Working in the startup ecosystem requires accepting that startup ventures have high failure rates. This is expected and a fact that all entrepreneurs deal with. What’s less expected are certain dilemmas that founders face — the most prominent being leaving or being forced out of the company.
Google’s Larry Page, Apple’s Steve Jobs, Makerbot’s Zachary Smith, Vimeo’s Jakob Lodwick, Facebook’s Eduardo Saverin, JetBlue’s David Neeleman and Etsy’s Robert Kalin are among the list of such individuals.
For diverse reasons, these founders either resigned, were ousted or disengaged from the company.
What exactly motivates company founders to leave an entity they built, despite their sacrifices and roles as the primary stakeholder, partner and developer?
The founder paradox This can be explained to some degree with the help of a research by Noam Wasserman from Harvard Business School . While it has been analysed and studied by other business academics, Wasserman examined it in-depth in 2003, when he assessed the succession histories of more than 200 internet firms.
The factors influencing changes in the top management of startup firms often involved extremes of performance. The number of founders that remained employed with their companies as CEO was low, especially in what were termed “high-potential ventures”. In Harvard Business Review of 2005 Wassermen stated:
“People like Bill Gates and Larry Ellison, who are able to lead their companies for quite a while, get all the attention because they are rare, not because they are typical.”
Founders who remain in the senior management are exceptions to the rule. As startup ventures gain traction and scale up, senior management — primarily the founders — must evolve their managerial competencies. Senior management team changes often occur when the firm’s growth is high, but less changes occur when senior management teams are functionally diverse and possess different expertise portfolios.
Venture capital ownership and board representation tend to increase the change of management changes, while greater managerial ownership decreases the chance of changes.
The paradox of founders getting ousted lie in their performance. When large corporations perform well, CEOs keep their job and receive a bonus. In smaller firms, Founder-CEOs who perform exceptionally increase their chances of getting ousted or replaced by individuals skilled in managing growth. In short, startup founders maintain a lose-lose position; both poor performance and superb performance result in their ouster.
This happens because Venture Capitalists (VCs) want to hire someone of scale and grow the company, and often see founders as lacking the expertise and experience. Challenges that startups face can change so dramatically as they scale up that many founders who are suited to leading early-stage companies, are perceived as unsuitable for leading further growth.
The classic example is Donald Valentine of Sequoia Capital who forced Sandy Lerner and Leonard Bosack out of Cisco Systems. As of 2013, Cisco had 75,000 employees, total assets worth US$101.19 billion and total equity worth US$59.13 billion. If they had not accepted investment from Sequioa, they wouldn’t have been fired, but neither would Cisco had made as much money or established its brand.
In this case, the company performed better without its founders involved. Once you hit the market, products have to be sold. Founders have to oversee multiple divisions and departments, create a sales force, manage multiple functions, manage customers, handle more complex financial issues and deal with a different set of challenges as they build the corporate infrastructure.
Founder management vs. professional management Conventional wisdom holds that rapidly growing startups outgrow a founder’s managerial capacity. Supposedly, unless founders are replaced or supplemented by professional management from the corporate sector, performance stagnates or declines.
In 1992, Purdue University assessed differences in performance between founder management and professional management, using manufacturing firms as a baseline. What it discovered was that no significant performance differences between founder-managed and professionally-managed firms existed. On an average, founder-managed firms were smaller, had less steep growth trajectories, but showed greater profitability. Employee productivity was identical for either. However, the share price performance of professionally managed firms exceeded founder-managed firms significantly.
Founder-managers often adapted to the increasing complexities of rapid growth in their firms, without sacrificing performance or losing control of their startup. Professional management created greater value for their shareholders and investors.
Founder-managers adapted to the challenges posed by the growth of their companies. While perhaps valid for the manufacturing sector, the disruptive innovation of 3D printing, cloud computing and progress of various information-communication and manufacturing technologies since then, as well as vastly altered market structure, has increased the complexities of growing inherent in founding, growing and scaling a business.
Managing the ouster Founder succession happens when VCs feel a company needs to scale faster. Robert Adelson, a partner at Boston-based Engel & Schultz, a law firm representing entrepreneurs in this situation, noted:
“Typically founders are men and women who are of great passion, but that doesn’t translate into scaling a company and building a large organisation. The person who took that company from nothing to US$5 million has done a daunting job, but that person, in the view of the VC, is very often not the person that will take them from US$5 million to US$100 million.”
Founder dismissals are not inevitable, with investors not looking to remove founders most of the time. Company lawyers are to maintain the interests of the company, not founders. Stock liquidity need careful consideration, especially when receiving venture capital, with close attention to these shares in the event of termination. It is also crucial to maintain positive relationships with the board of directors and investors.
If an ouster is inevitable, maintaining a personal exit strategy is the best approach. It preserves personal dignity and your interests in the company you built. Whenever money is involved, the nature of relationships change. The close friend you spent long hours building the company with, and the investor that mentored you, could change their tune just as readily tomorrow.