as sort of state of the union where they just run through the board pack. And it doesn't have to be that way. And I think investors, we always talk about how can investors provide value. It's such an overused phrase in the industry. But I think one way investors can really provide value is by helping founders build and maintain a high-functioning board. So to your question, how do you create a high-functioning board? I think ultimately, lead isn't structural, it's social, and it boils down to the founder creating a culture of transparency, collaboration, and frankness.

16:17Now, throughout the company's life cycle, you can make structural changes to foster board effectiveness. You can bring in a chair, you can start having subcommittees, you can change how many times the board meets and how long board meetings last. You can do all of that sort of stuff, but generally the key determinant in terms of high functionality will be the culture that the founder imprints. And just before we get to kind of ways you can create that sort of culture, so kind of tips to do that, I just quickly plug a really excellent piece of work that Laura McGinnis at Baldurton put together.

16:55It's essentially a 101 guide for founders covering some of these structural tips. and also it has some like super helpful templates and checklists. So maybe we can link to that. Yeah, we always put this kind of thing in the show notes, both saying that to you, Tom, but also to the listeners here. You know, whenever you hear something, it's typically in our show notes, so don't worry. Awesome. But yeah, it's a great resource that was very well researched and it shows. I know you know them by heart because you work so much with this. So I would actually love for you to just tell us, you know, give us your tips for the top founders here to when it comes to establishing the right culture.

17:35If you would take us through those, just the ones that you find most important. Sure thing. So I think the most important one is building trust with the investors. And, you know, it's really about being honest about your weaknesses, where you might have gaps in your knowledge. Be honest about what might not be going so well. And it's a two way street. And I think Fred Destin on your show, I think over the summer, talked about how it is a two-way street and investors should be more willing to give founders the benefit of the doubt as opposed to just thinking that, you know, they're ill-prepared or they're not willing to be vulnerable.

18:14Number one is like the top tip is just be honest with your investors and really seek out their help. something we hear a lot as well both on our podcast but whatever event you go that has you'll hear this like the potential value you can destroy as a board member like it clearly outweighs the potential value you can create as a board member right and and and i've heard of many stories and and i can't really disclose names but i was talking with with investors that i really look up to to be honest and one of them was telling me well i had this board member that you know at a later stage he just joined the board and i was like this this is a vc right early stage i was like my jaw dropped at the amount of value this this this board member was adding from day one and i was just like in awe of this dude and then eventually we uh he actually recommended the cro and the cro of that company actually ended up almost kind of leading the company to to implode right and so and this is not to say that was actually a bad board member no it goes to show So like the potential value that you can destroy is so high that you really need to be careful.

19:21So I'd love to ask, you know, you gave a tip from top tip from a founder perspective. How would you how would you tackle it from the investor perspective with this background? As an investor, you can be super helpful to a founder if you help the founder navigate their board and help the founder see things that they might not automatically see, you know, help them identify where incentives might be misaligned among the other members. help them understand that, for example, one investor might be pushing for an exit because he needs DPI or she needs DPI, whereas the other investors are saying, no, let's raise some more money and extend runway and not sell.

20:02One investor might be a strategic investor who might want to buy the company. They're not saying that explicitly, but maybe they are. So I think as an investor, if you're able to separate your roles, because they are two different roles, right? You're wearing your board hat and your investor hat. If you're able to separate the two and as part of your board hat, help the founder understand how the board ticks, how to make it work better, how to solve for misalignment, how to bring people together. I think that is incredibly useful. On that note of it being two roles, because yes, you're right, the function of the board is to take care of the company.

20:42The function of the investors is to take care of your own shareholdings. How do you kind of navigate that yourself, but also how do you talk about that inside North Zone and navigate it as a firm? Different funds approach this differently. Like some funds, they really delineate heavily in terms of their internal operations between these two roles. At Northstone, the person who, I mean, obviously it's a partnership that makes investment decisions about whether or not to, you know, to participate in a round in Northstone company. So it's kind of the collective that decides. But in Northstone's case, it's the person who's on the board, whose company it is for internal Northstone purposes and who's pushing for that financing to be made by Northstone into that company.

