The Five Most Important Founder Issues

Just ran into this posting that hits several critical founder issues right on the head. Take a look at Roger Anderson's Modern Magellan post entitled: Founder Issues - New wine in an old bottle Part 4. Roger lists the 5 most important founder issues for a new company:

1. Control
2. Communication
3. Personal value
4. Short-sightedness
5. Salary

"It could be argued that they all exist in most founders, regardless of the level of experience. A founder with prior experience may feel that they know more about business than anyone around them. Such over confidence can lead to errors that amateurs do not make."

His posting is a good read.

90% of Managers think they are among the Top 10% of Performers

Business Week, August 20 & 27 edition, reports on p. 43 that among other things associated with how people view their "work" environments, this startling statistic. The percentage gets even higher - 96% - when they segregate out only companies with 50 or fewer employees. Like Lake Wobegon, where all the students are above average, the idea that so many managers think they are doing so well is likely a surprise to their supervisors, or is it?

Certainly, it is a statement of the ineffectiveness of our employee review systems for this many employees to be this wrong. Companies must improve the process of evaluating employees and communicate this clearly to their people or risk a plethora of wrongful termination suits, seldom improving employees and mediocre company performance. Perhaps telling employees the "bad" news is a difficult task. However, the consequences of not doing so will likely be enormous.

Lessons learned

During the past year I have reviewed several dozen business propositions, talked with founders, entrepreneurs, angel investors, venture capitalists, and plain old rank and file business people. I've been in search of the the holy grail of business opportunities - and have yet to find it (but that is the definition of the holy grail isn't it?)

Along the way, I learned and confirmed some business truths that I thought were worth sharing.

Money

• There is lots of it available in the market. Even VCs have more capital than they can manage themselves.
• Valuations are always astronomical for other companies (i.e., not yours).
  
• Angel capital usually comes from people who have too much time on their hands and put their noses in places in which they have no expertise.
  
• Just because you have money to invest does not make you smart – in fact there may be an inverse correlation. (Thanks to Harry Gruner at JMI for that truism).
• Money alone can’t help a bad venture or a good venture with a bad management team.
  
• You probably can’t succeed without it.
  
• If you continually have too little of it, you either are spending too much time looking for it, your valuation is stupid, your management team is inept, your venture is not worthy, or more likely all of the above.

Management Talent

• There is not enough to go around.
• In the land of the blind the one eyed man is king.
  
• A combination of business savvy and engineering talent is virtually non existent.
  
• Most techies would disagree.
• Just because you are a founder, does not mean you deserve to run an organization (unless you are the only employee).
  
• Good management techniques transcend most industries.
  
• If you think your industry (or business) is different, you are wrong.
• Founders who hold the title of CEO only because they started the company are usually in the wrong job.
  
• Founders who have this epiphany, can actually become good CEOs.
  
• Friends and family teams are usually all that is necessary to burn down a very promising venture.
  
• Most bad management teams don’t agree with any of this.

Technology

• You can’t risk your success on the back of one or a small team of technical people who don’t believe in technology transfer as a priority.
  
• As a CEO if you don’t understand it, over time you still won’t get it.
  
• It is highly overrated.
  
• Companies that start with great technology and succeed have figured that out.
  
• In order to succeed, your technology actually has to solve some problem.
  
• Creating the problem just so your technology has something useful to do just won't cut it.
  

Sales

• Great sustainable sales only exist in an environment where there are processes and metrics.
• If you claim to have metrics, but don’t track them or can’t recite them, you are fooling yourself.
  
• If you think your business is different and you don't need metrics, you are wrong.
  
• Great sales talent is not personality based – it is process based.
  
• If you are not concentrating on how to create reproducible sales – you won’t have any.
• You can always spot a sales driven organization - their employees wear company-logoed clothing.

Founders

• Believe their ventures are worth at least an order of magnitude more than people with money do.
  
• Think that the money guys don’t get it.
  
• Expect that splitting the pie is equivalent to shaving ice.
  
• Need adult supervision.
  
• Every organization has at least one.
  
• If you care about how people feel about you, it’s probably best not to be his/her immediate successor.
• There is much too much more to include (see the rest of my blog postings for more).

Details

• Some people thrive in the details.
  
