To Hang In or to Let Go? When to KILL your Startup

Horse dead

“When the horse is dead – dismount” is succinct practical advice sometimes attributed to the famous cavalry general Lord Mountbatten. No matter what its origin, the essence of it is clear: stop agonizing and procrastinating when something ends; the only thing left to do is to get off the horse and move on with your life.

The fact is, not every startup works out; in reality most of them fail. It is a fact of life supported by a mountain of stats data. And yet, it is extremely hard for most people to disentangle themselves from what usually was a significant personal emotional investment. The biggest hurdle to overcome here is what’s known as sunk cost fallacy. It usually goes like this: “We have invested so much (money – if you are financial investor, or life – if you are a founder), we worked so hard, we achieved so much, etc, etc that we cannot possibly let go.”

“If we could only get more funding or bring in better talent, we would succeed!” NO, you would NOT if you missed the market opportunity (assuming there ever was one), the customers are not buying, your team is burnt out and your investors look ready to kill you. Under these circumstances no amount of whip cracking will help; just get off the dead horse and move on to pursue better prospects in your life.

I have been recently involved with a startup whose story perfectly illustrates my points. The founders developed a business plan addressing an emerging market problem which, although initially nascent, appeared to be destined to become a major issue (and therefore a market opportunity) in about a year or so. Theirs was a chance to pioneer a new industry and get all the glory of it.

They managed to raise some modest angel funding that allowed them to toil for about a year initially, investing their sweat equity and some cash of their own to develop a product prototype. At this point they attracted a $2M seed investment from a Toronto-based VC fund.

The experienced founders executed well, built a strong development team and launched the first product before the year was over. Good product reviews arrived and a couple of early-adopter customer purchases materialized. The CEO was walking tall, receiving inquiries from top tier VCs such as Kleiner Perkins, Sequoia, NEA, etc. A substantial funding round appeared to be a sure thing. However, during the second year of operation sales were slow as the market was taking its time to develop. Consequently, venture capitalists were in no hurry to jump in and adopted a wait-and-see attitude.

With the high burn and dwindling funding prospects, the seed investors started to worry. I remember going to Board meetings and hearing remarks like: “We may have to do a reset”, “The only thing a VC can do is replace the CEO”, and such. Sure enough, the founder-CEO was asked to find her replacement and the expensive $60K headhunter-led search started.

When a company is still in the startup mode, searching for a winning business model, as opposed to being in the execution mode, replacing the CEO is rarely a good idea – unless, of course, the existing CEO is clearly incompetent. There is a major difference between a non-linear skillset of a founding CEO with his vision, passion, and commitment, and a hired-CEO with his usually linear execution skills. Such a change is a major and costly disruption in the life of a young startup. If nothing else, it takes about a full one-year business cycle for the new CEO to fully understand the realities of his business. In addition, with the departure of its CEO the company loses an enormous amount of the painfully accumulated company specific business experience.

With the new face put on the company, the VCs provided additional cash support by twisting some arms in financial circles to close a new investment round of $3.5M. With these resources in hand, the team embarked on the second-life journey. However, in spite of the new face, talents, cash and the energy, the market readiness has not changed. Fast-forward through a few heroic-effort but modest sales, high burn, etc and 3 years later the company is again running out of money.

At this point, everyone is exhausted and out of ideas for what to do next. The horse is dead but it is so hard to admit it! The sunk cost fallacy is raising its ugly head: we invested so much, right? It is so hard to admit a mistake and let go. Thus, the company is put in a dormant state: most employees laid off, the hired CEO stays part-time while pursuing other income opportunities, the original investors write it off mentally but still keep it on the books, the most recently sucked-in investor has no clue what to do so lets the ship drift, barely keeping the lights on for appearances just in case…

But wait, that’s still not the end of this story. After a year of this malaise, the original founder-CEO gets approached to see if he could step back in and see what could be done with the company. Another restructuring follows with $0.5M new funding to see what could be done. More heroic sales efforts come with some modest results but the market still isn’t there. Finally, all the key members of the crew quit to pursue better prospects in their lives but the controlling investor hires yet another expensive sweet talking miracle-maker who promises resurrection and the recovery of that sunken cost…

Technology startups are not mature proven-viability companies that could be “management engineered” and played with. They are essentially experiments in market or technology. Their founding premises and hypotheses need to be quickly tested and verified before large amounts of money are deployed. If the business model fails repeatedly, abandon ship no matter what the sunken cost is.

