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November 4, 2018 - January 5, 2019
Conflict avoidance often leads founders to make easy short-term decisions; they succumb to the temptation to sidestep or postpone acknowledging—not to mention resolving—these dilemmas, especially if coming to a decision would require difficult conversations about what could go wrong.
They need to expect the best while preparing for the worst and to make decisions strategically rather than reactively. Founders may repeatedly find that simply following their instincts will prevent them from thinking hard enough about their decisions and the consequences of particular paths of action.
Founders who consistently make decisions that build wealth are more likely to achieve what I call a “Rich” outcome (greater financial gains, lesser control), while founders who consistently make decisions that enable them to maintain control of the startup are more likely to achieve what I call a “King” outcome (greater control, lesser financial gains).*
Before following their passions, potential founders should step back to answer the pre-founding questions we will tackle in this chapter: 1. Should I become an entrepreneur? 2. If so, when should I make the leap into founderhood—early in my career or after I accumulate more career experiences? 3. How can I dispassionately evaluate my idea?
market issues (“Is my idea good enough, or is my passion for it misleading me?”).
As we will see below, the lack of one or more “capitals” can create a hole that must be filled when building a successful startup.
More years of schooling is indeed linked to a greater likelihood of becoming a founder; after surveying a wide range of evidence, Professor Scott Shane concludes, “Including professional school, getting more education increases the likelihood that a person will start his own business.”16
An executive’s functional background can also have a powerful effect on the company’s strategy and focus. In particular, when company executives have backgrounds in “output functions” such as marketing, sales, and R&D, the company tends to emphasize product innovation, related diversification, and advertising. Conversely, when company executives have backgrounds in “throughput functions” such as production and process engineering, the company tends to emphasize automation, up-to-date plants and equipment, and backward integration.
Past research has suggested that founders who launch startups in industries in which they haven’t worked raise less capital, have lower employment growth, and have a higher rate of failure than founders with prior industry experience.
Even seemingly innocuous terms he had taken for granted took on opposite meanings. Finding himself confused during a meeting, he finally realized that when businesspeople use the term “burn rate,” they are referring to the amount of cash being used up and they want to keep it to a minimum. For a baseball pitcher, “burn rate” is the speed at which you can throw the ball—the higher the burn rate, the better. After grappling with each confusion, Curt struggled to figure out his disconnect and begin adjusting his mental model, only to find further disconnects between his old mental model and his
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“Prioritization is even more important [in a startup] than in a stable business,” said Barry. “I realized that I needed people to not only prioritize what to do, I needed them to create not-to-do lists.
The likelihood of an employee leaving to become a founder has also been linked to the employee’s own performance. Employees whose performance was in the middle of the distribution were the least likely to leave; the most likely were the poor-performing employees (the “slugs” whose pay wasn’t high and who had the least to lose by leaving to found a startup) and the high-performing employees (the “stars” who had the potential to earn high wages by becoming self-employed).
Market potential: Are customers willing to pay for such a product or service? How big is the market? Is it growing?
Competitive landscape: Is it favorable? Are many companies competing for scarce resources?
“Ticking clock”: Is there a ticking clock that requires me to move quickly to pursue my idea? Is the window of opportunity about to close?
Ticking-clock industries include (a) those in which products and services are quickly derived from and just as quickly outdated by technological or scientific advances, (b) those with strong “network effects”—that is, the value of the product increases as more people use it,54 and (c) those with significant economies of scale.
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Clouding Judgment: Passion and Optimism
In a survey asking entrepreneurs to compare the prospects of their startups to those of similar startups, 95% of the respondents believed that their own startups had a better than 50% chance of succeeding, but only 78% believed that a similar startup had the same chance of succeeding.
Most of these lies have to do with founders’ oversized confidence and naïve expectations, from their projections of revenue and market size to their “proven” management team to their lack of competition. When an entrepreneur says he or she will make $50 million in four years, explained Guy, “I add one year to delivery time and multiply [the revenue] by .1.”64
Steve Jobs, cofounder of Apple Computer, was fond of saying, “Follow your heart, but listen to your head.”
Experienced entrepreneurs seem to be more likely to use “effectual reasoning,” wherein they start with a given set of means—their personal strengths and the resources they already have at hand—rather than a predetermined goal, and then allow opportunities to emerge to which they can react. In contrast, non-entrepreneurial executives tend to use causal reasoning, in which they set a goal and then seek the best ways to achieve it. For more details, see Sarasvathy (2008).
board. Here, the founder’s instinct (or prior experience) is backed up by Arthur Stinchcombe’s groundbreaking article on what makes new organizations especially prone to failure.
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Three of the four factors he identified were repercussions of forming a founding team: cofounders were often challenged—and often undone—by the need to (a) learn new roles within the founding team, (b) negotiate the distribution of economic rewards among themselves, and (c) form trusting relationships with strangers (i.e., each other).
“Maniacal drive by a benevolent founder is a solo activity!”
As highlighted by Stinchcombe, the larger the team, the greater the coordination costs and the higher the risk that roles will overlap and cause conflict within the team.