• This isn’t always bad.
  
• There is a place for them in every organization.
  
• I’m not one of these people.

Quality of Life

• In today’s world this often takes center stage.
  
• Working with great people, having a flexible work environment, and controlling your own destiny often count more than fewer hours in the office.
  
• Working for a, with a, or just be- cause can shift this balance.

Risk

• There is a significant variance about the propensity of individuals to accept risk, which varies over time, with the weight of their pocket books, and the size of their mortgage.
• Potential participants in any venture have different short term vs long term needs which also varies over time.
• Everyone says they are looking for long term wealth generation.
• Most can’t afford to really do that.

People

• No good person wants to work with assholes.
  
• Most assholes would love to work with you!
• You are only as good as the company you keep.
  
• That includes clients and investors.
  
• Even a bad technology can succeed with good people.
  
• The converse is never true.

The Founders' Pie

A reader of this blog referred me to this article about a Founders' Pie Calculator as a way to add some science to splitting up the founding pie. While this method is also still an estimate, it does require that the founders put some tangible thought behind relative values brought to the organization and it does bode well for future sound decision making.

Make Yourself Dispensible

Where would your company be without you? Better off?

Most Founders don't even consider where their companies would be without them. In fact, founder organizations often require intimate and frequent communications with the founder. This is the natural result of a driven founder with intimate knowledge of the marketplace and the solution being produced . Founders tend to take few vacations that allow them to become untethered from the organizations they created. Founders make many (most) of the critical decisions for their companies. Founders hire people who execute on the founder's decisions - usually not decision makers themselves.

But have you ever thought about whether this is bad or good for your company? While it may feel good to the founder - no decision gets made by some bumble head who doesn't know as much as the founder - and it may make the early stages of a company function efficiently - no bureaucracy, in the long run this poses an undue constraint on the organization as it grows beyond double digits of employees.

Founder decision making is just like the days of time sharing computers. For those of you who are not old enough to remember, time sharing computers gave multiple people access to a single computing resource (usually connected via a slow dial up line and acoustic coupled modem) by slicing the time the processor was dedicated to each individual task. Usually this was done fast enough to make the user believe she had unfettered access to the computing resource. However, when enough people tried to access the computer all at the same time, the response times suffered. (We actually are spoiled now - we accepted these delays as normal - such lack of responsiveness even under the best of conditions would not be acceptable today.)

Similarly, as the load increases on the founder with more and more employees clamouring for access to the founder, decisions get slower and slower - sooner or later bringing the organization to its knees.

It is the unique founder who "gets this" (before her board steps in) and begins to decentralize decision making. Often founders feel uncomfortable taking this step - allowing the bumble heads to make the decisions. They are too used to being the "go to" person for all major issues that anything short of that leaves them numb. But as soon as a founder realizes that she can hire smart people and permit them to make some of their own decisions, the organization gains a whole other level of potential and cycle times can begin to reduce.

So next time you revel in the idea of your indispensability - think again! Maybe you need a vacation?

Vote with Your Feet

Ever been in an organization where after a change event occurs there is a constant back channel discussion about how the sky is falling? Ever participated in one of those conversations? Come on now, be honest!

There really is only a binary decision that needs to be made when experiencing a change event: either embrace the change or vote with your feet - that is get out if you don't like it.

Change is often accompanied by the unknown. It's human nature to expect the worst under conditions of change. So in the organizations I've led, I always suggest the following approach.

1) Give change a chance. Often times people react immediately to change. For all they know the change might be good or might enhance their career opportunities. So unless change hits you directly between the eyes (like in the case of being laid off due to a change), wait with a positive (or at least neutral) attitude to determine whether or not the change that is occuring is something you can live with.

2) Once you determine that you don't like the change (and you've at least given it a chance) vote with your feet. Get out. Or at least start the process for finding a new opportunity.

All too often employees choose a third path which is to stay and complain. When you stay and complain, you've got no one to fault but yourself. Complaints feed upon themselves. They foster an environment of resentment. And they don't lead to any positive results - either for the individual or the organization.

So either embrace the change ..... or vote with your feet!

