The new (February 2008) issue of Harvard Business Review has an article that delves into issues familiar to (and possibly of interest to) participants in this blog. Its title is “The Founder’s Dilemma.”
Below is the article summary from the HBR site. For the full article, see here at HBR or here at HBS Publishing.
If you want more details on the cases mentioned in the article, most are listed here. For details on the data that underlie the more systematic research described in the article, see A Note on My Research Approach and Data and a variety of research-specific posts within this blog.
The Founder’s Dilemma
Noam WassermanWhy do people start businesses? For the money and the chance to control their own companies, certainly. But new research from Harvard Business School professor Noam Wasserman shows that those goals are often incompatible.
The author’s studies indicate that a founder who gives up more equity to attract cofounders, new hires, and investors builds a more valuable company than one who parts with less equity. More often than not, however, those superior returns come from replacing the founder with a professional CEO more experienced with the needs of a growing company. This fundamental tension requires founders to make “rich” versus “king” trade-offs to maximize either their wealth or their control over the company.
Founders seeking to remain in control would do well to restrict themselves to businesses where large amounts of capital aren’t required and where they already have the skills and contacts they need. They may also want to wait until late in their careers, after they have developed broader management skills, before setting up shop. Entrepreneurs who focus on wealth can make the leap sooner because they won’t mind taking money from investors or depending on executives to manage their ventures. Such founders will often bring in new CEOs themselves and be more likely to work with their boards to develop new, post-succession roles for themselves.
Choosing between money and power allows entrepreneurs to come to grips with what success means to them. Founders who want to manage empires will not believe they are successes if they lose control, even if they end up rich. Conversely, founders who understand that their goal is to amass wealth will not view themselves as failures when they step down from the top job.
I have found this article in HBR enlightening and full of resonance.I am the founder of a multimillion dollar enterprise and had been pondering next steps, fearing my instinct to bring in a more experienced CEO in my place for the next raft of challenges.Upon reading your theories, I am now emboldened to carry out such a plan, and have made the appropriate recommendation to my board.Luckily I am still young enough (38) to move to the next project and am now relishing this armed with the knowledge of my prior achievements - plus hopefully the promise of a lot more wealth than if I stick around!
Thanks for sharing your experiences, Anonymous. One follow-up question, one observation:1. What is “the next raft of challenges” the CEO will be facing?2. Very interesting how you highlight the “repeated game” nature of the Founder’s Dilemma for serial founders. The fact that you can envision doing more ventures (your “next project(s)”) might change the choice you make at this point.Best of luck as you head into this next stage!
Thoughts from an entrepreneur. Great work but not sure if it applies to most cluster companies as they are formed by teams and so do not have the King approach. It is great having someone looking at the DNA of these companies but can we suggest macro policies from this micro data? Cluster companies have multi-partners (founders/investors) in multi-rounds and that is why we are using Equity Fingerprint to study what is a new class of Kingless companies!
I saw your name on the cover of HBR and went straight to your article. Excellent piece. Congratulations. It reminded me your lecture on LNV this fall.I’ve thought often on your paradox of Rich vs. King and I find myself in a strange situation. I founded a company in 2000 with more than 250 employees today. I gave shares to other founders and to VC funds so that today I do not have control of the company. I did it because I thought that was the best for the company, it has also been very good for me financially, but I wished I had kept better control of the board.Somehow doing the best for my company was also the best for me financially, but not specifically for what I wanted. But had I kept more control of the company I doubt the company would have been so successful. Does it make sense?Thanks for sharing your insights!
Thanks for the update, Jesus — great to hear from you!Your scenario and reflections make perfect sense. Sounds like you gave up control, the company grew faster because of it, and as a result your potential financial gains are higher. Despite this, you’re having some regrets about having given up control.To this, add the fact that seeing the implications of your choices is now helping you understand what your core motivation is (and thus what you might want to do differently in the future), and all of this seems to be right in line with Rich-versus-King tradeoffs, right?
I read your article with great interest. I have recently learned that one of the absolutely top tier silicon valley VC firms has analyzed company performance over the VC’s entire history - and multiple funds. They found first team CEO’s outperformed more experienced CEO’s in terms of value creation for the VC. Any insights into how this could be the case. Seems to completely contradict your point of view?
