The Founder's Dilemmas

Anticipating and Avoiding the Pitfalls That Can Sink a Startup

Noam Wasserman

• Publisher: Princeton University Press
• Year: 2012
• ISBN:
  9781400841936
• Topic: Business
• Subtopic: Entrepreneurship
• Index: Business

A guide to the early decisions that can make or break startup ventures Often downplayed in the excitement of starting up a new business venture is one of the most important decisions entrepreneurs will face: should they go it alone, or bring in cofounders, hires, and investors to help build the business? More than just financial rewards are at stake. Friendships and relationships can suffer. Bad decisions at the inception of a promising venture lay the foundations for its eventual ruin. The Founder's Dilemmas is the first book to examine the early decisions by entrepreneurs that can make or break a startup and its team.Drawing on a decade of research, Noam Wasserman reveals the common pitfalls founders face and how to avoid them. He looks at whether it is a good idea to cofound with friends or relatives, how and when to split the equity within the founding team, and how to recognize when a successful founder-CEO should exit or be fired. Wasserman explains how to anticipate, avoid, or recover from disastrous mistakes that can splinter a founding team, strip founders of control, and leave founders without a financial payoff for their hard work and innovative ideas. He highlights the need at each step to strike a careful balance between controlling the startup and attracting the best resources to grow it, and demonstrates why the easy short-term choice is often the most perilous in the long term. The Founder's Dilemmas draws on the inside stories of founders like Evan Williams of Twitter and Tim Westergren of Pandora, while mining quantitative data on almost ten thousand founders. People problems are the leading cause of failure in startups. This book offers solutions.

PART I

INTRODUCTION AND
PRE-FOUNDING

CHAPTER ONE

INTRODUCTION

IT’S UNFORTUNATE BUT TRUE: IF ENTREPRENEURSHIP IS A BATTLE, most casualties stem from friendly fire or self-inflicted wounds. Some four decades ago, sociologist Arthur Stinchcombe attributed much of the “liability of newness”—the particularly high failure rate of new organizations—to problems within a startup’s founding team. More recently, venture capitalists in one survey attributed 65% of failures within their portfolio companies to problems within the startup’s management team.¹ Another study asked investors to identify problems they thought might occur within their portfolio companies; a full 61% of such problems involved issues within the team.²

Researchers have extensively studied the failure rates highlighted by Stinchcombe. Unfortunately, they have focused almost entirely on external causes rather than on the more numerous internal problems Stinchcombe identified.* We know amazingly little about the chief perils that beset the entrepreneurial activity we so often acclaim as the very heart and soul of the economy. As researcher Amar Bhide put it, “Entrepreneurs who start and build new businesses are more celebrated than studied.”³

This book scrutinizes those all-important “people problems” that bedevil all founders—even solo founders—and their startups.* These problems often follow predictably from common dilemmas faced by any startup as it grows and evolves—what I call “founding dilemmas.” One such dilemma recurs throughout the stages of company development: The need to negotiate a trade-off between wealth and control, between building financial value and maintaining a grip on the steering wheel. Adding further complexity, founders’ early choices can have delayed and unexpected but significant effects,⁴ sometimes because natural inclinations such as passion, optimism, and conflict avoidance lead to shortsighted decisions. This book delves into the challenges faced or created by each of the main groups of players involved in a typical startup, beginning with the core founder and moving on to his or her cofounders, early hires, and investors.

I’ve spent over a decade working with hundreds of founders and future founders, and I’ve collected and analyzed data on nearly 10,000 founders in the technology and life sciences industries. This book will draw on my unique dataset, and we will also follow actual founders as they launch new companies and struggle with dilemmas identified in my research. Most centrally, we explore the experience of Evan Williams, a young entrepreneur who moved from rural Nebraska to the San Francisco area in the mid-1990s, hoping to catch the wave of the Internet boom after working on a failed startup back home. A self-taught Web designer and programmer, Evan recognized the potential of Internet applications, particularly in the exploding area of self-publishing, and created Blogger, one of the first and most popular blogging tools. Later, Evan developed an early podcasting idea, Odeo, which he believed would enable nontechnical people to produce, publish, and share audio content, much as Blogger had done for millions of ordinary people with the written word.

