Being a startup founder can be the very antithesis of entrepreneurship- and the role of founder at odds with the long-term growth and value of a startup. The very ingredients that make a successful startup founder, can be the startups’ death knell.
The skills required to found a startup and generate its first $1 million in revenue, are often at the opposite spectrum of scaling it to $10 million or even $100 million. It demands much more complex management, as more operational and commercial sophistication is required to grow the venture. Whilst many, if not the majority, of startup founders have a key ingredient which makes them successful entrepreneurs- passion– this trait is frequently the paradox to building a billion dollar startup.
And here’s why. It’s all about control. Silicon Valley culture has prioritized the myth of the founder-CEO ever since Mark Zuckenberg and Jack Dorsey remained on the helm despite raising millions in venture capital. However, plenty of evidence has emerged that letting the founder remain in control, will limit, if not destroy a startups’ success.
In a not-so distant past, founders were not expected to retain control of their startup through their series A. Noam Wasserman, author of The Founder’s Dilemma labelled this “The Paradox of Entrepreneurial Success”. He explained that what helps a founder become so successful in launching a company—his or her passion—also detracts from big picture managerial skills required when scaling a company. But in today’s funding climate, keeping control is not only expected, it has become the norm.
The trend shows fewer founders are willing to prioritize their companies success other their own. In recent HBR research, it was found that over 55% of founders remain in control while their companies scale. Thrust by the lore of Marc Benioff’s, Zuckenberg’s, or Ellisson’s- they dream of being the founder-CEO that will take the startup public, or receive unicorn status. When, for example, it was revealed that in the lead-up to Box’s IPO, Aaron Levie retained only a 4% stake in his company (plus stock options), it lead to a barrage of shock from wannabe-founders in social networking sites, includingthis Quora question, to which Levie himself answered:
So far, I have yet to bleed while building Box (well, one time I was late to a meeting and cut myself shaving). And honestly, if anyone is regularly bleeding while building a software company, I would have some serious questions about their strategy and if they’re executing properly. Definitely lots of tears and sweat though. Start your company because you want to change the world, and the rest is gravy.
The enigmatic charisma, visionary-stance, disregard for rules, perseverance, and risk-taking attitude of entrepreneurial founders have dogged the cult of the founder-CEO. The charisma of a startup founder is often one of the most pervasive facets in a startup’s culture. And when you’re building a startup and seeking to raise your first couple of millions- it has to be. The founder needs to compel not only potential investors, but employees. They need to buy into the vision, the story, the potential– and most often than not, this is based on the founder’s talent and charisma.
But this same charisma, which motivated employees, enchanted investors, and won-over clients has limited every-day practical scope when scaling a growing venture. Most founders are entrepreneurs for a reason- they love to create something new, build products, and thrive of the challenge of making a startup successful. Unless a founder has the true leadership, strategic management and visionary capacities that make him an excellent founder and CEO (and this is not unheard of), he will eventually lack the skills, and interest, in leading an increasingly complex company as it scales. The very same factors that made the startup successful, including the founder’s charisma- could be it’s Achilles heal, as the founder refuses to give up control to people better suited to leading the company at it’s crucial growth stage. This is reflected not only in the founder’s unwillingness to dilute ownership, but potential obstinacy, over-optimism, over-inflated ego, co-founder conflicts and ambivalence towards making decisions.
These traits seem to be a fairly common facet among entrepreneurs and startup founders. In a study, HEC Professor Thomas Astebrofound that 29% of founders who had been recommended to cut their losses and quit their startup, continued regardless.
Another 51% continued to spend time and resources on their startup, and a not unmeaningful 29% continued to spend money- from 50% to 100% more than capital already sunk in the company. The offenders? Those founders who demonstrated overly-optimistic beliefs in their products potential, and who had already dedicated significant time and resources, showed the highest unwillingness to pivot and quit.
It all seems rather inconsequential when an entrepreneur is in the throes of launching an exciting new project- but these characteristics can take momentous proportions when you’ve got investors stacked up on your board, and a couple hundred of dedicated and motivated employees that rely on the startups’ continued growth. Refusing to pivot, change-course, manage conflicts, adapt to new competitive pressures, sink more capital, spend (or burn less) or implement new commercial operations is often associated with the founder’s refusal to give up control. And when the founder experiences over-optimism, or even worst, ambivalence in making decisions or self-doubt, it can seep through to employees, co-founders and investors faster than gasoline.