Great question, Anonymous – it’s that kind of thought-inducing dialogue that keeps me writing this blog. Thanks for contributing!I have initial thoughts about your question on four levels. (I’m almost tempted to devote an entirely new blog-post to these, but let’s keep them here for now.) Feel free to fire back with any follow-ups about what’s wrong here (or, even better, with more details so we can resolve some of my questions below).<>First<>, let’s try a little thought experiment that’s perfectly consistent both with “The Founder’s Dilemma” and with what you say about that VC firm’s results. Here’s a very simple but common scenario: A first-time entrepreneur gets standard terms from a VC firm, builds her company, and has a successful exit event (splitting the proceeds with the VC). Now that that entrepreneur has succeeded, wouldn’t she gain negotiating leverage to get more favorable terms from investors in her next ventures (for reasons described in the article)? If so, across each of her ventures, that entrepreneur should be able to capture more and more of the value each time, decreasing the VC’s share of the gains, right? Hence, the result that your VC firm got in its study. <>Second<>, even with the small amount of information you provide about the VC firm’s study, it’s hard to argue that we’re comparing apples to apples. Three main reasons:- My guess is that the firm’s sample (comprised of a single top-tier firm’s portfolio) was quite different from mine (comprised of a more representative sample across start-ups; more details on my data are < HREF="http://founderresearch.blogspot.com/2005/09/note-on-my-research-approach-and-data.html" REL="nofollow">here<>). Do you have other details on what their sample looked like? Did its unusual composition affect the results they got?- The VC firm is understandably focusing on “value creation <>for the VC”<>. My focus has been on the returns to the <>founder<>, which can be very different (especially for first-time founders, who have less ability to push back against liquidation preferences and other terms that benefit VCs at the expense of the founder). Once again, see the thought experiment above.- My quantitative analyses did not examine the same serial entrepreneurs across their ventures, as seems to have been the focus of the VC firm’s study. Instead, I wanted a much broader sample of entrepreneurial experience (serial entrepreneurs are a small percentage of the overall pool of entrepreneurs). Is it possible that serial entrepreneurs are systematically different from first-timers? If so, then you should compare results cautiously.<>Third<>, a recent paper by 3 of my HBS colleagues (and one of our doctoral students) is more directly comparable to your VC firm’s study. In that paper, Paul Gompers, Josh Lerner, David Scharfstein, and Anna Kovner looked at how returns differ across the ventures of serial entrepreneurs (among other things). Their sample contained more than 8,000 entrepreneurs and 370 VC funds. Here’s the core of the abstract of their paper (you can see a < HREF="http://w4.stern.nyu.edu/finance/docs/pdfs/Seminars/063w-gompers.pdf" REL="nofollow">full draft of it here<>). Compare it to the VC firm’s results.“We show that entrepreneurs with a track record of success are more likely to succeed than first time entrepreneurs and those who have previously failed. Funding by more experienced venture capital firms enhances the chance of success, but only for entrepreneurs without a successful track record. Similarly, more experienced venture capitalists are able to identify and invest in first time entrepreneurs who are more likely to become serial entrepreneurs. <>Investments by venture capitalists in successful serial entrepreneurs generate higher returns for their venture capital investors.<>“<>Fourth<>, as a result of its own study’s results, will the VC firm be shying away from investing in serial entrepreneurs? (In the same vein, the firm’s study would seem to be great news for first-time founders!)Looking forward to learning more!
This is a wonderful article. We’ve passed it around our office, and found several interesting applications of your framework. One comment: I wonder if there is some explanatory power in the fact that a founder always has a greater probability of being “king” than being “rich.” Founders have a 100% chance of being “king,” even if the business fails and they are king only of themselves. Because founders judge that, on average, their businesses have a 81% chance of succeeding (the Purdue study you cited), they will, if they’re honest, realize that their chances of being “king” are always higher than being “rich.” So if a founder’s utility from being “rich” and being “king” is equal, the utility optimization strategy is to be “king” at the expense of being “rich” (100% of x utils being greater than 81% of x utils). Of course, if they have a bias toward being “rich,” it must be a bias that outweighs the higher probability of being king. The only other factor I can think of which might influence this optimization problem (beyond the founder’s bias along the rich-king dimension and their beliefs about the probability of each) is the discount rate (or time horizon to sale). Many thanks for the insights you’ve provided from highlighting this important trade-off.