Earnouts are for Sissies

The ultimate founder transition - when the time comes for a founder to sell his or her "baby" - the highest hurdle encountered is often the PRICE. Buyers and sellers may find that there is a large gulf between the realistic value for the company and the price the seller is willing to take. Whether this is due to asymmetric information, scarcity, or the psychology of a founder expecting their kid (like in Lake Wobegon) always being better than average, it does create an obstacle to completing the transaction.

All too often, this gulf is bridged with a mechanism commonly called an earnout. An earnout is simply a way to pay less money today and (perhaps) more money in the future, based upon "proving" the value is actually higher than it appears today. How do you prove it? Typically, by increasing revenue, earnings, or the accomplishment of prescribed milestones.

So the seller agrees to take less cash today with the promise of a future upside (sounds very entrepreneurial) and the buyer agrees to pay what she believes to be the value today and something in the future if certain conditions are met. In theory, this appears to be a sound compromise. In practice, it often becomes a contentious and inexact computation.

So, if they appear so promising, why don't earnouts work?

Less than obvious to the innocent bystander is the fact that an earnout is used to paper over a disagreement. Like any good, long term relationship, a firm foundation of understanding, trust, and agreement is required to perpetuate the relationship. One founded on a disagreement is an indication of the quality of its construction.

Extenuating circumstances become the rule, not the exception. Once merged together, decision making on issues that may impact the trigger criteria may fall under the control of the buyer. While reputable buyers may not purposefully "game" the system to ensure that triggers are not met, they may in fact find that it is in the interests of the now "greater good" for the business to be run in a way that no longer hits those triggers. And guess who is making those calls now? Usually, it is not the seller - who has the vested interested in hitting those targets.

Who determines the payout? Sellers should understand that once a transaction is completed, the "golden rule" controls. (The "golden rule" is usually understood to be - he who holds the gold, makes the rules!) Buyers will make the determination as to when and if additional payouts occur. While agreements may be carefully crafted by expensive and sometimes even competent counsel, in practice it just may not be clear whether or not the trigger criteria has been met, several years into the future - especially if in between, the game has changed.

History has shown that earnouts don't always get paid out at the times or at the values that the seller had expected.

So should a Seller just say no? The realistic answer is no (I think that is a double negative!). Earnouts are ok to use as a seller if the expectation is clearly set that this portion of the potential purchase price is just gravy (or icing on the cake if you like that analogy better). Negotiating a purchase price that is "acceptable" even if the earnout is not paid, and accepting the earnout as a potential extra to the deal, will lead to a much sounder future relationship.

Of course if you are buyer - Earnouts are great!

Cheating - or Postmodern Learning

I was absolutely amazed to read the commentary in Business Week, May 14, 2007 p. 42 from Michelle Conlin on the Cheating scandal at Duke's Business School. Can there really be a question here of whether these graduate business students, who in complete disregard of all ethical and statutory standards of this prestigious business school, did something WRONG by collaborating (CHEATING) on a take home exam?

I too am a fan of open source, collaboration and the idea that capturing the participation of customers and employees is required in this new 21st century competitive environment. But to write off this cheating scandal based upon the "mixed signals" society is giving to these students, is tantamount to explaining away Enron's criminal activities as just doing what everyone else was doing. The idea that email, instant messaging, and the iPod has somehow created a society in which cheating is de rigueur is just plain misguided! Michelle, if you don't believe that these students thought they were doing something wrong, then I suggest you think again!

How can a publication like Business Week publish such garbage and even allow the thought that this behavior should be condoned as a plausible argument? Haven't we had enough of our fair share of misguided business, political and religious leaders provide a large enough pool of miscreants to make us all uncomfortable with the role models our society has created?

This argument that "one can understand the confusion" that somehow cheating on an exam should be written off as postmodern learning is not "food for thought" as Michelle portrays it, this is our corrupt view of the lowest level that our standards have ever achieved. Business Week should know better!

Running the Funding Marathon

So what is the right value for raising institutional (venture) capital?

As with many things, beauty is in the eye of the beholder, or in our case, value is in the wallet of the investor. Whatever the market will bear is the real value of the company. This value may and will have nothing to do with the value your angel investors paid for their stock. It will have absolutely nothing to do with the amount of work you and your team put into making your product or putting together your offering. And it certainly bears no relationship to how much the company would have to be valued so that you retain control.

