Fiduciary duty is a concept that sounds like dry legalese until it becomes the reason a founder gets sued. At its core, it is a legal obligation where one party is required to act entirely in the best interest of another party. In the context of a startup, this usually refers to the obligations that the officers and the Board of Directors owe to the company and its shareholders.
When you are bootstrapping a company by yourself, you are the board, the shareholder, and the CEO. You can do whatever you want with the money. You can take risks based on gut feeling alone.
However, the moment you take outside capital or appoint a board of directors, the dynamic shifts. You are no longer just a creative visionary. You are a steward of other people’s capital. You have a legal responsibility to prioritize their financial interests above your own personal gain.
The Core Obligations
#Fiduciary duty is generally broken down into two primary components that govern your behavior.
The Duty of Care requires you to make informed decisions. You cannot be negligent. You must exercise the same level of care that a prudent person would use in a similar situation. This means you must read the financial reports before the board meeting. You must consult experts before signing a massive contract. Ignorance is not a defense.
The Duty of Loyalty requires you to put the company first. You cannot use your position to profit personally at the expense of the company. If you see a great business opportunity, you cannot take it for yourself personally; you must offer it to the company first. This also covers conflicts of interest. You cannot hire your brother’s marketing agency if they are twice as expensive as the market rate.
Founder versus Fiduciary
#There is often a psychological conflict between being a founder and being a fiduciary. A founder is often driven by a specific product vision or a desire to change the world, regardless of the cost. A fiduciary is driven by the obligation to maximize value for shareholders.
These two drives usually align, but not always.
Consider an acquisition offer. Google offers to buy your startup for fifty million dollars. As a founder, you might want to say no because you want to keep building your legacy. As a fiduciary, if that offer represents a massive return for your investors and the risk of continuing alone is high, you have a legal obligation to seriously consider the sale. You cannot reject it simply because you are not done playing CEO.
Scenarios of Conflict
#The most common place where fiduciary duty is tested is during fundraising and insolvency.
When raising a “down round” (raising money at a lower valuation), the board has a duty to ensure the terms are fair to existing shareholders and that they aren’t just washing out early investors to save themselves.
If a company approaches insolvency, the fiduciary duty can shift. In some jurisdictions, when a company is in the “zone of insolvency,” the duty shifts from the shareholders to the creditors. This means you can no longer gamble the remaining cash on a hail mary marketing campaign. You might have a legal duty to preserve that cash to pay off the debts you owe.
Founders must understand that board minutes are not just notes. They are the legal record proving you exercised your fiduciary duty during critical decisions.