Determine Who Are Founders and Who Are Executives

When founders develop a venture concept and value proposition, they’ve created the basis of a company. One frequent problem, though, is that founders tend to think of themselves as executives of the company. Founders certainly can become CEOs and executives, and it happens many times, but a visionary founder may not have the skills or even the inclination to focus on the operational elements of the company that will make it a success. For example, a scientist who discovers a breakthrough technology may have world-leading technology talents but may lack the market knowledge and business experience that is learned over years. It’s not likely that this founder is the kind of CEO who can lead a company to success. (Naturally, there are exceptions, and we shouldn’t be dogmatic in such matters. Excellent CEOs have emerged who had no previous senior management experiences—think Larry Page of Google or Jeff Ganek of Neustar.)

An inventor or passionate founder may not be a good leader or executive because he is driven by the desire to create and advance the science vision or technology, and not to create a product. This is why researchers and scientists from universities and laboratories are not always the people you need to run a company. To create the product and make it commercially available requires a different type of talent, those who focus on all aspects of the product, such as customer experience, design, form and function, cost and quality, and timelines and deliverables.

There is a long-standing debate in the research community as to whether the venture concept or the CEO and team is more important for the success of a company. The issue is often referred to as the “horse and rider” question: if you have a great business idea (the horse), will it succeed with a less-than-stellar CEO and team (the rider), or if you have a great CEO and team, will it succeed with a less-than-stellar business idea? Academically, this may be an open question, but most venture capitalists (including us) come down strongly in favor of the rider.

We believe that an outstanding CEO and team have a good chance to be able to navigate to success through all the great difficulties of building a company, even when the business plan is challenged with unforeseen obstacles. On the other hand, a less-than-stellar CEO and team, no matter how great their business plan, won’t be able to navigate through the almost certain series of challenges that new ventures always face.

Identify the CEO

Although the strength of the entire team is crucial, the CEO, as the leader of the company, is by far the most important team member. He is the final authority on all forms of decision making, including strategy, culture, recruiting, incentives and rewards, schedules, milestones, and deliverables. If you’re an entrepreneur starting a venture, don’t assume that you must be CEO. You might have many roles on the operational team, or only be a founder and still be of enormous value to the company, as well as receive great rewards. At SRI, we’ve spun out only one or two ventures over the past twenty years that had a CEO who came from within SRI.

To create a great company, the CEO must be able to motivate people under difficult conditions. She must be an individual of high integrity who gains the loyalty and trust of the team. She must be able to listen and have a flexible mind capable of adapting to changing situations. Most of all, she must have the energy, ambition, passion, and drive to create a company that can make a difference to the world.

Vinod Khosla, one of the world’s leading venture capitalists, speaks of the type of CEO he would want to invest in, and on whose board he would want to serve. He seeks people who have radical new ideas. He likes ideas that create new categories of business and don’t just fit in to an existing category.

Khosla seeks a CEO and team members who have a bold vision of what they want to accomplish and have the ability to execute. “It’s not about people who have focus groups to determine products—which reduces everything to mediocrity,” he said. “It’s not about consensus or common opinions. Steve Jobs famously ignored consensus advice. The development of really new product concepts is done by vision, not by process. It’s about vision, passion, and the courage of convictions.”¹

Khosla has two favorite quotes relating to his vision of the type of CEO he wants to invest in. The first is from George Bernard Shaw.

The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.

The second is from Martin Luther King Jr.

But I say to you, my friends, as I move to my conclusion, there are certain things in our nation and in the world which I am proud to be maladjusted and which I hope all men of good-will will be maladjusted until the good societies realize.

In our experience, when we’ve created a new venture that depends on a breakthrough technology, it’s almost inevitable that we encounter two critiques from doubters. They say it’s already been done, or they say it’s impossible. It takes the kind of leadership and passion that Khosla discusses for you to move ahead in the face of those two objections—and to maintain your convictions that it is possible and has not been done before.