Your article is interesting and addresses several important issues. I am a founder of multiple medical companies that required substantial capital, and in my experience the timing of relinquishing control is crucial. Specifically, if a founder turns over such a cash-starved company to venture capitalists at inception and receives, for example, a founder’s share of five to twenty percent of the equity, then by the time the company completes multiple financings, the founder’s stake may well be diluted to insignificance. (Investors avoid such dilution by investing at least their pro rata share in subsequent rounds.) If the founder holds on too long, then the founder’s equity may be worthless if the founder is not qualified to manage the company. The solution that has worked for me has been to raise start-up capital from so-called Angel investors. In both cases, I received about 60 percent of the company’s equity after the first financing, much more than I would have received in a venture capital round. Then, after building substantial value, we turned the company over to VCs and I became a consultant. Subsequently, both companies underwent multiple dilutive financings; however, when they were sold, my equity stake was still reasonable. Had I turned the company over to the VCs at inception, my economic outcome would have been considerably worse, if not negligible. Had I maintained control for much longer even when the company needed professional management, the equity would have been worth less. In conclusion, I have found that the timing of relinquishing control has been critical.
I had a few questions the article did not address and was hoping you could address.If an entrepreneur wants to be rich and king, what is the path he/she should follow? Does a founder have to be a multiple startup entrepreneur to achieve both? Are founders who plan their first startups to be rich and then following startups to be king successful?Are founders like Bill Gates, Larry Ellison, the Google Guys just anomolies? Does a founder have to invent new technology to be like the above mentioned people?Is a startup more likely to be successful if the founder only plans to be rich?Venkat Rao
Nice list of “Rich and King” questions, Venkat. The article was focusing on the _tradeoff_ between Rich and King (rather than on the “Exception” box in the article) … but much of my current research and case writing focuses on increasing the chances that you can achieve both, and there’s no reason why we can’t start delving into that box within this blog. I might use some of your questions to kick off an upcoming post about it, and look forward to getting your (and everyone else’s) insights into it!
Congrats on the article in HBR and it is very good. My only concern is that it appears that your data appears to be primarily focused on IT and Life Sciences companies that may be looking to grow very quickly - in that case the Rich vs. King is appropriate since the primary source of capital (VC) is seeking higher expected rates of return and taking on higher risk. For a lot of mid-market companies that are not fast-growth Life Science or IT companies, their choices and sources of capital are a bit broader and they may have more opportunities to be wealthy and king. I guess I found your article reflective of the choices for a founder of an IT company looking to grow significantly but not for a founder of say a $40 million revenue baked goods company where the choices aren’t as black and white.
Thanks for the input, Milan! You are indeed correct that the core of my quantitative data (both in the article and in this research blog) is from private ventures in the IT and Life Sciences industries, as mentioned in the article.However, my field studies (see below for one example) and the arguments in the article are bit broader than that. A core definition of “entrepreneurship,” and the one used in the article, is the pursuit of opportunity beyond the resources currently controlled by the entrepreneur. The more the entrepreneur is trying to build something for which he or she lacks necessary resources, the more the entrepreneur faces the tradeoffs described in the article.This may be true in IT and Life Sciences ventures, but it is also true of high-potential ventures in a lot of other industries where founders do not start out controlling all of the resources they need. (In fact, one of my recently-completed case studies focuses on these tradeoffs in the rubbish-hauling industry, about as far from IT and Life Sciences as you can get. :->)Your baked-goods example might be a good realm in which to explore these issues. Do the founders of baked-goods companies have to make early capital expenditures? Invest in developing distribution channels, sales forces, or store fronts? Invest in product development or testing? Given that there are some hard assets involved, they would seem to have several resource options not available to other founders. If so, how do they usually get the resources (financial, human, etc.) to do all of those things (and others)?
I found the article to be very thought provoking which has given a new perspective (Rich vs. King) to me. Thanks for your efforts.The message you convey is clear that not everyone is fit to do all kinds of jobs. You need not be a zookeeper if you have started the zoo, monkeys need to be rightfully handled by their trainers else they will be on your back.Does it mean that CEO’s job is a very tactical and leans more toward meeting the objectives as laid down by stakeholders in a timely fashion, whereas founders are more strategic and visionary and often start missing the points after a while as they are more long term focused? Does this fact asserts that most of the founders altogether miss the traits what so-called effective CEOs have? Are “Rich CEOs” aligned to make profit by forming a team and devise a mechanism to achieve the profit to the fullest potential and on contrary the “King CEOs” are more passionate and like to influence the power to keep control (and perhaps in the process keep his close allies in their core team) and fail to make profit not to the full potential? So if I may conclude, the founders and CEOs are two different animals and they rarely overlap, accordingly they have two distinct and complementary (and/or sometimes supplementary) roles to play for each other.Further, the article did not explain as why the founder CEOs succeed until a point and suddenly are not effective after a stage (as suggested by your study typically after the Venture Capitalists or external players come to play). Does it have to do with the maturity of organization that after certain point in that maturity curve a different “style” of leadership is found to be more effective?
