A start-up’s success requires the founder to realize that have to start thinking and acting like a Chief Executive Officer (CEO), likely the first time that they have served in this role. Typically, a first time founder’s experience has been limited to a technical or managerial role in a large corporation, and the shift to the CEO role in an entrepreneurial firm entails a major change in their responsibilities. It is the rare individual who can make this transition seamlessly.
The easiest way to describe the problem is to note that a new start-up CEO does not know what they do not know. I have been involved with advising several founders/CEOs and there is a progression that they must work their way through if they are to become successful. Implicit in the preceding statement is the notion that a failure to make this progression will likely lead to significant difficulties for the entrepreneur and for their firm. Making this transition requires a founder to actively seek out, and listen to, external advice.
The difficulties experienced by a new CEO are not limited to start-ups. Studies have found that even after the board of a large publicly traded corporation has completed an exhaustive process to hire a new CEO, about 40% of the new hires fail in this role within 18 months. As one study stated, “Just when an executive feels he has reached the pinnacle of his career, capturing the coveted goal for which he has so long been striving, he begins to realize that the CEO’s job is different and more complicated than he imagined”.[1] The article then goes on to describe the seven surprises that a newly appointed CEO of a large publicly traded corporation will face. In addition to these generic CEO surprises, the start-up CEO needs to be aware of additional issues.
To be successful, a founder requires the ability to engage with the multiple stakeholders needed to support their start-up’s success. As stated by Shawn Abbott, Co-Founder and Partner, of the VC firm Inovia Capital:
I think this really plays to the core, key success factor that a founder has to have. Whether you are attracting investors, employees, customers, board members or advisors, they all have a common, required characteristic. The founder must be able to paint a picture of the future and pull people into alignment. There is a behaviour, language, integrity, and commitment to a future that a great founder creates that becomes palpable, becomes real, for people around them. The core observation here is that this is a skill a founder has. If that is not something that a founder can go do, then they are not cut out to be a founder of a business.[2]
Based on my experiences when mentoring founders who are transitioning to the CEO role, I have noted seven surprises that await a newly appointed start-up CEO trying to pull people into alignment:
- It is Not Just “Your Venture” Anymore
- Your Reputation is Valuable
- You Do Not Have the Luxury of Time
- Everyone Has an Agenda
- Corporate Survival Requires the Ability to Adapt
- Cash Really is King
- The Firm Will Likely Outgrow You
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It is Not Just “Your Venture” Anymore
As the above quote by Shawn Abbott indicates, a CEO has to recruit executive talent to their organization, and to develop compensation policies that will retain this talent through the challenging work, and the potentially demanding times, to come. Potential investors will closely examine the quality of the venture’s executives, as well as its advisors and directors. When I worked as a VC, an early aspect of the due diligence process was to meet with the entire senior leadership team and observe how they responded when asked detailed questions about the corporation’s activities. As noted by Andrea Drager, a Partner with the VC firm Azure Capital Partners:
We spend quite a lot of time looking at the set of advisors and the board that is serving the early-stage companies that we invest in. It’s not just about whether they have the right people from a title perspective, it’s about how those people are engaging in the business. So, we’ll often have conversations with them to get a sense of how involved they are.[3]
In addition to being able to attract employees, advisors, directors, and investors, a founder has to realize that their decision-making process also needs to change. The entrepreneur now has legal duties to the corporation as a whole, including these new stakeholders, and an inability to effectively discharge these duties will limit corporate success.[4] Developing strong corporate governance practices, including an effective board of directors, is the best way to ensure that decisions are made in an appropriate manner. If a founder is not willing to adopt good corporate governance practices then their ability to attract employees and investors, and other key stakeholders, will be significantly diminished.
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Your Reputation is Valuable
As a corporation develops it will face challenges, some expected, and many unexpected. As a start-up CEO, you will be called upon to make decisions that you have not made before, and these decisions typically involve making trade-offs. The manner in which you behave when times are difficult says a great deal about your character, and can have an enormous impact on your firm’s chance of future success.