There are many ways of looking at the talents of great CEOs, but the ability to inspire people to do the impossible is high on the list. Ken Langone, cofounder of The Home Depot, has stated it well: “A great leader gets people to do things they didn’t think they could do. A great leader gives them confidence and self-assurance, and it’s OK if you fail. If you fail, it doesn’t make you a bad person. It just means you got to try harder or differently the next time.”²

Even with a compelling venture concept, ventures can fail because of poor leadership. Some CEOs and teams lack a vision of a clear product opportunity and its market value. Many lack experience and expertise in the market and technology domains. Others lack the ability to lead and motivate people or to navigate difficult events or recognize new opportunities. Still others may be visionary but are not operationally skilled and can’t execute.

Perhaps the biggest failing of unsuccessful CEOs is their inability to assess timing and execution risk related to entering the market and generating revenue. Because time translates into cash burn, misjudgments mean that businesses run out of money before achieving certain goals that would have encouraged further investment. Such times test the mettle of CEOs. Delays are sometimes unavoidable—the price of entering new markets. But the time lag between technology readiness and market acceptance can be a huge problem for new technologies.

In the case of flash memory devices, it took several years after the founding of SanDisk for a major market (digital cameras) to be established. As CEO Harari said, “The company kept losing money beyond the period that we had scheduled, because the first application, digital cameras, took longer to gain acceptance than we expected. However, once they did, our company took off like a rocket.”³ In the interim, the company was fortunate in having a tenacious CEO and supportive group of investors who continued to fund the company.

Successful CEOs, in our experience, have had one common trait: the ability to lead by example and gain the loyalty of talented people willing to give their very best for a common objective. And it was not only because of the CEOs’ generosity with stock options and other financial incentives; they also were able to inspire people to work to achieve what had not been done before. The lure of pioneering is powerful, and it attracts talented people who are willing to forgo immediate financial returns for the privilege of feeling that they’ve accomplished something that has not been done before, such as bringing a revolutionary product to market and building a great company.

Having a vision that is shared by others is essential, and that vision cannot be of getting a quick financial reward by selling the company at the first opportunity. In fact, employees as well as founders are often reluctant to sell (even with a nice financial reward) before they have achieved some elements of the dream that made them toil day and night in the early years. This is the difference between a venture that is designed for quick financial reward, and a venture with a goal of great success and impact.

It’s also a common misperception to think of CEOs as CEOs for the life of the company. As the company evolves, different leadership talents are necessary. In Silicon Valley, our best guess is that the average tenure of a CEO is about four years. A great founding CEO will know when the company has reached a stage that demands new strengths and leadership. There is nothing negative associated with that event, and in fact it leaves an opportunity for the CEO to find her next early-stage company opportunity.

Define the Characteristics of the Start-Up Team

The start-up team, though entrepreneurial, needs to have the leadership, market, operational, and technical skills necessary to execute the plan, as well as a common vision of the goals it’s aiming to achieve.

Start-up teams are very different from management teams that run large companies. Start-up teams get paid less, and the expectation is that their ultimate financial reward is the equity they have in the business they’re building. They are problem solvers and risk takers and not dependent on the infrastructure of a big company to get their jobs done. They also expect to work day and night, seven days a week. Usually they have no retirement plan except for the equity they’re granted in the venture.

The leaders need to be clearly established and respected. Although internal consultation and discussion are needed, decisions are rarely made unanimously. But the decisions must be respected by all, and this is why trust is important and the confidence in leadership critical. Agreeing to a decision in a meeting and then ignoring it afterward is a formula for failure. It’s also true that the CEO needs to listen to the team members and carefully evaluate their ideas before making a decision. Team members should express their ideas only from the point of view of what they believe is the best way for the company to achieve its goals, and not only what they think the CEO might want to hear. “If two people always agree, one of them is unnecessary,” Henry Ford is reputed to have said.

The ability to attract top talent depends on the location of the venture and particularly on the kinds of companies in the region, general economic conditions, and the local culture—the degree to which being employed by a new company is considered socially desirable in the community. We go into greater depth about choosing a location in chapter 7.

It’s a great advantage when team members already know each other, either by having worked together in the past or by reputation. Adam Cheyer, VP of engineering at Siri, throughout his career kept a list of the top five people in various technological fields. In meetings, Adam would talk about his recruiting progress with statements like, “I’ve got three of the top five people in this field. I’m going after the other two this month.” As a result of having this top talent, the Siri team exceeded goals and expectations at every stage.