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Venture Money In, Entrepreneur Out

The delicate relationships between founders and venture capitalists are rarely openly discussed and even less frequently have carefully laid down rules that protect both sides sensitive interests. Since nothing ever goes smooth in early-stage company, the reality of the situation calls to put in place measures which would allow to deal with unavoidable conflicts in a civilized manner while protecting interests of both parties. The article below illustrates these realities.

NOTE from Paul: The guest post below is written by Bob Hebert and originally appeared on his site. It is re-blogged here by permission.

A recent edition of Profit Magazine is headlined “Lessons from Canada’s Best Employers”. It features a collection of “highly successful” entrepreneurs regaling on how to create “loyal, turbo-charged teams” and great businesses.

Inconveniently, at least one of the featured entrepreneurs was removed from the helm of his business before the magazine hit the newsstands. A man of undeniable vision, this entrepreneur had proven adept at attracting and energizing a team of bright, young employees in the pursuit of that vision. He possessed the same evangelical abilities with customers who signed up in droves for his product offering. But as the business grew, the supremely confident entrepreneur proved less adroit in evolving the hands-on, micromanaging leadership style that served him well when the firm was small. This in turn had a negative impact on his ability to attract, manage and retain an executive team capable of scaling the business. Though strong revenue growth temporarily cloaked the costs of this churn, maturation clouds were on the horizon. Given enough time the young entrepreneur may well have sorted out the leadership requirements of a growing, more complex business. But time became a scarce resource the moment the entrepreneur pursued big-time U.S. venture capital to fuel the next stage of his firm’s growth.

While in the business of risking capital, venture capitalists take every step possible to de-risk their investment decisions. Each success and failure is analyzed and processed into lessons learned, best practices and playbooks for future investments. Proven leadership is valued over its alternative, and young, promising entrepreneurs are rarely more than a few missteps from replacement. This is especially true in Silicon Valley where a class of serial CEOs and executive teams provide a bench of standby replacement talent. With the costs of trial and error learning thus needlessly high, it took but a few execution errors for the Canadian entrepreneur to find himself unceremoniously dumped at the helm of his own company. It took less than 4 months for the entrepreneur’s new ‘partners’ to become his executioners.

Learning is an iterative process, a cycle of action, reaction, reflection, adjusted action and so forth.  Self-awareness lubricates the cycle either increasing or reducing the time for individual learning. Hubris is a decided inhibitor. Entrepreneurs who own their businesses outright have the benefit of time to learn from the trials and tribulations of growing a business. But for those who secure professional investors or go public, their time becomes enmeshed with others money and a compression effect takes place. Their trials must now be almost error free. For our young Canadian entrepreneur, an award winning company and glowing magazine articles could not protect him from these realities. The good news, if it can be called that, is that he now has time to reflect on the meaning of hubris, humility, personal development and resilience.

About the Author

Robert Hebert is the founder and Managing Partner of StoneWood Group Inc., a leading executive search firm in Canada. Since 1981, he has helped firms across a wide range of sectors address their senior recruiting, assessment and leadership development requirements.

Startup Math for Techies

“Build a better mousetrap, and the world will beat a path to your door” is a saying derived from Ralph Waldo Emerson. Apparently many take this metaphor quite literally, with more than 4,400 patents issued by the US Patent Office for new mousetraps, with thousands of more unsuccessful applicants, making mousetraps the “most frequently invented device in U.S. history”.  However, you don’t want to be one of these inventors.

The assumption that technical wizardry is sufficient to build a successful business is a common psychological flaw among aspiring tech entrepreneurs. Thus to help you see the light through the fog, let me give you a brief tutorial using the language favoured by engineers – mathematical equations.

T ≠ B

Technology IS NOT a Business

Innovative technology is just a starting point and the skills and talent required for R&D do not always translate into product development know-how.