In one past situation, the CEO of s struggling corporation had just raised several hundred thousand dollars and then used some of the proceeds to pay themself and other members of the senior leadership team several months of past wages, and previously unclaimed personal expenses. Unfortunately, these costs were not disclosed upfront to potential investors and the unexpected expenses did not allow the firm to develop as projected. When investors learned about this issue and asked the CEO why they had acted in this manner, they stated “Business plans are meant to be changed.” The CEO was unable to raise additional equity capital from existing investors, but was able to find one investor willing to purchase a debt security. Issuing the debt security was an act of desperation, as it limited the firm’s ability to raise additional equity capital. In this case, the debt raised was not sufficient to allow the firm to survive and it ultimately went bankrupt.
On the other side, I know of a CEO for a VC-backed technology firm who was able to attract a follow-on round of financing even after it became obvious that there was not a viable market for the firm’s product. When the VC investor was asked why they were willing to make an additional investment they stated, “The CEO never withheld information from me or lied to me, and I had confidence that they had built a strong management team.” The VC’s faith was rewarded when the CEO’s firm successfully pivoted and was purchased a few years later for many times more than the invested capital.
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You Do Not Have the Luxury of Time
The world is a highly competitive place and if you have identified a market opportunity it is likely that competitors are not far behind. Success requires creating early relationships with customers to understand their needs and wants, and to quickly developing marketing capabilities. If a CEO is reluctant to reveal their product or service to potential customers until it has been “perfected”, this will slow down the development process and likely result in a solution that does not meet all customer needs. A key insight of the Lean Start-up Model is the need to develop a minimum viable product (MVP) that can be demonstrated to potential customers to receive feedback that will allow for subsequent iterations.
When a commercial product has been developed, the CEO needs to have a rapid growth, “pedal to the metal”, philosophy. While private equity investors provide “patient” capital, they expect a corporation to move quickly when a market opportunity has been identified. A failure to move rapidly exploit the opportunity may limit access to capital, or may cause existing investors to seek a change in the CEO role.
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Everyone Has an Agenda
In developing and marketing your corporation’s products, you will interact with many distinct types of stakeholders, including employees, contractors, and strategic partners. A larger “strategic partner” may offer to manufacture or market your product to help you keep your costs low. You must be aware that such an opportunity also entail risks. In the software industry, there are horror stories of larger more established software firms acting as marketers of a smaller firm’s product only until the larger firm has developed its own version of the software that they then use to directly compete with their partner. Similarly, manufacturers may try to reverse engineer your product and develop a competing version. Developing effective Intellectual Property (IP) protection when dealing with various types of stakeholders is critically important.
Issues can also develop when interacting with the investment community. For example, a VC investor may push a firm to go public too soon so that the VC can show its limited partner (LP) investors that it has had a successful exit from an investment. Similarly, an underwriting firm will negotiate for a lower price as a firm is taken public so that it can show a higher return to investors in that firm’s initial public offering (IPO) shares.
Maintaining a perspective of diverse stakeholder needs, and how to avoid pitfalls for the corporation is a key learning for a CEO. Being able to attract outside advisors and directors who have extensive experience and contacts in the industry in which you are operating can help you better understand your industry and its normal business practices, and avoid making significant errors.
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Firm’s Survival Requires the Ability to Adapt
A founder starts their venture with a view of the world and how their product/service is going to satisfy customer needs better than competitive offerings. During its development, the start-up faces many risks including technology risk (will the firm be able to develop its product on time and on budget) and market risk (will the market adopt this new product). As the firm develops its technology and interacts with potential customers it may need to modify its strategy and change its activities. In fact, the vast majority of successful technology firms have significantly revised their strategy at least once.
The CEO of an early stage firm has to be aware that such changes may be needed and be prepared to adapt the organization to reflect the new reality. Developing a strong leadership team, and having highly engaged external advisors and directors, will help the CEO identify when such changes are needed. Investors are well aware of this potential need to adapt, and a common requirement of a VC investor in an early-stage firm is that board meetings need to be held at least monthly. Thus, the CEO needs to be aware of an interesting paradox in that their firm will not be able to raise any capital from a sophisticated investor unless the firm has a thoughtful business model; however, the providers of that capital realize that the model will need to evolve over time.
