Before pitching your business idea to investors, you need to know what the relationship will entail. Investors don't just provide funding; they're also valuable partners—and that comes with certain expectations.
Accepting funding from investors puts you in a fiduciary role in which you’re responsible for managing their money and putting their needs above your own. It also requires acting ethically, leading effectively, and fulfilling your fiduciary duties.
Here's an overview of your business's fiduciary duties to investors and how to fulfill them.
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Your investors will want a positive return on their investment, which requires your business to succeed financially. In providing funding, investors trust you to use their capital wisely. To avoid derailing the relationship by focusing on personal interests, it’s crucial to abide by your fiduciary duties.
A fiduciary duty is a responsibility to honor investors’ trust in your company. It’s related to how you use investments and maintain integrity in communications.
“Rather than require specific outcomes–such as achieving maximum share price–fiduciary duties are largely about conduct, process, and motivation,” says Harvard Business School Professor Nien-hê Hsieh in the online course Leadership, Ethics, and Corporate Accountability.
If you’re in the early stages of securing your startup’s funding, here are four fiduciary duties you must understand and uphold.
4 Fiduciary Duties to Investors
1. Duty of Obedience
The first duty is obedience, which encompasses adhering to corporate bylaws, superiors’ instructions, and the law.
“This duty applies not only to CEOs, board members, and others in fiduciary roles but also to employees in an organization,” Hsieh explains in Leadership, Ethics, and Corporate Accountability.
When funding your business, investors reasonably expect it to have bylaws that you and your employees uphold. This helps prevent fraud, which can be detrimental to your company's success.
The exception is when legality takes precedence over bylaws. When following a superior's instructions or a company memo necessitating illegal action, the duty of obedience demands obeying the law.
2. Duty of Information
Investors don’t just fund products; they also invest in teams and ideas. Because of this, it’s critical to avoid misleading them about your products’ success. The duty of information requires disclosing necessary information and being truthful.
“Fiduciary duties are meant to ensure that investors can trust executives so they’re willing to provide the financial capital necessary to start and grow businesses,” Hsieh says in Leadership, Ethics, and Corporate Accountability. “This, in turn, can benefit not only investors and corporations but also customers, employees, and society.”
You must uphold two duties of information:
- Candor: The obligation to be open and honest with shareholders.
- Confidentiality: The refusal to share confidential information when necessary.
An example of breaching this duty is greenwashing, which is misleading customers or investors about a product's environmental impact. It can be damaging to investors who prefer to fund sustainable businesses and negatively affect your reputation. Given that the majority of startups fail, you often can't afford negative press.
“For entrepreneurs, one challenge is to avoid moral disengagement and crossing the line from 'fake it till you make it' to fraud,” Hsieh says in the course, “even when there’s great pressure and temptation to do so.”
3. Duty of Loyalty
The third duty is loyalty, which requires acting in shareholders' best interests.
It requires avoiding potential conflicts of interest, which occur when you directly benefit from acting on your company’s behalf.
“As a general matter, the duty of loyalty requires a fiduciary to place the beneficiary’s interests ahead of their own," Hsieh says in Leadership, Ethics, and Corporate Accountability. “This means the fiduciary should act in a disinterested manner and refrain from engaging in any activity for personal gain at the expense of a beneficiary.”
Conflicts of interest to avoid include:
- Self-dealing: Capitalizing on your position to benefit from transactions. Doing so can violate your duty of loyalty and have legal consequences.
- Insider trading: Using your access to nonpublic information to benefit personally. This violates your duties of obedience and information because it's illegal and involves sharing confidential details.
Acting in self-interest can breach multiple duties. In addition to being illegal, it can damage your reputation and upset shareholders.
4. Duty of Care
Careless decisions can be just as damaging as intentional fiduciary responsibility violations. The duty of care requires evaluating decisions’ potential outcomes before taking action.
“As a general matter, the duty of care requires that corporate officers and directors exercise diligence when making decisions, acting, or managing resources on behalf of the company, partners, or shareholders,” Hsieh says in Leadership, Ethics, and Corporate Accountability.
When founding and scaling a business, it's vital to understand the difference between risk and negligence. Investors understand the inherent uncertainties of funding a venture but expect you to avoid exacerbating risk through carelessness.
Similar to obedience, information, and loyalty, breaching the duty of care can pose legal challenges, depending on the degree of negligence.
The Importance of Avoiding Fraud
Despite being detrimental to business success, fraud commonly occurs. It's estimated that corruption is found in 32 percent of small businesses and 43 percent of companies with more than 100 employees.
It can originate from leadership (for example, at Theranos and FTX) or employees (like at Wells Fargo).
Even if a company doesn't fail because of deception, the financial damages can be difficult to recover from—especially for startups. It's estimated that owner and executive fraud costs companies a median of $850,000, and businesses lose an average of five percent of total gross revenue annually because of fraudulent behavior.
Carrying out your fiduciary duties of obedience, information, loyalty, and care can go a long way toward promoting ethical behavior within your organization and preventing fraud.
Learn How to Create an Ethical Corporate Culture
A large part of adhering to fiduciary duties is creating an ethical corporate culture. Prioritizing business ethics is critical not just to fulfilling your fiduciary responsibilities to investors but also to increasing the chances that your venture will succeed.
If you're interested in developing the skills to become a more ethical business leader, consider taking an online course, such as Leadership, Ethics, and Corporate Accountability. Doing so can enable you to fulfill your responsibilities to customers, employees, investors, and society and achieve long-term success.
Ready to learn the tools needed to fulfill your fiduciary duties? Enroll in Leadership, Ethics, and Corporate Accountability—one of our online leadership and management courses—and download our free e-book on how to be a more effective leader.
