How to Sink A Startup

I work with small businesses, including some startups. They typically have a number of challenges (e.g., meeting payroll). Sometimes, however, the behavior of the entrepreneur that began the startup can cause fatal problems. Thus, this Q&A interview in a recent issue of the Harvard Business School Working Knowledge blog really resonated the me:

When Noam Wasserman (HBS MBA 1999) spent his MBA summer internship working for a VC firm, he observed important universalities in the decisions that founders faced. He also saw that the “fundamental implications of those decisions were getting the startups into trouble down the road.” That’s when Wasserman realized that he wanted to learn more about the dilemmas inherent in launching ventures. He returned to HBS, first to earn a PhD (in 2002) and then as a professor, dedicating his research to the pitfalls of founding and how to avoid them.

Based on a decade of research, Wasserman’s new best-selling book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup, draws on data gleaned from nearly 4,000 high-potential startups and 10,000 founders, while incorporating case studies and anecdotes about the follies and triumphs of prominent entrepreneurs such as Tim Westergren of Pandora and Evan Williams of Twitter. YouTube cofounder and former CEO Chad Hurley has called the book “an invaluable alternative to real-world trial and error.”

A past recipient of the HBS student-voted award for teaching excellence, Wasserman developed and teaches the popular MBA elective Founders’ Dilemmas. In 2011, the course was named one of the top entrepreneurship courses in the United States by Inc. magazine.

Here’s an interview with Noam Wasserman that profiles some of his findings:

Garry Emmons: What’s a common instance of ill-advised behavior by entrepreneurs?

Noam Wasserman: Splitting equity with your cofounders is a prime example. My data, drawn mostly from high-tech and life-science startups, show that 73 percent of teams decide on terms in the venture’s first month, and the majority finalizes the split at that point. But there’s a real danger in splitting equity too soon and setting it in stone. It is inevitable that change will come to the venture and the founding team, putting that early split into disarray and imperiling the team. Splitting equity early can be valuable in maintaining team stability when a venture is just launching, but devising a static split doesn’t properly reflect the fluid nature of startups.

My research also shows that 33 percent of startups split 50-50, usually when the team is splitting early. In these cases, the founders are assuming that every member is equally valuable and will continue to be as the venture grows, or they are avoiding a serious conversation about the split. Such an arrangement ignores life’s vicissitudes and a venture’s changing business requirements. Imposing vesting terms on themselves and their cofounders can offer some protection for founders and the venture.

Q: “Rich vs. King” is a concept that you’ve introduced to the venture lexicon. Please explain it and give an example of how it affects decision-making.

A: At almost every stage of a startup’s evolution, founders face a tension between attracting the resources needed to maximize the venture’s value and maintaining control of the enterprise—what I call the Rich vs. King dilemma.

Rich vs. King is central for two reasons. First, data that I analyzed with Dr. Tim Butler of HBS and that I detail in the book show that Rich and King dominate the top motivations of entrepreneurs. Second, at key forks in the road, Rich options directly conflict with King options. For example, on the one hand, founders who do not raise money risk handicapping their venture if money dwindles or dries up completely. On the other hand, founders who accept funding risk losing control of their venture since there’s almost always an amount of control that founders relinquish in exchange for funding. That’s why founders need to understand which one is most important to them, so they can make the best decisions for themselves at those critical junctures.

Q: But for a novice founder, wouldn’t having an experienced VC as a board member be a good thing?

A: Not necessarily. The Rich founder should pursue the best VCs, but the King founder should think seriously about avoiding VC funding and finding other ways to learn about the road ahead. Each type of founder has a different definition of success and varying degrees of outside influence they will and should tolerate. A Rich founder whose firm is lacking in human capital, experience, and capital may benefit greatly from a VC’s experience, contacts, and financial resources. A downside is that VCs often will be inclined toward courses of action that a King founder might not like.

Also, it’s important to remember that in the key areas of relationships, roles, and rewards—the “Three Rs” of momentous early choices made within the founding team—many decisions come at the outset, often before any mentors are involved. In the pre-mentor phase, founders should prepare as we do in the classroom, learning about the fateful decisions ahead and where each choice is likely to take them.

Q: What do you hope readers will take away from the book?

A: Awareness of the road ahead, matched by an awareness of who they are as entrepreneurs. Knowing one’s strengths, weaknesses, and motivation is critical to making the right decisions. Armed with awareness, founders will be better equipped to anticipate and respond to the many decision points along their journeys, beginning with when-to-found considerations and moving into idea generation, building the team, finding financing, and ultimately culminating with their exits.

What I’m really trying to do is to get founders to understand how early decisions can enable or inhibit them from achieving their goals.

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