Great people want to join an organization that has the vision to accomplish great things. Inevitably, they have many career options because they are well regarded. What makes them want to take the financial risk of joining a start-up? The short answer is that they’re driven to “make a dent in the universe,” as Steve Jobs would say. They expect the financial rewards to come if they’re successful.

The financial rewards do have to be there, and equity in the company is the currency that must be shared with employees. They will have heard about other situations where early joiners of great companies have made lots of money, and they know that part of the package they’re offered will include stock options that will be valuable when the company has a public offering or is sold. A major task of the entrepreneur and the investors is to quantify the percentage ownership offered to employees. There is always a vesting period as an inducement for people to stay. In the case of departures, the conditions are specified, but the idea is to induce desired and successful people to stay with the company.

In Silicon Valley there are broadly defined terms for equity to employees in venture-backed companies. Decades of history have led to these expectations. Often, at the start-up formation stage, a CEO might expect around 8 to 12 percent of a company. VPs of engineering, product, or marketing might each get 2 to 4 percent, and the rest of the team might share another 10 or 15 percent. It is essential that every member of a start-up team be rewarded with equity and no one is left out. The founders and cash investors will share the rest of the equity.

Recruit the Start-Up Team

To recruit a venture team, you start with a step-by-step determination of needs, subdivided into various stages gated by events. For example, a software product company needs to start with the most talented product architects along with programmers and quality control people. The product architects in turn cannot work without the expertise provided by experts in applications and user experience. There’s no need to hire a large staff of programmers until the product definition is in hand.

Develop the Team and the Culture of Corporate Integrity

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There is never perfect alignment or cooperation in a team. There will always be many “fault lines.” In times of great stress, and great stress will always happen, the team will either fracture or fuse. How that plays out will determine the future of the company.

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People who work with customers and product features are optimists by nature—otherwise they would not be joining a start-up—but their opinions must reflect reality, and not what others in the company or the investors might want to hear. People like good news and tend to withhold the bad stuff until it is too late. A key element of corporate integrity is knowing how to recognize and attack potentially company-killing problems, but integrity is the hardest element to cultivate in any new organization.

In the early years of Neustar, the original software had to enable a number port time of 15 seconds; the company had to meet this industry requirement to continue the contract and not incur penalties. But the original test time was 60 seconds. The problem was to determine the cause of the slow response. Was it the relational object database (purchased from a small company, with special features well adapted to this requirement), or was it the delays in the associated data processing?

It would have been easy to place blame on various team members, but Jeff Ganek tolerated none of that. Instead, he hired specialized consultants to conduct the forensic investigation and work with the team to meet the requirements. He also enlisted the help of the database vendor, which recognized that its future as a provider was on the line. In this way Ganek promoted teamwork, and not finger-pointing. At the same time, he learned from the experience that the skills inside the company were not up to the longer-term task. Later, when the pressure was off, he replaced some workers to gain the needed skills.

The company’s vision and team loyalty can quickly be tarnished by a lapse in integrity. It is during times of stress that such lapses manifest themselves, and the resulting loss of confidence in leadership can quickly lead to the demise of the venture. Employee morale is vital. When things don’t go well, people want to feel that they’re not being misled about the actions or sacrifices that will be needed.

Integrity is usually defined as the firm adherence to a code of moral values, but that code tends to vary greatly. In a business context we’re talking about the ability to instill trust that the leader is sharing the hard work, understanding the difficult issues, and being honest in dealing with people so that all the team members feel they’re in the same boat in good times and bad times. People have to feel that when hard actions are called for, their leader will be there to take responsibility and be prepared to sacrifice more than others to reach a satisfactory end.

A common time of stress occurs when companies run out of cash. We have seen situations where a start-up was running low on cash, and prospects for new funding or sales looked uncertain because of setbacks. Yet not a single team member left, because they trusted their leader and believed that through their team effort a good outcome was certain. On the other hand, we have seen companies whose most talented people have left because they’ve lost respect for their leader owing to perceptions of dishonesty, flight from realistic thinking, or the inability to make people feel that problem solving is a team effort and not something that is dictated from the top.

Develop the Team over Stages of the Company’s Life

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A venture is a dynamic organization that constantly needs to evaluate the market and develop new and different team skills as it moves into different stages of success. A caterpillar and a butterfly need different resources.