Unknowingly, the issue of control raises its ugly head right at the inception stage of a startup. Over 73% of founders and co-founders divide equity in the first month of founding, and a majority set this equity split in stone- regardless of the capabilities, commitment and expertise of other founding members. A 50/50 split seems fair, disregarding the fact that to attract talent and capital- equity will eventually have to be diluted. What happens when founders need to start attracting capital and providing equity to early-employees? Conflicts arise. A decision has to be made. Build a valuable business, or retain a lion’s share of the profit of a not-so valuable company. Splitting equity so early-on shows little regard to what the startup may require in the long-run and dramatic changes that may occur. The numbers say it all. An estimated 62% of startups fail due to co-founder conflicts, and unhappiness with the initial equity split increases over time.
Take a look at XFund, an early stage venture capital group founded by Patrick Chung and Hugo Van Vuuren. After the initial success of The Experiment Fund, they launched XFund2, in what has been described as a true 50/50 split equity partnership. What happen’s next shows the ugly side of success and founder control. Allegedly, shortly after the new fund’s establishment, Van Vuuren was sent legal documents giving Chung governance control. Or in other words, Chung would have final say if a joint-decision could not be agreed. Van Vuuren claims he was hoodwinked into signing, whilst Chung claims (in ongoing litigation between the founders) that his partner lacked commitment. Suffice to say, amidst accusations of whistle-blowing, threatening behavior and a restraining order-despite Chung remaining at the helm of XFund2- investors have retraced $50 million from the fund. What could have been one of Massachusetts fastest-growing early-stage funds fell victim to a rookie startup mistake, and alienated its investors (which include for those interested Saudi Aramco). Control, took precedence over growth.
A quick look at questions asked by founders on social network Quora shows that founders are increasingly demanding and expecting to retain control at the first stages of founding their startup, regardless of the value they, and others will bring on board.
I am the initial founder of a stealth-mode tech start-up. I was speaking to my mentor earlier and my mentor strongly recommended that I keep 51% and distribute 49%. The reason being that he thinks I need to stay in control, and avoid a situation where the two other co-founders might gang up. I believe in collaboration within a start-up to narrow down on an idea, but I also believe one person needs to be in charge. The issue is control of the vision, not greed. How do I protect my control over the company, and what are your thoughts on the appropriate equity division?
Another asked ‘why does the founder and CEO have the highest equity and control?’- and these are the responses he received:
Because we OWN it. We create it, stay up late sweating over it, take responsibility for its success/failure, and risk more for it then most people can even come close to.
The founder and CEO both take the highest proportion of risk in the company, therefore they are entitled to the highest potential payoff.
This new trend is being backed, if not motivated by a change in attitude from VCs, who support the charisma-fueled image of the startup founder, beloved by the media. Andreessen Horowitz is famous for only backing founder-CEO ventures, believing it is easier to teach a techie to maximize revenue, than to innovate. They also state that their preference for founder-CEOs stems from belief that they continuously beat CEO in key metrics such as the amount of funding raised, exit valuations, and return on investments. However, Reid Hoffman, LinkedIn founder, disagrees, and voluntarily ousted himself as CEO, when he realized he was disinterested in the ‘nuts and bolts’ of running a scaling company.
But as we scaled from a handful of people in my living room to dozens of people at an office, I saw the job of the CEO shifting. At 50 people and beyond, a CEO increasingly has to focus on process and organization, and that wasn’t what I was passionate about.
Which brings us to the cold, hard numbers.
Founder-CEOs are 69% less likely to raise more capital than professional CEOs, and have a median exit valuation of $80 million compared to $105 million for their CEO counterparts. Furthermore,recently published research (by no other than Noam Wasserman again!) found that founders that are CEO’s or have significant control of their board reduces the startups value by up to 58.1%. This also applies to pre-fundraising valuations, where startup valuation decreases by up to 22%.
Each founder at one point will have to decide what trade-off is most worth the risk. Keep control, and potentially risk the scaling and devaluation of his startup- or accept that dilution is most likely to occur at some point in the future, and that its better to own 5% of a $700 million dollar valuation, than 50% of a $2 million dollar valuation.
That is not to say that all founder-CEO’s are doomed to lose control, and cannot take on the responsibilities of founder and CEO. This also doesn’t mean that they can’t retain a position as a leader and visionary, even after having diluted their shares- and have significant influence on their company, its culture and growth. However, in today’s climate, founders should dig deep in assessing if they have the skills, and motivation to do what it takes to scale a startup to the next level. Or as Reid Hoffman put it, ‘be passionate about the nuts and bolts‘
Tatjana de Kerros-Budkov is the author of “The Startup Illusion" - the blog that believes that entrepreneurship is more than just a buzzword.
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