In both startups, and then later when he went on to found and lead Twitter before leaving to work on yet another startup, Evan faced key dilemmas—difficult decisions at important forks in the road of his entrepreneurial journey—and took steps that would shape the startup’s future, affect its value, and help determine his degree of control over it. With Blogger, Evan chose to cofound with his former girlfriend, fighting to retain for himself the CEO title and a majority of the equity. He funded the company using his own money along with money from friends, family, and angel investors, intentionally avoiding venture capitalists (VCs). He hired friends (and later, volunteers) to inexpensively develop the technology. When the dot-com boom ended and Blogger ran low on cash, he received an acquisition offer but refused to sell—a decision that would send his cofounder and his entire staff fleeing for the exits and reduce him to soliciting donations to keep Blogger alive.

Evan eventually sold Blogger to Google and turned next to developing Odeo, partnering with an acquaintance who had experience in online audio. Using some of his proceeds from Blogger, Evan seeded Odeo and let his cofounder take the CEO role. As Evan realized the huge potential for podcasting, he took over as CEO and raised $5 million from VCs, who stepped in to help make significant decisions. With the VC money, Evan hired an experienced and expensive leadership team, hoping to develop Odeo quickly enough to stay ahead of foreseeable and formidable competitors such as Apple and Yahoo.

Evan holds particular interest for us because his very different approaches to founding and running Blogger and Odeo highlight the wide variety of options available to founders. Evan’s decisions may seem wildly inconsistent: He takes VC funding in one case and vehemently resists it in another. He hires his pals for next to nothing in one case and pays big bucks for the pros in another. He battles his own ex-girlfriend for the CEO role and finally squeezes her out of the company but then readily turns the reins over to a mere acquaintance in his second startup. Going deep into Evan’s story, we will explore both the underlying consistency of his decisions and the powerful motivations and situational factors at work, an exercise that will enable current or would-be founders and others involved in startups to unlock the mystery of their own motivations and dilemmas as they enter the battle that is entrepreneurship.

CORE CONCEPTS AND ARGUMENTS

Founding a startup can seem like a fragmented, even chaotic, way of life. Perhaps no business pursuit is messier than creating an organization from scratch. Founders themselves are an extremely varied group, and academic research on entrepreneurs is fragmented, with different researchers looking at different stages of the founding process, turning different disciplinary or functional lenses on the issues they study, and developing findings with little apparent consistency. Meant for entrepreneurial scholars, educators, and mentors of entrepreneurs as well as entrepreneurs themselves, The Founder’s Dilemmas highlights the consistent, coherent, and systematic patterns and trade-offs involved in the most critical founding decisions, from the dreamer’s decision of whether or not to found in the first place through the founder’s decision to exit the company he or she has created.

Before we can get started, we must define some core concepts and arguments. I focus the discussion on the founding of high-potential startups; that is, startups (often technology- or science-based) with the potential to become large and valuable, even though their founders may subsequently make decisions that limit their growth. Where necessary, I integrate relevant findings from research on high-potential startups with the larger literature on founding small businesses, careful to note differences between the founding of high-potential startups and the founding of small businesses that are designed to remain small and owner-operated.*

Founders, as I speak of them, are individuals who start new organizations to pursue opportunities, as scholar Howard Stevenson put it, “without regard to the resources they currently control.”⁵ They make the early decisions that shape the startup and its growth, an influence that begins even before the founding itself and that can extend through all stages of the startup’s development.* This book’s central message is that these founding decisions need to be made by design, not by default. Each decision requires the founder to assess multiple options; there are more critical decisions—and more options within each decision—than many founders realize. Often, the “right” decision is by no means obvious, and may even be counterintuitive. In addition, it can come with a burdensome cost, making the decision gut-wrenching and requiring the founder to face stark trade-offs. Meanwhile, the most common decisions—cofounding with friends, splitting equity equally among cofounders, etc.—are often the most fraught with peril. That’s why I refer to the decisions discussed in this book as dilemmas. Founders who feel they have gained everything and lost nothing by an early decision that felt like a no-brainer may be in for a nasty surprise later on, when they find out what trade-off they should actually have been considering.

