Founders Dilemmas - Detailed Table of Contents

Detailed Table of Contents NoamWasserman.com

The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup

Noam Wasserman

Part I: Introduction & Pre‐founding Chapter 1: Introduction ........................................................................................................................ 3 Core Concepts and Arguments .................................................................................................................... 6  Short‐term versus Long‐term Consequences ................................................................................ 10  Natural Biases: The Perils of Passion, Optimism, and Instinct ....................................................... 10  Divergences among Can, Do, and Should ...................................................................................... 11 Wealth versus Control: A Closer Look ......................................................................................................... 12 Unsolved Puzzles ......................................................................................................................................... 15 10,000 Founders Strong .............................................................................................................................. 19 Introduction to the Principle Case Studies ................................................................................................. 21 Chapter 2: Career Dilemmas .............................................................................................................. 27 Should I Found? .......................................................................................................................................... 30  Early Influences .............................................................................................................................. 30  Founder Motivations: The Centrality of Wealth and Control ........................................................ 32 When Should I Found? ................................................................................................................................ 36  Reasons to Wait ............................................................................................................................. 36 o Building Human Capital .................................................................................................... 36  Work and School .................................................................................................. 37  Managerial Experience ........................................................................................ 38  Functional Backgrounds ....................................................................................... 39  Industry Knowledge ............................................................................................. 40  Working in Small versus Big Companies ............................................................. 43  Harnessing Nontraditional Experiences ............................................................... 46 o Building Social and Financial Capital ................................................................................. 47  The Perils of Waiting ...................................................................................................................... 48 o Stronger Career Handcuffs ............................................................................................... 49 o Lower “Fitness to Found” ................................................................................................. 50 o Stronger Family Handcuffs ................................................................................................ 50  Developments That Release the Handcuffs ................................................................................... 52 o An Employer’s Slowing Growth ........................................................................................ 53 o An Employer’s Change in Strategy .................................................................................... 53 o Employment Shocks .......................................................................................................... 53 o Financial Shocks ................................................................................................................ 54 o Family Developments ....................................................................................................... 54 How Can I Dispassionately Evaluate My Idea? ........................................................................................... 55  Evaluating Ideas ............................................................................................................................. 55  Clouding Judgment: Passion and Optimism .................................................................................. 58 Closing Remarks .......................................................................................................................................... 59  “I Have Everything But an Idea!” ................................................................................................... 63  “But I’m Not Armed for Battle Yet!” .............................................................................................. 63  “But I’m Going to Hurt My Family!” ............................................................................................... 64  “My Handcuffs Have Gotten Too Strong!” .................................................................................... 66