21:35But yeah, it's a tough dance for any investor. Could I ask you to comment on something, Tom? Again, I'm quoting someone which I cannot name. I was told recently that the best founders treat the board as their employees. Could you comment on that from your perspective? It's a very interesting quote. I'm trying to kind of figure out how I think about it. Just to give you time to also kind of digest it and reach mine, the context was very much of, you know, they treat them as employees in the sense that they're not necessarily sitting and waiting for the board members to come and add value. No, they're very proactive in saying, okay, this is what we need.

22:12And I think you specifically can help with X, Y, Z, you know, very proactive as a founder right in the board. Well, a couple of thoughts on that that just popped into my mind. And so one is, I love that. And one of the most high functioning boards I've seen involved the founder starting off board meetings with basically like giving investors points based on whatever they had done in the period leading up to the board meeting. Harry Potter, Hogwarts house style. Creating that sort of accountability. And also a bit of obviously investors are competitive or can be at least. Exactly. We should start the UBC episodes.

22:54Yeah. Start the UBC episodes giving points on preparation. Yeah, totally. Tom, you've done a great job. So everyone, if you want to, you can, you know, I was about to say, if you turn on the video, if you're watching this on YouTube or on EU.vc, then I'll share my screen and then you can see it. That's what Tom did. He did a fabulous job. So I love that. That's sort of like creating accountability. and I also again it goes back to the point I was making around kind of honesty transparency frankness vulnerability right with your employees you'll be that right because you know one dream one team one dream sort of thing right so so if you if you have that sort of same candid relationship with your employees as you do with your board members, I think that's a good thing.

23:46I'd love to take us to your key tips to foster board effectiveness because we've been kind of going around it now, but as I just said, you've done your homework. So I have seven beautiful bullets here, and I would love for us to really have the time to get through them and talk about them. So please, Tom, take the floor and really, really tell us, lead on us. I know I included a number of points here. In the interest of time, I'd probably focus on the three biggest ones from my perspective. So one, kind of echoing something I said earlier, be aware of misalignment among your investors. As a founder, that is super, super important.

24:28Know where, for example, a fund is in terms of its own fundraising process. How is that dictating or shaping the way that investor is making decisions? So be aware of misalignment, super, super key. The second one I'd say is use each fundraising as an opportunity to level the board up. This often doesn't get done. Virtually every fundraising I've seen has been, let's just get it done as soon as possible so that we can focus back on running the business and let's forward all of the stuff that we have. Let's forward the board, You know, just roll it forward. You know, and when you're getting new money in and you're recutting governance anyway, that's really the best opportunity to, you know, have a discussion and some thinking around, hey, is the board fit for purpose for where we are as a company and where we want to go?

25:29And again, the best time to do it is at the term sheet stage, because you can use the new money as kind of a forcing mechanism to make that change happen. It happens fairly rarely that that tough discussion around what the board should look like post-close takes place. And if it doesn't take place at the term sheet, it typically doesn't take place at all, you know, in the context of that round. Second top tip is use of financing as an opportunity to level the board up. I'd say the third one is I think it's very useful for the board to evaluate itself annually. maybe not annually, but let's just say regularly.

26:08I think annually is a good starting point. And kind of depending on how complex the company is operationally, you know, the focus should be on kind of the board, the subcommittees, but also the directors individually. A good way I've seen this done is where kind of an independent director has candid interviews with all of the board members, you know, or all of the subcommittee members kind of collates the feedback and also compares that to benchmarks across the industry, across similar companies. So I think like an evaluation process is a super useful thing to do as a board. Oftentimes board roles are given on the back of shareholdings and rights slash positions when you do a round rather than competence and value add and so on.

27:01I'd love to ask you, or as you say here, based on being independent. So I'd love to ask you, how do you think about that and how do you advise both VCs to manage that process of putting together the board? There are a few ways to think about this. One is you want to make sure that your board is strategically aligned from day one. So whenever you're doing a new round and there's a new investor who's joining the family, make sure that that new investor who's likely going to be on the board is a good fit and is making your family stronger. Make sure you're strategically aligned. And typically that's also, it goes back to incentives, right?