Here are three founder scenarios, all with parallels to cases I teach our MBA students:
#1: You have an idea for a great product and want to start a company. Do you start it yourself (and keep all of the equity) or do you find a good co-founder (with whom you have to split the equity 50/50)?
#2: You have 2 similar offers from potential investors. However, one is from angels (who want one board seat out of 3, leaving you in control of the board) and the other is from VCs (who want 2 of 3 board seats). Which do you take?
#3: You have been doing a good job as a founder-CEO, and have really enjoyed being able to control major decisions and being able to “put my stamp on my company.” However, you are starting to feel that a more experienced CEO would be able to grow a more valuable company than you could. Should you keep your CEO seat, or should you offer to step down (into a “ceremonial CTO” role) and find a better CEO to take over your “baby”?
Is there a common thread running through these decisions?
To me, the first choice in each decision would increase the chances that you will be able to keep control of the company and retain more of its equity. However, this control might come at the expense of building a more valuable company; you would probably end up with a less-capable founding team, lower quality investors (yes, I am going out on a limb here and assuming that the typical VC will add more value than the typical angel :->), and a less experienced CEO, preventing the venture from reaching its full potential.
In contrast, the second choice in each decision would require you to give up more control and more equity, but it would enable you to attract more and higher-quality people who could help build the company’s overall value. In my keynote address last month, I used this image to capture the tradeoff.
Perhaps a bit too colloquially, I refer to these choices as “Rich versus King.” The phrase comes from our ONSET Ventures case, where the VCs try to identify which founder-CEOs will willingly step aside when the VCs want to bring in a better CEO (to ONSET, these founders want to be “rich”) and which founder-CEOs will fight such a change (to ONSET, these founders want to be “king”). In this paper, I extend this phrase to encompass the much broader set of decisions faced by founders who need to attract a wide variety of resources (human, financial, other) to their ventures if the venture is going to reach full potential.
King options are ones that will enable founders to keep control of key decisions (by keeping control of the CEO position and of the board) and, often, to keep more of the equity for themselves. Rich options are ones that should enable the company (and, likewise, the value of the founder’s equity stake) to become more valuable, but which sideline the founder by taking away the CEO position and control over major decisions. In the 3 scenarios above, each of the first choices are “King” choices, each of the second choices are “Rich” choices. The chart below (oh no, an HBS 2X2 matrix!) captures what should result from the consistent selection of King or Rich options when making (1.) co-founder decisions (scenario #1 above), (2.) investor/board decisions (scenario #2), and (3.) non-founder hiring/succession decisions (scenario #3).
The ideal scenario is one in which the founder can be both rich and king. (“Rich and Regal,” if you will.) It’s easy for all of us to name some founders who achieved this ideal: Gates, Dell, et al. However, these founders are by far the exception. (That is why they are so well known!) In my “Rich versus King” paper, I establish that most founders should (theoretically) and actually do (shown using my multi-year dataset of hundreds of private IT ventures) face the Rich-versus-King tradeoff, where the actions they take to build company value can compromise their ability to control key decisions and to retain equity, and, conversely, the actions they take to keep control and equity harm their ability to build a more valuable company.
Academic aside: The theoretical foundation for this paper integrates Stevenson’s definition of entrepreneurship with resource dependency theory (RDT). According to Stevenson’s definition, “Entrepreneurship is the pursuit of opportunity beyond the resources currently controlled” (e.g., Stevenson and Jarillo, 1990 SMJ). Unless they already control all of the resources needed to pursue their opportunity, founders will have to gain control over — or secure the cooperation of — the resources they are missing. RDT highlights how gaining such control over external resources will require the manager (here, founder) to give up things of value (here, equity stakes or decision making control) in order to secure those resources, especially when those resources are critical and scarce. The result: founders will have to give up equity and control if they want to attract key resources — i.e., will face a Rich-versus-King tradeoff.
My field research indicates that a critical factor in this tradeoff is the founder’s motivation: Is the founder starting the venture in order to “run the show” and leave his or her imprint on the venture, or is the founder pursuing the good old profit motive? The key isn’t that a particular Rich choice is better than the competing King choice (or vice versa), but how well each choice fits with the founder’s motivation. Founders who make choices that are consistent with their motivations and goals (e.g., a King-motivated founder who doesn’t give up a lot of equity and decision-making control to co-founders, non-founder hires, or investors; a Rich-motivated founder who does give up equity and control to attract excellent co-founders, hires, and investors) should have a much better chance of achieving their goals.
It could be argued that the key isn’t what percentage of equity the founder holds but the value of that equity stake (a “smaller slice of a larger pie” analogy), and that when equity value is considered, there won’t be a Rich-versus-King tradeoff. In actuality, even when using an estimate for the current value of the founder’s stake, I find a significant tradeoff between that value and whether the founder has kept control of the CEO position and board.
Side note: A related factor that might also affect the founder’s motivation is the founder’s perception of the venture’s potential. Founders who think their ventures have the potential to be extremely valuable may make very different choices from founders who think their ventures will be successful but not extremely valuable. To cite an example with added relevance to anyone reading a Blogger.com blog (e.g., this one): Last week, the Wall Street Journal quoted Evan Williams, founder of Blogger.com, about the different ways he approached his last two ventures. First, Evan built Blogger.com without any VC money, before selling the venture to Google in 2003. However, for his current venture, Odeo (podcasting), he took VC money from Charles River. Why?
With Odeo, “we thought we had the opportunity to do something more substantial,” and that required venture capital, he says.
Same person, very different approaches to building his ventures. Evan seems to have expected Blogger.com to be “less substantial” (have less potential value) than he expects Odeo to be, and this expectation affected his investor decision. (Revisiting our 3 scenarios: Does anyone know if it also led to different co-founder and hiring decisions in Odeo vs. Blogger.com?)