T+P  ≠ B

Technology and Product IS NOT a Business

Productization skills are essential in the new tech business. But even having an innovative product without a good market for it will not result in sales.

T+P+M  ≠ B

Technology and Product and Market IS NOT a Business

Arriving at a good market fit with an innovative product that customers are buying is an excellent place to be. But this by itself still does not make for a successful profitable business.

T+P+M+E  = B

Technology and Product and Market and Execution IS a Business

Like well-oiled machinery that performs reliably day in and out at a reasonable cost, making something useful for which there is a demand and what could be sold profitably – a well-run successful business pulls all these elements together in a harmonious whole, managed by an experienced team with complementary skills and talents.

So, there you have it! And if you are hungry for more complex math, here is another equation to ponder 🙂

VisionIntoAction Equation

Challenge: Please let me know in the Comments section below how you interpret this “equation”. I am happy to fund a dinner for further discussion with an author of the most interesting comment!

Shareholders Agreement 101

agreementIn the exciting early days in life of a startup, when the founders team is being setup or the external investors were just landed, one of the most important legal documents that defines the rules of the game, the Shareholders Agreement, is often treated lightly or its power underestimated by the first-time founders. Having been through this experience recently with one of the local startups, here is one of the most direct and readable summary of the issues that should be thought through and addressed very seriously as the consequences will haunt you throughout the lifetime of your company.

NOTE from Paul: The post below is written by Mike Volker and originally appeared on his site. It is the best I could find on this topic and is re-blogged here by permission.

Why Bother?

A company is owned by its shareholders. The shareholders appoint the directors who then appoint the management. The directors are the “soul” and conscience of the company. They are liable for its actions. Shareholders are not liable for company actions. Management may or may not be liable for company actions. Often these roles are assumed by the same individuals but as a company grows and becomes larger, this may not be the case. When a company is created, its founding shareholders determine how a company will be owned and managed. This takes the form of a “shareholders agreement”. As new shareholders enter the picture, for example angel investors, they will want to become part of the agreement and they will most likely add additional complexity. For example, they may want to impose vesting terms and also mechanisms to ensure that they ultimately can exit and get a return on their investment. Not having such an agreement can lead to serious problems and disputes and can result in corporate failure. It’s a bit like a prenuptial agreement.

Companies must comply with the law. Companies are incorporated in a particular jurisdiction (e.g. State, Province or Country) and must adhere to the applicable legislation, e.g. the Canada Business Corporations Act, or the B.C. Corporations Act. This legislation lays out the ground rules for corporate governance – what you can and cannot do, e.g. who can be a director? can a company issue shares? how can you buy or sell shares? etc. When a company is formed, it files a Memorandum and Articles of Incorporation (depending on jurisdiction) which are public documents filed with the Registrar of Companies. A shareholders agreement is confidential and its contents need not be filed or made public.

When a company is formed, its shareholders may decide on a set of ground rules over and above the basic legislation that will govern their behavior. For example, how do you handle a shareholder who wants “out” (and sell her shares)? Should it be possible to “force” (i.e. buyout) a shareholder? How are disagreements handled? Who gets to sit on the Board? What authority is given to whom for various decision-making activities? Can a shareholder (i.e. company founder) be fired? And so on…

A company which is wholly owned by one person need not have such an agreement. However, as soon as there is more than one owner, such an agreement is essential. The spirit of such an agreement will depend on what type of company is contemplated. For example, a three-owner retail shop may adopt a totally different approach to that of a high tech venture which may have many owners. When a company has hundreds of shareholders or becomes a “public” company, the need for such an agreement disappears and the applicable Act and securities regulations then take over.

Corporate Governance

There is no substitute for good corporate governance. Even small companies with few shareholders are better served by good governance practices. Instead of trying to anticipate every possible future event or trying to be overly prescriptive, a structure that ensures the installation of an experienced board of directors is arguably the best approach. Why? Because directors are responsible to the company – NOTto the shareholders as is commonly thought. If directors add diligently with this mandate, many problems that arise can be solved.