Detailed Table of Contents

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Noam Wasserman

Part II: Founding Team Dilemmas Introduction ................................................................................................................................................ 69 Overview of Chapters ................................................................................................................................. 70 Chapter 3: The Solo‐versus‐Team Dilemma ........................................................................................ 73 Reasons to Go Solo ..................................................................................................................................... 73 The Argument for Cofounders .................................................................................................................... 76 How Many Cofounders? ............................................................................................................................. 81 The Broader Context ................................................................................................................................... 82 Symbolic Founders versus Hires ................................................................................................................. 83 Closing Remarks .......................................................................................................................................... 85 Chapter 4: Relationship Dilemmas: Flocking Together and Playing With Fire ...................................... 89 Founding Team Homogeneity versus Diversity .......................................................................................... 90  Short‐term Benefits of Homogeneity ............................................................................................ 91  Longer‐term Risks of Homogeneity ............................................................................................... 93  Tangible versus Intangible Differences .......................................................................................... 96  A Recurring Metaphor ................................................................................................................... 99 Founding Team Outcomes  Friends and Family are Less Stable ................................................................................................ 99  Cofounding with Past Coworkers: Less Endearing but More Enduring ....................................... 102 Taking Relationship Risks versus Creating Firewalls ................................................................................. 105  The Playing‐with‐Fire Gap: Damage versus Avoidance ............................................................... 105 o Damage If the Social Relationship Blows Up .................................................................. 105 o Avoiding the “Elephant in the Room” ............................................................................. 106 o The Playing‐with‐Fire Gap ............................................................................................... 109  Reducing the Gap: Forcing Sensitive Discussions and Creating Firewalls ................................... 110 Closing Remarks ........................................................................................................................................ 112 Chapter 5: Role Dilemmas: Positions and Decision Making ............................................................... 117 Executive Titles: Who Wants Them? ........................................................................................................ 119 Executive Titles: Who Gets Them? ........................................................................................................... 121 Overlapping Roles versus Division of Labor .............................................................................................. 124 Decision‐Making Approaches: Egalitarian versus Hierarchical ................................................................. 129  The Benefits of Egalitarianism ..................................................................................................... 130  When Are Founders Likely to Choose Egalitarianism? ............................................................... 130  The Problems of Egalitarianism ................................................................................................... 132  Rocky Transitions from Egalitarianism to Hierarchy .................................................................... 134  Balancing the Best of Egalitarianism and Hierarchy .................................................................... 135 Duos versus Trios ...................................................................................................................................... 136 One Founder on the Board versus Multiple Founders ............................................................................. 138 Roles and Wealth‐versus‐Control Motivations ......................................................................................... 141 Closing Remarks ........................................................................................................................................ 142  Avoiding Conflict .......................................................................................................................... 142  Underestimating “Title Inertia” ................................................................................................... 142  Inflating Titles .............................................................................................................................. 143 Detailed Table of Contents

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Noam Wasserman

Wanting Allies on the Board ........................................................................................................ 143 Ignoring Incompatible Motivations ............................................................................................. 144

Chapter 6: Reward Dilemmas: Equity Splits and Cash Compensation ................................................ 145 “War” Over Equity Splits ........................................................................................................................... 145 When to Split ............................................................................................................................................ 147 Criteria For Equity Splits ............................................................................................................................ 150  Past contributions ........................................................................................................................ 151 o The Idea Premium ........................................................................................................... 151 o Capital Contribution ........................................................................................................ 153  Opportunity Cost ......................................................................................................................... 154  Future Contributions .................................................................................................................... 155  Founder Motivations and Preferences ........................................................................................ 156 Equal versus Unequal Splits ...................................................................................................................... 157  A Threshold of Psychological Pain versus Financial Gain ............................................................. 159  “We’re a Team” ........................................................................................................................... 160  Financing Outcomes: Quick Handshakes versus Thoughtful Equal Splits .................................... 161  51% versus 50% ........................................................................................................................... 162 Formal versus Informal Splits .................................................................................................................... 163 Static versus Dynamic Splits: The Perils of Setting Things in Stone .......................................................... 165  A Template for Founders ............................................................................................................. 168  Terms, Contingencies, and Trust ................................................................................................. 171  Protecting Yourself from Your Cofounders: Self Imposed Vesting .............................................. 174  High Attraction, High Motivation ................................................................................................. 177 Cash Compensation .................................................................................................................................. 177  Salary Equality versus Inequality ................................................................................................. 178  The Founder Discount – Dedication or Exploitation .................................................................... 179 Closing Remarks ........................................................................................................................................ 182 Chapter 7: The Three Rs System: Alignment and Equilibrium ........................................................... 186 Beyond the Individual Decisions: Context and Linkages ........................................................................... 186 Linking Relationships and Roles ................................................................................................................ 189  Founding with Friends and Family ............................................................................................... 189  Founding with Coworkers ............................................................................................................ 190  Founding with Strangers .............................................................................................................. 191 Linking Relationships and Rewards ........................................................................................................... 193 Linking Roles and Rewards ........................................................................................................................ 197 Closing Remarks ........................................................................................................................................ 199  Communication ............................................................................................................................ 200  Change ......................................................................................................................................... 200  Inertia ........................................................................................................................................... 201


