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November 4, 2018 - January 5, 2019
We also have prescriptive expectations that a friend or relative will not hurt our feelings, will not double-deal, will not throw away a friendship or family unity for the sake of a business advantage.
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.
Such a weeding-out process would be painfully unaligned with the relationship choices of a team of relatives or friends.
However, even these teams should seriously consider adopting dynamic terms within the split, for the unexpected—illnesses, family crises, even visa problems—can happen to them, too.
If two cofounders find themselves stepping on each other’s toes, for example, or one finds himself or herself working much harder on an exciting lead while the other is working on incremental product development, they may keep their frustrations to themselves so as not to disturb the team spirit.
One founder lamented to me, several months after his startup had failed, “Even after you showed us the data about the risks of founding with a friend and of splitting 50/50, we just figured, ‘Those things happen to other people, they won’t happen to us.’ ”
Bill Holodnak, head of executive-search firm J. Robert Scott, says, “If a startup has a COO, it’s a red flag: Either the COO doesn’t belong or the CEO doesn’t.”
Then he just sat there for three months. He didn’t do anything. He didn’t hire anyone. He didn’t come up with a plan, he didn’t create a strategy. He wasn’t comfortable creating something from nothing. It’s like if you have a crank, he can crank, but he can’t actually build the crank. Building something from nothing requires a different skill set.”
To survive and grow, startups need human capital, social capital, and financial capital.
A startup with a small cash cushion is more vulnerable to liquidity problems and more likely to disband.2 As Professor Bill Sahlman points out, 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.
The startup’s industry, the macroeconomic context in which it operates, its degree of capital-intensity, and its business model all have powerful impacts on its financing strategy.
Friends and family are typically investing to support someone they love, like, or admire—not to make a lot of money. Lew Cirne, whom we will study in Chapter 10, raised $100,000 in seed money for his startup from his family and friends. “They didn’t understand any of it,” he explained, “but they were willing to bet on me.” While such faith grants the founders a certain freedom from the demands and scrutiny that would come with professional investors, it also introduces a much more extreme risk if the startup fails, as discussed below.
Founders who are confident in their startups’ prospects and who are passionate about their ideas often discount the possibility that the startup could fail, but founders and investors who have already been burned by playing with fire take a very different view. One experienced advisor of startups observed, “If you go into business with money from friends and family, then you will either lose the business or lose your family, and have a very good chance of losing both.” A serial entrepreneur explained, “Out of principle, I do not include family in business/financial transactions or pursuits.
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“If you can’t convince someone more objective than your friends and family to invest in you, there’s probably a flaw with your business, which will result in them losing their money and you feeling terrible. Even if you have a dozen rich uncles, I would suggest you find someone outside that circle who believes in you and your idea.”
Similarly, Tim Westergren, founder of Pandora Radio, persisted with his startup long after others might have called it quits, in large part because he could not face the idea of losing the money invested by his cofounders’ friends or reneging on the $1 million in salary deferrals the company owed its employees, most of them personal friends of the founders. As Tim explained, “I’ve brought everyone into it and can’t turn back. My persistence might look like a virtue, but I have to put myself through this because of all the people I’ve involved who I have ties to.” Indeed, objective observers
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An experienced startup advisor takes a more negative view, comparing “burning the boats” to “entrepreneurial suicide.” He explains, “If one sets oneself up in situations where you must ‘succeed or die,’ then your fundamental motivation must be called into question. . . . Instead of taking prudent risks to maximize your chance for succeeding, you live constantly on the edge in a world of ‘possible success.’ If this is the case, then the business is your ‘addiction’ that you’re asking your friends and family to support. Further, founders and entrepreneurs should have a ‘safe haven’ if they are
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I had 13 people who, now that they had $20,000 invested, wanted to call me and ask about an article in the Wall Street Journal, taking 45 minutes of the CEO’s time when he should be running the business!”
In fact, the more reputable, experienced, and well connected the VC firm, the more unfavorable the terms an entrepreneur will accept in order to secure an investment from it: A study of entrepreneurs who had received offers from multiple VC firms showed that, on average, entrepreneurs were willing to give up more than $4 million in valuation to get a better VC firm on board.
“The goal of every board meeting is to end it.”)
“My having board control is less important than my making sure someone else doesn’t have it.”
Among VC-backed startups, 75% of founders received no financial return from their years of hard work building the startup (Hall et al., 2010).
Lacking resources is a big reason why new ventures have such a high failure rate.5 Lack of resources lies behind all the dilemmas we have described so far. If a founder started out with all the human, social, and financial resources he or she needed, there would be no need for cofounders, hires, or investors, nor any need for him or her to be replaced as CEO.
It appears, then, that each of our founding dilemmas is also a dilemma of what resources to acquire at what cost in ownership and control.
As we have seen throughout this book, systematic consideration of early decisions can yield much better outcomes than an accumulation of reactive decisions; founders need to “decide rather than default.”
Controlling for a wide variety of differences across the 460 startups I analyzed,11 founders who had kept control of both the CEO position and the board of directors held equity stakes that were only 52% as valuable as those held by founders who had given up both the CEO position and control of the board, as shown in Figure 11.3. (The founders’ equity stakes had an intermediate value if they had given up control of either the CEO position or the board but not both.) This result held in both younger startups and older ones, suggesting that founders face a trade-off between wealth and control,
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The downside was that Frank spent valuable time having to direct his team and was frustrated by their lack of motivation and self-direction.
Another potential risk of hybrid or hedging strategies is that founders who shift strategy in the middle of building a startup may cause major tensions within the startup or harm their ability to attract the best resources. For instance, if they initially attract the best cofounders and hires (wealth), then refuse to raise money from outside investors (control), they may bring on major dissention and high turnover among critical employees and lack the resources to continue paying the ones who remain.
What’s “worse” is a set of choices that are inconsistent with each other, which means that some of them must be inconsistent with the founder’s core motivation. Worst of all would be a consistent set of choices all of which were in opposition to the founder’s core motivation.
“It’s not who’s the best flat-out leader, but who’s best suited to the tasks at that stage of development.”
In particular, if the cofounders are both control-motivated, they may end up like Evan and Meg at Blogger, with intense startup-endangering fighting over who is CEO and who controls the most important decisions.
Similarly, founders who want to keep control should strive to begin startups that have low capital-intensity or that require few or no resources beyond those the founder already controls. Founders who want to maximize startup value, on the other hand, should be open to pursuing ideas that require high capital-intensity and to attracting the necessary resources.
“If one does not know to which port one is sailing, no wind is favorable.”