First Steps

Before jumping into a shareholders’ agreement, some very careful thought must be given to the share ownership. Who owns how many shares (and for what contribution – cash? time? intellectual property, etc)? And, how are these shares held? This is the time to talk to tax experts about some serious personal tax planning. Too many entrepreneurs ignore this important facet of owning shares only to find that when they “cash in”, they have a major tax headache. One should consider the merits of using Family trusts or issuing shares to one’s spouse and children. How is share ownership (and subsequent selling) treated by the tax authorities? Is there a disadvantage to granting stock options to employees versus giving shares (with possible vesting provisions) to them instead? Please refer to related articles on “structuring” and “dividing the pie“. A “Cap Table” (ie Capitalization Table) is essential.

What to Include

Some of the main points (ie. a checklist) to include in a shareholders agreement are:

  • what is the “structure” of the company? (and how is equity divided among shareholders?)
  • should the agreement be unanimous and involve all (or just some) of the shareholders?
  • who owns (or will own) shares (i.e. the parties to the agreement), i.e. a “capitalization table” often called a “cap table”.
  • are there vesting provisions? (i.e. shares may be subject to cancellation is a shareholder/manager quits)
  • are shareholders allowed to pledge or hypothecate their shares?
  • who is on the Board? What about outside board members?
  • who are the officers and managers?
  • what constitutes a quorum for meetings?
  • what are the restrictions on new equity issues, e.g. anti-dilution aspects, pre-emptive rights and tag-along provisions
  • how are ownership buyouts to be handled? (e.g. shotgun clause approach versus voluntary sale approach)
  • how are disputes to be resolved among shareholders? (arbitration clause?)
  • how are share sales handled? e.g. first right of refusal
  • what are a shareholders’ obligations and commitment? (conflict of interest or commitment? Full-time or ??)
  • what are shareholders’ rights? (what information, financial statements, reports, etc.can shareholders access?)
  • what happens in the event of death/incapacity?
  • how is a share valuation determined (e.g. to buy out an estate in the event of death)
  • is life insurance required? e.g. funding for purchase of shares from estate or for key person insurance
  • what are the operating guidelines or restrictions (budget approvals, spending limits banking, etc)
  • what types of decisions require unanimous board and/or unanimous shareholder approval?
  • compensation issues – remuneration of officers & directors, dividend policies
  • are other agreements required as well, e.g. management contracts, confidentiality agreements, patent rights, etc?
  • should there be any restrictions on shareholders with respect to competing interests?
  • what could trigger the dissolution of the business?
  • what is the liability exposure and is there any corporate indemnification (and insurance)?
  • who are the company’s professional advisors (legal, audit, etc.)?
  • are there any financial obligations by shareholders (bank guarantees, shareholder loans, etc)?

Some Do’s & Don’ts:

  • don’t confuse shareholder issues with management issues
  • don’t confuse return on capital with return on labor (i.e. cash investment vs founders’ time commitment)
  • don’t assume that everyone will always be agreeable (greedy? who-me?)
  • don’t get bogged down in legalese – decide what you want, then have your lawyer put it in proper form
  • do make sure everyone’s objectives and visions are compatible (this can be a major problem area)
  • do separate the roles of shareholders, directors, and managers (these roles often get confused in these agreements)
  • do talk to others who have gone through this process
  • do ask yourself what the downside is,  i.e. what’s the worst that can happen to you under the agreement?
  • do get some tax advice. It is very important that some tax planning be done early to avoid a headache later when you’ve made millions. e.g. you want to make sure that you are not compensated by being given shares, you want to make sure you own shares early so that you can use the small business lifetime capital gains exemption, maybe a family trust or holding company should own your shares.

Questions to Ask

After drafting an agreement, it is a good idea to ask a few key questions to ensure that the agreement will in fact be useful. Ask yourself the following:

1.Am I happy with my ownership stake? (If I’m the key founder, am I treating others fairly?)
2.Can I get out of this deal if I need to? i.e. can I sell the shares?
3.Can I buy more shares (ie more control) if I’d like to?
4.Am I committing to something I cannot live up to?
5.Will I be able to exert sufficient influence to protect my investment?
6.What is my total financial exposure and legal liability (present and future) on this deal?