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Part III: Beyond the Founding Team: Hires and Investors Introduction .............................................................................................................................................. 205 Overview of Chapters ............................................................................................................................... 207 Chapter 8: Hiring Dilemmas: The Right Hires at the Right Time ........................................................ 209 Relationships ............................................................................................................................................. 212  The Founder‐CEO’s Hires versus Investors’ Hires ........................................................................ 209  Casting a Wide Net versus Getting Cultural Fit ............................................................................ 214  The Playing‐with‐Fire Gap: The Risk of Hiring Friends and Family .............................................. 216 Roles .......................................................................................................................................................... 217  When to Create New Positions? .................................................................................................. 218  When Should I Upgrade Existing Positions? ................................................................................ 222  Whom to Hire When? .................................................................................................................. 224 o Generalists versus Specialists: Option Value versus Depth ............................................ 224 o Small‐Company vs. Big Company Backgrounds: “He Can’t Actually Build the Crank” ... 227 o Experienced versus Inexperienced Hires ........................................................................ 229 Rewards .................................................................................................................................................... 232  Cash Compensation ..................................................................................................................... 233 o The Ups and Downs of Salaries ....................................................................................... 233 o High versus Low Bonus‐Sensitivity .................................................................................. 236 o Gender Gaps: Male versus Female Compensation ......................................................... 237  C‐level versus VP‐level Equity Stakes ........................................................................................... 240 o Locking on the Golden Handcuffs ................................................................................... 242  Cash‐versus‐Equity Seesaw .......................................................................................................... 244 Closing Remarks ........................................................................................................................................ 245 Chapter 9: Investor Dilemmas: Adding Value, Adding Risk ............................................................... 249 Enter the Investor ..................................................................................................................................... 251 Self‐funding ............................................................................................................................................... 252 When Investors Become Desirable ........................................................................................................... 253 Accessible but Risky: Money from Friends and Family ............................................................................. 257  Motivation to Take Friends‐and‐Family Money: Comfort, Desperation, or Ignorance? ............ 258  “Burning the Boats”: Productive Motivation or “Entrepreneurial Suicide”?............................... 260 High Variance: Angel Investors ................................................................................................................. 262 Strikeout or Home Run: Venture Capitalists ............................................................................................. 267  Benefits of Venture Capital .......................................................................................................... 269 o Financial Capital .............................................................................................................. 269 o Social Capital: Connections and Credibility .................................................................... 271 o Human Capital: Guidance and Mentoring, Both Informally and Through the Board of Directors .......................................................................................................................... 272  Costs of Venture Capital: Giving Up Ownership .......................................................................... 278 o Changes in Overall Ownership ........................................................................................ 278 o Liquidation Preferences: Giving Up “Small” Exits ........................................................... 280 o Investors Forcing Ownership Shifts within the Founding Team ..................................... 283  Costs of Venture Capital: Losing Control of Decision Making ..................................................... 284 o Board Control .................................................................................................................. 285 Detailed Table of Contents

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o Managing the Board: The Middle of the “Hourglass” .................................................... 288 o Effects of Board Formalization ........................................................................................ 289 o Staging as a Control Mechanism ..................................................................................... 290 Divergent Paths: Wealth versus. Control with Investors .......................................................................... 291 Closing Remarks ........................................................................................................................................ 293 Chapter 10: Failure, Success, and Founder‐CEO Succession .............................................................. 297 Triggers for Change ................................................................................................................................... 300  Voluntary Succession ................................................................................................................... 301  Fired for Failure ............................................................................................................................ 302  The Paradox of Entrepreneurial Success ..................................................................................... 303  Succeeding at Product Development........................................................................................... 304  Succeeding at Fund‐Raising ......................................................................................................... 307  Implications for Succession .......................................................................................................... 309 Searching for a Successor ......................................................................................................................... 310  Sources of Successors .................................................................................................................. 310  Founder Involvement ................................................................................................................... 312  Successor Dissimilarity ................................................................................................................. 314 After the Succession ................................................................................................................................. 316  “A Tidal Change” .......................................................................................................................... 316  The Replaced Founder’s New Position ........................................................................................ 317  Keeping the Founder: High Risk, High Return? ............................................................................ 320  Smoothing the Transition: The Board’s Role ............................................................................... 321  Gaining the Predecessor’s Support: The New CEO’s Actions ...................................................... 324 Closing Remarks ........................................................................................................................................ 326


