The Founder's Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup

by Noam Wasserman

Used to being peers on a social basis, such cofounders tend to transfer the peer relationship to their professional relationship within the startup.

mutual [professional] trust for each other.”

there is an inherent difficulty in aligning roles (or rewards) with what is actually the lack of a relationship.

adopt a clear division of labor in order to circumvent uncomfortable ambiguity.

“You need history if you want to do overlapping roles; if you don’t have history, it’s probably better to go for more defined roles. If you have overlapping roles [but no history together], you start to loo...

if a founding team included at least one set of family members, it was more likely to split the equity equally.

family relationships can skew equity stakes: When a core founder included a family member on the founding team, that family member received an equity stake that was 1.11 times the stake of a comparable non-family cofounder.2 This can make for a serious misalignment if the family and non-family cofounders are not actually making roughly equal contributions to the startup.

founding teams can be categorized as operating under a social logic or a business logic, depending on the type of prior relationship shared by the cofounders. For teams operating under a social logic, preserving personal relationships takes precedence over maximizing business success; for teams operating under a business logic, maximizing business success takes precedence over preserving personal relationships.

a husband-and-wife founding team has to care about growth and profits, but such a team (if it is truly operating under a social logic, as one would expect) would choose a suboptimal business outcome if the optimal outcome could be achieved only at the cost of their marriage. When it comes to splitting equity, teams operating under a social logic will find the rule of equal distribution—distributing rewards equally, even if individuals have very different levels of contribution4—to be most aligned with the priority they give to their relationships.

Equity theory ultimately concludes that the best equity split for one type of team could be the worst equity split for another type of team, depending on the dominant logic operating in the specific circumstance.

Within the group of teams with prior social relationships (i.e., the ones presumably operating under more of a social logic), the most stable teams (i.e., the teams that are still fully intact after various amounts of time) tend to be the ones who split the equity equally. In contrast, within the group of teams with prior professional relationships (and presumably operating under a business logic), the most stable teams tend to be the ones who split equitably.

Without knowing the cofounders’ prior relationships, we can’t state categorically that an equal split is better or worse for team stability than an unequal split. Knowing the type of relationship, however, does indeed lead to a particular approach to splitting that seems better aligned for team stability.

Such teams have much to gain by holding off their equity split until they have learned a lot more about each other, although they may pay a price for this benefit by sacrificing some of their ability to attract key cofounders (as did the Smartix team when it waited to split and thus lost the potential cofounder who had deep knowledge of and contacts in their industry).

dynamic equity splits are an invaluable way for such teams of unfamiliar cofounders to deal with the trade-offs between attraction and motivation when facing the challenges of founding a startup.

Overlapping, nondistinct roles make it harder for cofounders to determine the value that each has contributed or will contribute to the startup and therefore make it more likely that the team will decide to split the equity equally.

founder-CEOs receive a CEO premium (i.e., an additional amount of equity for being CEO) of 14 to 20 percentage points.

premium for founder-CTOs is lower—5 to 8 percentage points—but also highly significant from a statistical perspective.

idea premium discussed in Chapter 6 may also be, in part, a premium for adding greater value to the startup by initially articulating its vision, attracting other cofounders, and completing other critical early tasks often performed by the idea person. (Founders who serve on the official boar...

this need to make trade-offs between (a) roles and decision-making control and (b) financial rewards recurs throughout each of the key dilemmas faced by founders, beginning with the first decisions they make regarding when to found and how to build their founding teams and continuing through the hiring, investor, and exit decisions that we will discuss in Part

Equity stakes are a scarce resource, and the allocation of equity is usually more efficient when the team has distinct roles than when the founders have overlapping roles and are therefore somewhat redundant.

Thus, early inefficient uses of equity rewards within the founding team can leave the team handcuffed when it needs to fill necessary roles.

“Three Rs equilibrium” in which tensions will tend to be low and the team can focus on building the value of the startup.

Communication Relationships, roles, and rewards are all sensitive issues that most teams try to avoid discussing.

Change Startups regularly face unexpected changes in personnel, competition, technology, economic conditions, regulation, and so on. Even if a team has achieved early alignment, it must be ready to adapt its arrangements or must have done the hard work early on to craft effective dynamic elements in its agreements, so that it can realign itself after the unexpected happens.

Inertia Although early alignment can contribute to early success, it can also cause inertia and complacency that prevent effective adjustments to rapid shifts in the organizational environment.11

proactively look ahead to the changes that will be caused by startup growth and evolution, plan for those changes (e.g., by setting expectations about when each founder might relinquish his or her C-level position), and regularly reassess the alignment of those arrangements.

force themselves to plan for the worst and to vigilantly watch for signs that their Three Rs equilibrium has fallen out of balance and needs to be reevaluated or renegotiated.

Startups then go through a transitional stage that is most clearly characterized by two inflection points that affect the degree of formalization and the availability of resources: closing on the initial rounds of outside funding and completing the development of the first product. Both changes add resources (outside capital and customer revenues, respectively) but also call for new skills and processes within the organization. The division of labor deepens and decision making increasingly shifts away from the founders.

mature stage, it becomes relatively well funded and usually has a steady revenue stream from a standardized product or service line. Decision making is decentralized across functions and becomes more hierarchical; there is much less of a premium on flexibility.

Building something from nothing requires a different skill set.”

divide between “doer” and “manager”

I realized that in an early-stage company, there’s no such thing as a manager. Everyone is a contributor, including the CEO!

founder-CEOs are much less likely to have four years of vesting and more likely to have no vesting or only one year of it than nonfounder-CEOs are, even after investors have entered the picture.

investors may feel less need to impose “golden handcuffs” on a founder they know would be most unwilling to leave.

in startups, money buys time: time to experiment, to collect and evaluate data about what worked and what did not, and to adjust the strategy and operations based on what was learned.