However, as captured by founder and investor Jeff Bussgang’s “jungle, dirt road, and highway” metaphor,
company. The psychology of a family unit can really create an impasse in the growth of a company. Friendships can also suffer, though to a lesser degree, as people try to balance being nice and being business.”
Likewise, risk tolerance is hard to measure, but incompatibilities in risk tolerance can be stressful or even fatal in anything as inherently risky as founding a startup.
“In my opinion, those who found companies with friends will (a) lose the company, (b) lose their friends, or (c) lose both. I strongly advise against it and shy away from deals where the teams are too tightly knit on the personal side. Blood [family relationships] is almost always a show-stopper.”
For example, each additional social relationship (i.e., a preexisting relationship not involving shared work experience) within the team increased the hazard rate—that is, the likelihood—of cofounder departure by 28.6%.
Most surprising, teams with prior social relationships were even less stable than teams of strangers.
However, the picture that emerges from the data is that founding with coworkers can be beneficial, while founding with friends or family is a high-risk, “high-variance” proposition. (The complexities can multiply when a team includes a mix of these prior relationships.)
At worst, the cofounders make suboptimal business decisions in order to protect their social relationships, but as the business suffers from those poor decisions, tension rises and the social relationships suffer, too.
Business historian Richard Tedlow, paraphrasing John D. Rockefeller, puts it succinctly: “A friendship built on business can be glorious, while a business built on friendship can be murder.”
“I don’t mix friendship and business anymore. It’s turned out very uncomfortable in the past. It’s very hard to maintain a friendship after the business relationship turns sour.”
“Because they are your most trusted friends, you can be almost 99% open with them. But somehow there is 1% out there you think you will risk hurting them if you say it. It is exactly this 1% that makes all the difference.”
“We trust our friends too much at times; founding with a stranger will force a person to critically assess both the idea behind the startup and what their own personal role will be. The startup will be viewed not so much as an exciting fun project with a bunch of old coworkers and friends, but as a business proposal with significant career risks.”
The mistaken assumption that friends and relatives will be able to make a smooth transition to a cofounding relationship can be very dangerous if it leads the cofounders to avoid tackling sensitive issues up front.
The Benefits of Egalitarianism Some teams prioritize team cohesion and early trust building and believe that these will be facilitated by a collective decision-making approach. Other teams see collective decision making as the best way to avoid mistakes. In the dynamic, high-velocity environments faced by high-tech entrepreneurs, dominant, autocratic CEOs are likely to be less successful than their less dominant counterparts. In a study of 26 large firms in the innovation-intensive computer industry, CEO dominance was associated with a 19% decrease in firm performance.7 Similarly, a study of
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Echoing this metaphor—and highlighting the trouble that duos have resolving a split (1–1) vote—one founder said, “One thing I am clear about now: Two people at the wheel is the worst way to drive. You end up going straight when either a right or a left would be better.”
Another founder said that tensions between him and his cofounder harmed both the startup’s exit value and their personal relationship. “We finally managed to get an exit for the company, but it cost us a lot in our personal relationship and, worse, the outcome of the company to which we devoted years of our lives. Arguably the exit was substantially less than it might have been had we been of one mind or had we ‘fallen into line’ with one of us being dictator sooner.”
Even when there seems to be clarity within the executive hierarchy, this clarity can be compromised when non-CEO founders serve on the board of directors. If one founder is CEO but other founders are on the board, it is less clear that the CEO has the final say within the executive team. Similarly, if the CEO has a subordinate who is also on the board to which the CEO reports, their power relationship can be unclear. Having a non-CEO founder on the board can even interfere with the board’s effectiveness. For instance, if a founder-CEO who is facing challenging cofounder issues wants to get the
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Another founder echoed that “a quick handshake is a symptom of inexperience and/or lack of real preparation, or real glue to the idea, before going on the ‘tough journey.’ ” We’ll see examples later in this chapter of founders who regretted making an equal split.
“We spend time during our diligence process understanding how the split came to be” (e.g., whether it had resulted from a quick handshake); whether the split had “led to suboptimal behavior,” indicated weaknesses within the team, or introduced additional tensions within it; and whether those issues should affect the startup’s valuation.
Setting the early equity split in stone, without allowing for changes, is one of the biggest mistakes founders can make.
Each founder places more value on his or her own contributions than on the contributions of the other cofounders, knowing the cost and extent of his or own efforts in a way that he or she cannot know the cost and extent of others’ efforts.
Such trust, if it has had a chance to become strong before tension-filled problems arise, allows cofounders to act outside their immediate self-interest—above and beyond the call of duty—confident that, in the longer term, they will reap as they have sown.
Although it is easy for cofounders to assume that they will always trust each other, the trial by fire of founding a startup often burns a team instead of forging a stronger team.
startup. For business-oriented founders, the milestones may pertain to fund-raising, customer acquisition, revenues, or the establishment of partnership agreements. For technical founders, milestones may be tied to completing a prototype, conducting a successful beta test, or introducing the full initial version.
Better to find out sooner that the team has insurmountable difficulties making tough decisions together than to find that out after each founder has sunk a lot of time and money into a doomed startup.
