EntrepreneursVenture Capital

Founder transitions

By August 20, 2008 15 Comments

Fred Wilson has a great post today on The Human Piece of the Venture Equation. It is a long post covering topics including the age of founders and the rise of new incubator models (like Y-Combinator), but for me the best piece is towards the end, where he talks about founder succession.

This is a difficult topic fraught with emotion and ego. I’m going to reproduce a lot of what Fred wrote because of the fair and objective ways in which he lays out the issues. Fred has been in venture for 22 years and he says he still finds this stuff really hard. At eight years I have been working in this industry for less than half the time Fred has, but I certainly echo that, and I see very experienced VCs struggling to get it right all the time. These are wise words.

Firstly, the role of CEO changes as the company grows:

the failure rate of first time CEOs is incredibly high”. You just don’t know what you  don’t know. And it leads to making rookie mistakes. Early on in a company, those mistakes don’t cost much. And some mistakes can even be turned into wins.

But as a company grows, the rookie mistakes become harder to manage around. The value that everyone has invested in the business, most importantly the work of the team, starts to weigh on everyone’s minds. The CEO’s job goes from managing the product, writing a little code, doing customer support, and raising money to managing people and teams, processes and priorities. It’s not a job that most people enjoy doing
and it’s a job where experience really does matter.

Some founders will make the transition, this next excerpt is for those founders who either don’t want to or find it hard:

I’ve learned that nothing can replace the entrepreneur’s passion and vision for the product and the company. If you rip that out of the company too early, you’ll lose your investment. I think it’s best to wait until the initial product has succeeded in obtaining a critical mass of users and a business model has been developed that works and
make sense for the business and is scaling. Then, if its warranted, you can sit down and have the conversation about bringing in experienced management.

Some entrepreneurs react very negatively to that discussion. They have their own ego and self worth tied up in the company and cannot imagine the company operating successfully without them in the driver’s seat. They also don’t know what else they’d do if they didn’t run the company. It’s a really hard transition and can cause great pain for everyone, including the company.

I always try to focus people on what is in the best interests of the company, not specific individuals. That, of course, is easy for me to say because nobody is talking about me leaving the company. I don’t work there. But even so, it’s the right point of view for everyone to take. Sometimes the founders get it right away and are happy to part ways and do something new. Sometimes the founders understand it intellectually but have a hard time emotionally. In that scenario, I think time and patience can yield the right outcome most of the time. But sometimes, it’s never going to happen without a fight. And of course, sometimes the founders shouldn’t leave at all.

The point in the last paragraph about acting in the best interests of the company is important.  Prior to investment I always talk with entrepreneurs about the importance of acting as shareholders rather than managers if the topic of transition comes up.  If we are not on the same page in regarding this as important it sends up a red flag.

However, whilst it is easy to be wise in theory at the time of initial investment you usually don’t know if the founder will be the long term CEO, so you just have to see how it goes.  Fred puts it this way:

it’s important to observe them [founders] in the CEO role. Do they communicate well? Do they excel at having difficult face to face conversations with their team and their investors? Do they hire well? Do they move quickly to get rid of problem employees? Do they think about the people side of the business most of the time? Do they have a sense of urgency? Do they command the respect and loyalty of the entire team?

Those are the kinds of things I look for in “long term” CEOs. Of course they need to be able to set the long term strategy and vision and hold the company on that line. And they need to be able to raise capital and manage a Board and investor group.

I reproduce all this partly as an aide memoir to myself, but also in the hope it might help a few entrepreneurs out there to help understand how VCs think about this issue. I am painfully aware that some (maybe many) entrepreneurs are turned off VC because of fears that poorly thought through management changes will be imposed and their companies will suffer.

Update – from Henry Yates‘ comment – this link goes to some similar advice from the point of view on the entrepreneur.