I am one of two founders of a manufacturing company with a killer app. We are approaching a B round terms sheet, and we openly embrace the idea of bringing on a new CEO. We have what we believe is the dream VC (I know you say: naive.) They have already identified the CEO that they would chose, and we have been actively working with him for months. He is great.Nevertheless, the A investors and the potential CEO are at an impasse with negotiations. Do you have suggestions for mediation or resources to use to broker a good faith offer?
A very interesting topic, I'm glad I found your blog.A very important variable about future success relative to past success (es) with valuations is the economic environment.Terms are more or less dictated by a VCs ability to exit rather than past relationships. Since an IPO is a less likely scenario today additional duress is being created on M&A valuations. This phenomenon was occurring prior to the financial melt-down. Cisco, for example, does not have has much competition now as they did a few years ago when they look to acquire a company.Wouldn't you agree that the back-end of the funding chain has more impact than the front end in terms of valuation leverage? Entrepreneurs have very little negotiating leverage in this environment regardless of past success.Of course those who have made money for others before are intuitively better positioned than those who have not.
I chanced upon to view your blog and found it very interesting. Great … Keep it up!
Hello:
I am a founder of a company that is on its way to meaningful success. While to some we may seem small, we are on a path. We closed 3 million in revenue in 2009and expect to close 7 in 2010; 3 million in Q1. Our plan expects to take us to 50 million by 2014. We are recognized by many, including Gartner, IBM, SAP, Accenture, etc, as pioneering a new space that is expected to grow to over 2 billion in annual market size.
I chose to bring in a professional CEO. I chose to step aside to be the CSO. Last week I filed an Oppression Claim resulting from a round of financing driven purely to execute anti dilution rights. In this case, the anti dilution rights are being treated as a mechanism to average down at a time when the company does not need money. The pure driver of the financing is the timing of the expiry of anti dilution…and dare I say greed.
So, I disagree with your premise of the founders' dilemna. I am me…a non serial founder who's reasons for starting my company are not consistent with riches or control. While the concepts in your article may apply to some, there are instances of outliers. I am most curious about outliers.
I have evidence of changing board seats to manipulate votes, conflict of interest, turning down a higher price financing to support an insider round.
I am most curious about how my oppression claim will pan out.
My story is in complete conflict with your premise.
Thank you for your reflections, Anonymous (from 12/23/09). I definitely agree that it is worth looking at “instances of outliers,” and would love to hear more about your experiences.
For starters:
1. What was your original motivation for starting the venture?
2. Why did you take the outside money that caused you to lose control of the board and led to those other problems?
3. Why did you “choose to bring in a professional CEO”?
4. What would you do differently next time? Why?
Looking forward to hearing more!
Noam - I've been reading your blog for a while (all day, in fact) and I have a question from an economics perspective:
What is the elasticity of the initial founding of a new business in terms of the investments of time, money, and the need for co-fonders? Founders who initially self-finance ought to be excluded from the analysis for obvious reasons. So my question is asking the relative necessity of three F's money (friends, family, and fools) versus the availability of good co-founders (I'll be reading your acquaintance vs stranger article for some insight) versus the availability of time to devote to a new venture (recently laid off, students doing it as a class project, living with the parents, etc.).
I'll tell you a quick story for context. As a new entrepreneur I am questioning how to prioritize the time/money/co-founder variables. I'm debating whether to quit my job (put time ahead of money), borrow money from a bank (put money+time ahead of finding a co-founder), or invest my spare time networking (put finding a co-founder ahead of working on the project myself). I would love to have a guide (my instincts are that, with time constant, a good co-founder trumps money, but I'd like to know empirically).
Noam, you have a great blog here.
Hello …
My name is Stacy H. I love how you talk about this in your blog … I feel much passion for the business … I love the subject and also keep me informed about this. I hope some day be a great businesswoman and develop in this area that I like.
Many thanks for your help ..
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