The major parts of The Founder’s Dilemmas explore the dilemmas founders face by progressively introducing new players whose involvement in a startup provokes difficult decisions that significantly affect the startup’s direction and outcomes. We begin with the core founder, then add cofounders, and end with hires and investors. In each unfolding part, we examine the impact of these players on the startup’s outcomes—most centrally, on the stability of the founding team, the valuation of the startup, and the founders’ abilities to keep control of the board of directors and the CEO position. An appendix to Chapter 11 also delves into exit dilemmas, which come long after founding but are faced by founders lucky enough to make it to that point, and which involve many of the same underlying factors.

The primary founding dilemmas we’ll explore, and the questions a potential founder should ask about them, break down into the following:

1. Pre-founding: Career Dilemmas—When in my career should I launch a startup? If I am passionate about an idea, but haven’t accumulated the right career experiences yet, or the market is not yet receptive to my idea, or my personal situation is unfavorable, should I make the leap anyway?

2. Founding Team Dilemmas—Deciding to launch a startup introduces many more dilemmas regarding the startup’s founders.

a. The Solo-versus-Team Dilemma—Should I launch the business myself or try to attract cofounders?

b. Relationship Dilemmas—Whom should I try to attract as cofounders: Friends? Family? Acquaintances? Strangers? Prior coworkers?

c. Role Dilemmas—What positions should each of us take within the startup? Which decisions can we make alone, and which should we make as a team? How should we make those decisions?

d. Reward Dilemmas—How should we divide equity and other financial rewards among the founding team?

3. Beyond the Founding Team—Both the startup’s growth and lingering gaps in the founding team’s abilities or resources often require founders to consider adding nonfounders and their resources. This introduces further dilemmas.

a. Hiring Dilemmas—What types of people should I hire at different stages of growth? What challenges will my early hires face as the startup grows? Should I compensate early hires differently from later hires?

b. Investor Dilemmas—What types of investors should I target at different stages of growth? What challenges will these investors introduce?

c. Founder-CEO Succession—Why and how are founders replaced as CEOs of the startups they founded? How can founders exert more control over the process? What happens to the founder and to the startup after he or she is replaced by a hired “professional CEO”?

Figure 1.1. Sequence of Founding Dilemmas

Figure 1.1 is a high-level summary of these dilemmas and a road-map to which we will return regularly.

These dilemmas do not necessarily occur in the clear sequence implied by the book’s structure. The founding process is often chaotic and nonlinear,⁶ with founders improvising rather than following a script to build their startups.⁷ For example, core founders often get an idea—the proverbial light bulb goes off—and then face the question of whether to pursue it alone or attract cofounders. This is the “idea-then-team” approach to building a startup, exemplified in this book by Tim Westergren (of Pandora Radio) and others. But it can also happen that a team decides to work together on a startup, then hunts for an idea. This is the “team-then-idea” approach, exemplified by Janet Kraus and Kathy Sherbrooke, who met at Stanford Business School, formed a close working relationship through joint leadership roles, and decided that they would eventually try to find an idea with which to found a company. That startup later became the corporate-concierge company Circles. Given such differences in sequence, I’ve written this book so that people who want to learn about founding dilemmas in sequence can read the chapters in order while people interested in specific dilemmas can go straight to the chapters that most interest them.

More important than the sequence is what the dilemmas have in common: They are all difficult but necessary decision points, each with a number of often-unrecognized options that, in turn, have important consequences for the founder(s) and the startup. They each call for careful and rational decision making—sometimes by a lone founder and sometimes by a founding team. Finally, the dilemmas examined in this book all hold in common their tendency to manifest the following three major themes.

Short-term versus Long-term Consequences

An “easy” short-term decision may introduce long-term problems; a “hard” short-term decision may often be best in the long run. 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. Let’s suppose you have started a company and made your brother the chief financial officer, as did one of the founders we will study. What if your brother turns out not to be very good at it? The only thing more awkward and awful than talking about that in advance would be dealing with it once it’s happening. Founding a startup is akin to a wedding, a declaration of mutual devotion. It seems inappropriate and even counterproductive to plan for a breakup, yet in entrepreneurship, failing to make the prenup part of the wedding vows, so to speak, can prove disastrous.

To make matters worse, entrepreneurs usually find it much harder an...