Rather than focusing on the paper value of their current ownership, founders should think ahead, through as many of the "gates" as they can forecast, that stand between them and commercial success (all the way to a liquidity event). It's like a marathon, as opposed to a sprint. The leader at the mid point is not necessarily indicative of the winner at the finish line. Not all money is created equal. It may be more important to get a good value, rather than the best value, from a partner who is in it for the long haul. This may mean taking a lower valuation today in return for accelerated market entry and mind share from a partner who brings much more than just capital to the equation.

Often we see founders falling prey to early angel investors "bidding up" the value of their companies during several cash calls in an effort to increase their short term valuations. While this may "feel good" at the moment, it could become a critical obstacle to their long term success. Founders should understand that it will be VERY DIFFICULT to later get an early investor to digest a crammed down valuation if these angel values were artificially inflated.

Here's an example: A plastics company in upstate NY purchases some very interesting patents from a large industrial conglomerate who doesn't view them as critical. They raise angel capital to begin to prototype this product. They run out of cash. Management either knew or should have known they would need more cash. They go back to their investors needing more capital. The investors agree, perhaps they bring in a few of their friends in this round, but only at a newly established higher value. This continues for several more years. By this time the company has yet to commercialize its product, yet the valuation is now in the double digit millions - based almost entirely upon the angel investors bidding against themselves to increase the value and to feel good that their investment is increasing in value. Has this higher valuation helped them?

Absolutely not!

They are now getting closer to being able to commercialize the product. They need sales and marketing funding, they need production facilities, they are ready for their launch. This requires capital in excess of anything they have raised in the past. So they seek out institutional investors. In fact as they become a bit more desperate, they also seek a strategic buyer. There are several interested acquirors - but they each in turn demur due to the demanded valuations. Ultimately there is interest from institutional investors (bigger fool theory in play here?), they can't justify the lofty valuations the angels' fictions have created! But the company needs the capital. And voila - cram down occurs. Founders get squeezed (out completely in this case). Early investors get burned. Later investors get fried! And company's prospects for success are still in doubt. But the founders felt great at these lofty values, that is at least until ... they got dumped!

What could have happened?

With some foresight, the founders might have begun to understand that the only real valuation that matters is the one just before they cash out. Restricting their fund raising rounds to smaller increases (or sideways) in value that were commensurate with their market progress, might have enabled them to keep the valuations in line and then be able to raise capital from institutions at an appropriate rate. Or, it might have enabled them to cash out in a sale to a competitor at a valuation they could stomach.

This vortex of capital raising can stymie the progress of even the most promising venture. So beware when you hear yourself remarking about how the world doesn't get your value proposition! The "best" valuation you can have for your company, may not be the one that momentarily makes you currently feel the richest.

Your Money or Your Life?

When is the right time and at what is the right valuation to seek outside funding? Founders and entrepreneurs constantly quip that the world (that is everyone outside of their four walls) does not understand their true valuation. Obviously, they know something that everyone else doesn't. (But do they?) And as such, entrepreneurs often wait, sometimes too late, to raise funds.

Sometimes waiting is exactly the right thing to do. If the product is not yet complete, the value proposition for the outside world has not yet been proven, or if the claims the company is making are just not yet credible to the financial community, this can be the appropriate move - assuming the company has the wherewithall to survive. But founders and entrepreneurs should be wary of continuing to push that rock by themselves for a bit too long and the implications that their "slow" pace of progress will have on their competitive strength.

Sometimes getting to market first is just not enough! The market is strewn with dead companies who introduced the next great thing to the market, only to bowled over by a better heeled competitor who follows in their path. Getting there first is part of the battle, having the resources to execute, to capture market and mind share, is a critical hurdle that must be overcome to be a commercial success.

The savvy entrepreneur should understand that having the appropriate resources at just the right time (no earlier - but certainly no later) is critical for maximizing the value of their opportunity. If your product or service is ready to be launched, but you delay due to perceived poor valuations, you may in fact be giving up much more value to the market than the lower-than-expected valuation costs you. If you miss a market opportunity, or enable a competitor to impinge upon your market space, or create noise or confusion in the market, you may just find that you have diminished the value of your creation beyond repair.