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Part IV: Conclusion Chapter 11: Wealth‐versus‐Control Dilemmas .................................................................................. 331 A Central Dilemma: Wealth versus Control .............................................................................................. 333  Divergent Outcomes: Rich versus King ........................................................................................ 337  Using the Wealth‐versus‐Control Lens to Revisit Evan Williams’s Decisions .............................. 340  Other Alternatives: Second‐tier Resources.................................................................................. 343  Other Alternatives: Hybrid Paths ................................................................................................. 344 “Better” and “Worse” Outcomes .............................................................................................................. 346  The Core Founder’s View: Self‐Knowledge and Decision Making ............................................... 346  The Views of Other Participants: The Need to Assess the Founder ............................................ 349 Can Founders Change? ............................................................................................................................. 352 Other Choices that Affect Rich versus King Outcomes ............................................................................. 354  Preferred Rate of Startup Growth ............................................................................................... 355  Capital Intensity ........................................................................................................................... 355  Boundaries of the Firm ................................................................................................................ 356 Increasing the Chances of Achieving the “Entrepreneurial Ideal” ............................................................ 356  Increasing Pre‐founding Resource Endowments ......................................................................... 356 o Human Capital ................................................................................................................ 357 o Social Capital ................................................................................................................... 357 o Financial Capital .............................................................................................................. 358  Anticipating Trouble .................................................................................................................... 359  Getting Closer Each Time: Serial Entrepreneurs .......................................................................... 360 Implications for “Unsolved Puzzles” ......................................................................................................... 361  Is the Missing “Private Equity Premium” Really a “Puzzle”? ....................................................... 361  Founder Power? ........................................................................................................................... 361  Stewards Rather Than Agents? .................................................................................................... 362 Boundary Conditions and Opportunities for Future Research ................................................................. 363  Testing Boundary Conditions ....................................................................................................... 363 o Specific to High‐Potential Startups? ............................................................................... 364 o Specific to the United States? ......................................................................................... 365  Opportunities for Future Research .............................................................................................. 366 o Beyond Wealth and Control: The Effects of Other Motivations ..................................... 366 o Beyond First‐Time Founders: Serial Entrepreneurship ................................................... 367 o Beyond Founders, Hires, and Investors: Other Potential Participants ........................... 367 o Where to Found, Exits, & Other Important Dilemmas ................................................... 368 o Other Outcomes: Realized Exits and Risk Differences .................................................... 369 Closing Remarks ........................................................................................................................................ 370 Appendix 11‐1 – A Thought Experiment: Would a Hybrid Path Be Better? ............................................. 372 Appendix 11‐2 – A Model of Founder Decisions ....................................................................................... 374 Appendix 11‐3 – Exit Dilemmas: Which Way Out? ................................................................................... 376  Should We Sell Our Startup? ........................................................................................................ 376 o Reasons Not to Sell ......................................................................................................... 377 o Reasons to Sell ................................................................................................................ 378 o Eroding Prospects for the Startup .................................................................................. 379 o Attractive Post‐Acquisition Strategies ............................................................................ 380 o How Should We Structure the Sale? ............................................................................... 381 Detailed Table of Contents

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Noam Wasserman

Should We Go Public? ................................................................................................................. 383 Divergence within the Team ........................................................................................................ 385

Acknowledgments ........................................................................................................................... 387 Appendix A: Quantitative Data ........................................................................................................ 391 Survey Process .......................................................................................................................................... 391 Demographics of Respondents ................................................................................................................. 395 Survey Contents ........................................................................................................................................ 396 Appendix B: Summary of Startups and People ................................................................................. 403 Table B.1: Table of Startups ...................................................................................................................... 404 Table B.2: Table of People ........................................................................................................................ 413 Notes ............................................................................................................................................... 425 Bibliography .................................................................................................................................... 451 Index ............................................................................................................................................... 467


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