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There is a delicate balance in a new organization between being focused on initial objectives and being open to new realities that force a change in direction. In our experience, a frequent point of failure is in failing to maintain that balance. Although start-ups cannot afford to take lightly a change in direction, they cannot ignore the world around them. The ability to successfully navigate your course in changing environments can determine your success. There are no fixed road maps, only a direction. The team must modify its road map as events evolve, as long as it maintains its sense of true north.

Ensuring that your employees possess the right talent is a constant requirement. Personalities may not fit, and people may not live up to expectations as they take on increasing responsibility, or the pressure of the daily work might be too much for them to cope with. In the happy situation where the business needs to grow rapidly, heads of departments may not be able to manage fast-growing organizations. Thus, a key element of successful entrepreneurship is knowing when changes are needed and making them happen. That’s always painful, because the people found to be inadequate at a later stage in the company might have been stars in the early days, and strong loyalties were built.

The entrepreneurial team will navigate the venture through many phases of life—from concept to initial team, to developing the product, to gaining revenue, to profitability, to scaling up as a major company. These phases are often called the seed or angel round, the A round, the B round, and beyond. The company will start with a few founders and potentially grow to twenty employees, then one hundred, then one thousand, and so on. If you think in these terms, it’s easy to understand that a team’s talents need to change as the company evolves. A CEO and team that created a company, scaled it to ten or twenty people, and developed and marketed a product may not be the CEO and team that grow the company to the stage of employing a thousand people and scaling the market internationally.

The best entrepreneurs we’ve seen recognize this fact. When we start ventures at SRI, we often talk with the CEO and team members about their talents and identify the stage at which they are most effective. For example, some CEOs and team members enjoy the early start-up environment, with its all-for-one-and-one-for-all spirit, driving a vision forward to reality. But they recognize that they may not be either capable enough or knowledgeable enough to bring the company to thousands of people and revenues of hundreds of millions of dollars.

When new team members with new skills are brought in and other team members leave, those who leave have still succeeded. There is usually an equity reward that comes with stock option vesting for departing people. There is no shame in that—in fact, there is often glory—and departing team members are often rapidly recruited to other ventures that need their talents.

An essential element in making this evolutionary process effective is an internal review process wherein employees, including the highest levels in the company, have a periodic review (perhaps every six months) during which they and their supervisors discuss performance against objectives. Face-to-face discussions are critical. We always recommend that young companies avail themselves of consultants who are specialists in employee evaluations to set up such programs.

We’ve found that, without training of the supervisors, the personnel review process does not do the job of either tracking the progress of individuals or providing useful feedback. The problem comes from the reality that no one likes to tell people bad news: “You’re not doing well, you need to do better, and here are things you need to do.” We had the benefit ourselves of receiving personnel review training at RCA. This training is important for conducting successful evaluation meetings. In the absence of critical reviews, employees are left in doubt, or perhaps misled, about their performance. As a result, you cannot address deficiencies.

Consider the case of Nova, the start-up that transformed the credit card payment industry for small merchants. It’s a great success story, but over time many changes had to be made to the founding team. Of the eleven original members, not long after the company went into serious operation, only one remained: COO Ed Grzedzinski, who had moved up to CEO.

Why? The first to exit was the CEO, who left the company for personal health reasons. However, the good fortune was that Grzedzinski was a brilliant strategist and manager. He managed the company throughout the investment period and even beyond, after the merger with US Bancorp. With limited experience before Nova, Grzedzinski quickly learned the job. Another one who left was the head of software development, who did a great job in building the basic systems but proved unable to manage the scale-up to one hundred thousand merchants. The heads of sales and marketing, as well as customer service, proved unable to manage the novel marketing strategy, which involved dealing with hundreds of community banks as distribution partners for the Nova service.

However, the most difficult task was that of the chief financial officer, because of the financial complexity of the company’s business and the fact that more than sixty acquisitions were made over a period of years. Finding a suitable person for that job proved to be a trial-and-error process, as people were hired and proved inadequate to the task. Finally, a CFO was hired who had the talent to take the company to the billion-dollar revenue level.

It’s clear that building the right team at the right stage is no easy thing. But if you want your new venture to succeed, you must have laserlike focus on how the team operates and gets the venture to the next stage of success.