"Live" notes from Business of Software 2012 in Boston, October 1-3, 2012.
Let’s start with a happy topic: Failure.
Most companies fail. We wring our hands about it but we can’t do anything about it. Let’s accept it. However, there are some things we can learn about them that will let us move the needle and change that fact. Things we can think about that are key elements between success and failure.
What goes on in VC firms? How do they evaluate companies, do due diligence, bring founders onboard and join them, etc. What goes into being a successful investor? Research has shown that the key question is “Let’s take a look at the VC-funded portfolio companies that no one hears about. The failures. Let’s talk about those.”
Causes of Failure in VC-Backed Startups
35% of the reasons are product development, functional management, and market problems. The kind of stuff you’d guess would be the sources of failure!
65% of the reasons for failure were something else: People problems. Tensions between cofounders, or between founders and hires. For almost 2/3 of the failures, this people side was the key problem.
So I’ve devoted my last dozen years of research to understanding these people problems. How can we help startups make better decisions and avoid them?
When you’re founding, you don’t have a roadmap through these key decisions. The most you can hope for is for someone to wish you good luck :). And without this roadmap there are very natural intuitions you’ll be tempted to follow, gut, anecdotes, rules of thumb. And sometimes they’ll mislead you.
Favorite Steve Jobs quote: “Follow your heart, but check it with your head.” Those intuitions are the Heart element.
Founder’s Dilemma book has 3 dozen case studies. They inform everything. But they’re anecdotes. So we complement it with data on 10,000 founders. And we’ll see how various decisions led to success or failure of various kinds.
Phases of Core Dilemmas
- When to Found
- Building the Team
- New-Venture Hiring
- Beyond the Team
- Exit Dilemmas
We’re going to take a deep dive into a couple of these today.
Founding Team Dilemmas
You’ve decided to make the leap. How are you going to go forward and build your venture. What’s the first decision? Go solo, or build a team.
In the tech sector, only 16% of foundings are solo. So most people build a team.
Building a team introduces choices. We call these Relationships, Roles, and Rewards.
Hire your friends/family? It’s a very common practice. These make up more than 50% of the ventures in the dataset. The book calls this “playing with fire.” It can build glorious teams, but it can also blow up. If you decide to found with friends & family, there are things you can do to protect yourself.
Hire prior professional relationships/all-stars? This is the flip side of the friends/family decision.
Roles & Decision making:
Peter Pan lived in Neverland. Some companies do, too. Consensus, voting, “Co-CEOs.”
Another model, is the “Zeus” model. Zeus is on top and runs the show, makes the decisions.
As you grow, if you’re in Neverland, will you have to transition to being Zeus? Whichever approach you pick, the transition can cause problems when you have to adjust later.
What’s the highest-tension part of the founding decision? Equity; splitting the ownership. All sorts of challenges introduced by this decision.
Individual and team tensions are heightened or reduced by specific decisions in each of the three Rs, but they’re also interrelated. If you treat all three Rs as totally independent you’ll miss these interdependencies and discover the problems too late.
Founders are human. Humans have natural inclinations to things like conflict avoidance. Elephants in the room that we avoid discussing until they start to destroy the relationship(s).
73% of founding teams split the equity at the beginning (within a month of founding). To the extent that you haven’t figured out yet how the work will get done, setting it early can be risky. On the other hand, it gets the problem out of the way. The majority of those that split equity at the beginning also set it in stone.
Example: Zipcar. Split equally. Started by two women who met at daycare. Decided to cofound together. One founder (Robin) had heard a horror story from a friend about an equity split gone bad. So Robin was panicked about this and surfaced the equity issue as soon as we could. “We shook and said 50/50, and I thought everything was great.” Over the next 18 months Robin became the heart & soul of Zipcar. Her cofounder didn’t quit her day job and contributed little. So this created a lot of tension. “It was a stupidest handshake I ever made. Who knew what skillets we would need, what milestones we’d need to hit? That handshake became a major source of tension and a major distraction for me as CEO.” So punting on this decision without having a deep dialogue created a lot problems for them.
Example: Ockham Technologies (salesforce software). Group of 3 cofounders who had worked together before. They’d honed the ability to have tough dialogues together, and surfaced early on that they didn’t expect everyone to contribute equally – different skill levels, different industry knowledge. So they crafted an unequal split that acknowledged that: 50/30/20. But they also had a deep dialogue early on about their biggest uncertainties, the biggest risks they faced. They honed in on one: Ken (the idea guy) had just become a first-time father. So not knowing his startup life, he also didn’t know his family life and a day job he liked. So this team had a deep dialogue about commitment and about who could be on board. They took a series of scenarios into their founding agreement as a list of if/then/else cases. So they captured their key uncertainties and built a dynamic split into the agreement handle them.
There are several key levels of uncertainty in a venture.
- Is the strategy stabilized yet?
- Is the business model set?
- Are future skill requirements known?
- Are future roles set?
- Is each founder 100% committed throughout?
- Are there personal uncertainties for anyone?
If you don’t have all of these answered, research shows a dynamic split reduces tension and increases the chance of keeping a great team.
Two major ways to do it: Bootstrapping and Funding. Each leads to a bunch of ripple decisions.
Source of funding. Smart money vs. dumb money. Do you want money from people who have been there before, and who will try to steer your business even if you don’t like it, or do you want “dumb” money from people who don’t understand your business and will stay out of your way.
The Board. Controls decisions like who is going to be CEO, etc. Big decisions. The choice you make about capital has huge implications for how these decisions at the top of the firm happen.
Example: Wily Technology. Lew Cirne built a 50-person company and was able to raise 2 rounds from top VC firms. Revenues up, losses down. Lew’s reward: Fired. Had a pretty typical technical founder path, worked at Apple & Hummingbird. Was given 6 months to resign by one of the investors. First reaction was bafflement. Jack Dorsey (Twitter) described being fired as CEO as “Being punched in the stomach.” But as time evolved, Lew got over the shock. Negotiated to have veto power over his successor. 6 month search for a replacement becomes nine, then 12 months. After 13 months, they find a successor. Then the successor has final demands: way more compensation than Lew, and wants Lew to resign as chairman. Lew took the deal and Wily took an exit a couple years later.
Looking at the data on this, the rate of CEO succession increases after things we generally see as big wins:
- After product development is completed.
- After raising a new round of financing
What we’re really celebrating at those events is actually the chance our founder/CEO will be replaced.
"If the company tanks, I’m gone. If it’s a big hit, I’m also gone."
The Rich vs. King fork in the road. To become king by having more control over a small player, or become rich by having less control over a big player.
So these decisions lead to cumulative effects on the founder’s control over the company, and they have long-term effects that aren’t obvious at first.
What is motivating me to go and do this? Would I be more excited to give up control and be richer for it, or would I rue the decisions to give up control and rather celebrate being king of what I’ve built?