Other Points to Consider

Preparing and discussing such an agreement will give you valuable insights into other parties’ styles, objectives, etc. It should force a close and honest evaluation of who will do what and who is committed to doing what. Most importantly, are the founders’ personal goals, objectives and propensities to take risk compatible? If one founder envisages a small, closely-held company as way to be self-employed and another envisages a dynamic, go-for-it enterprise, this marriage won’t work!  Even if you’re not sure about certain things and no matter how thorough you are, you will overlook something. Do it, then fix it if necessary, i.e. revise an agreement later rather than defer having one in the first instance.


Sample Agreement

Feel free to look at a sample agreement, albeit unprofessionally drafted, for some specific dertails. It will at least get you started. DON’T rely solely on your lawyer’s advice. Lawyers do have their biases and may steer you in a direction that is not in your best interest. (Note – are they acting for you personally or for the company or for other shareholders?)  Talk to other entrepreneurs who have gone through this exercise. Their experience may be worth many legal lunches!


Mike Volker is the Director of the University/Industry Liaison Office at Simon Fraser University, Past-Chairman of the Vancouver Enterprise Forum, President of WUTIF Capital and a technology entrepreneur. 

 

On the Virtues of Controlling Your Ego

Oh, the pleasures of having your ego tickled! Who is immune to that? I bet even the pope upon election cannot suppress an inner smile from having all those impressive titles bestowed upon himself. However, the trouble with startup founders is that it is so easy to ingratiate yourself with a grandiose feel-good title which often leads to unforeseen difficulties in the future.

I have been recently working with a tech startup founded by a brilliant engineer with a strong research background and interests, who adopted himself a couple of co-founders:  another engineer and a sales guy. For several years they were pursuing a bootstrapped advanced engineering design services business with its usual ups and downs, but were recently ready to turn it into a product-focused venture. As I started to work with the company a number of issues popped up related to the deceptively innocent sins from the early days of company setup.

The use of self-awarded job titles in an early-stage company could be a problem if the real qualifications do not correspond to the scale of the job title. It all starts quite innocently. The newly formed company needs formal management, so the main founder becomes the President & CEO,  a technical expert becomes VP of Engineering and the sales guy naturally becomes the VP of Sales & Marketing. This might be fine if the startup is moving at the speed of Hyperloop and the calibre of folks involved is adequate to the task – but this is rare with early-stage companies.

In this particular case, the individuals involved were all very talented but simply did not have the management or business experience to occupy these positions as the company started to grow. The problems manifested themselves at several levels:

·        Fundraising – the quality of the management team is key in any investment decision, and in this case was not passing scrutiny, but just becoming a major hurdle in raising the sought $2M round

·        Customer relationships – as the company typically had large organizations as its customers, the imbalance  of titles in the intense customer interactions was creating awkward situations when our “VPs” were often dealing either with junior corporate managers or with true senior executives; not good in either case!

·        Internal operations – with the business growth came the increase in staff hiring, HR issues, etc. and it became clear that being a brilliant engineer does not necessarily translate into a “titled” manager

·        Shareholders – having individuals as subordinates, while at the same time being major shareholders, creates tricky problems which could easily de-stabilize the company; reasonable measures and safeguards need to be put in place to protect against catastrophe

It took me, as an appointed company Chairman, quite a while and a lot of tip-toeing and gentle maneuvering to rectify this situation. We ended up re-classifying job titles as CTO, Director of Sales, and, a face-saving, Chief Designer. This created room to bring in more experienced talent to help steer the company. It goes without saying that nobody likes to feel “degraded” and it was not easy on all the fragile egos involved. It all worked out for the better but could have been avoided if only we learned to control our egos!

Take-aways from this post:

·        Members of the Founders team should go easy on the job titles and avoid loftiness incommensurate with experience

·        As a controlling Founder, be careful with the use of fancy titles, in lieu of adequate compensation, as a bait to attract talent  – it could be difficult to undo it

·        Expect and plan to bring along experienced new hires while having org chart room and job titles available

·        Don’t confuse shareholders role with the employment function; build safe guarding measures to protect from interference

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