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Cash Really is King
As a start-up develops, its need for financing may begin to exceed the founder’s personal resources. A founder may choose to use bootstrapping, using funds from initial operations to fuel growth, and many of the world’s largest tech ventures have pursued this strategy.[5] To pursue rapid growth will, however, at some point entail raising capital from increasingly sophisticated investors on a regular basis. This need to constantly be raising capital to implement their plan is a significant learning for a start-up CEO who has worked their entire career in a large corporation where financial capital may be less constrained. Thus, a start-up CEO has to begin to think about raising capital in terms of “rounds” of financing, and that the firm will need to attract multiple rounds as it develops.
A round has to be large enough to interest investors, but more importantly it must be able to take the firm to a new level of development. As one VC investor put it to me, “There is no point in starting out to cross a desert with your tank half full of gas”. It requires careful planning by the firm to be able to develop realistic “milestones” for the firm’s development, and then to finance the firm against those milestones.
A friend of mine once took on the CFO role in a technology firm and described to me how their role was to raise at least $10,000 each week to allow the firm to keep afloat. They were able to make this happen for several months, but then had a string of bad weeks and the firm had to shut down when it could not meet payroll.
The act of developing milestones commits the firm to a set of activities that it will then be judged against. If a CEO raises capital based upon a plan, then deviates significantly from the plan without the support of investors and does not meet the required milestones then it is very unlikely that the firm will be able to raise follow-on financing. The message here is clear; do not deviate from the budget without authorization from the investors, and do not squander resources.
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The Firm Will Likely Outgrow You
An interesting paradox is that your task as a start-up CEO is to grow the corporation into an entity that would likely not be willing to hire you as the CEO in the first place. An entrepreneurial organization begins life as a very unstructured entity with a team of talented individuals working together to create something of value. Firm policies and procedures are kept to a minimum so employees can focus on being creative and nimble, and the firm is flexible enough to quickly change strategic direction if warranted.
As the firm learns about its products, markets, and begins to attract customers, it needs to implement more formal procedures. Similarly, as the number of employees in the firm increases, formal job titles, responsibilities, and lines of communications need to be established. The task of the CEO changes from dealing with the uncertain of a start-up to managing the complexities of a rapidly growing corporation.
If a CEO has not thought carefully about how this evolution of the firm will unfold then one of two negative events may occur. First, the firm will be unable to attract institutional investors who will see this lack of thought as a negative reflection on the skill of the CEO. A VC will invest in an early stage firm that does not have a complete management team; however, the VC expects that there is a plan to grow the management team and develop an effective organizational structure over time. Second, if the firm succeeds in attracting capital to enable it to develop it may run into significant organizational problems once it reaches a certain size.
A CEO also has to realize that if the organization outgrows their capabilities, this does not mean that they have failed. In fact, it is a sign of spectacular success when a founder has been able to move their corporation through the development phase to the growth phase of its evolution. At this point, the CEO has to reflect upon whether they have the personality and capability to continue to lead the corporation. As a start-up grows the elements that caused the CEO to start the corporation in the first place, the ability to build something of value in a small entrepreneurial team environment, are likely gone. In their place are the challenges of managing a corporation, consisting of multiple stakeholders, that is meeting the evolving needs of a loyal customer base. Some entrepreneurial CEOs miss the excitement of living on the edge in a start-up entity and find they do not fit into the culture of the more professionally managed corporation. This is why there are serial entrepreneurs, individuals who develop a firm to a certain size, sell it off to a larger entity, and then start all over. If you are fortunate enough to have your firm succeed and reach a size where it is attractive to potential acquirers, you must decide which path you wish to follow.
The purpose of this article has been to highlight some of the key issues that a start-up founder needs to consider as they grow their business. To achieve success, a founder has to realize that as soon as they start their corporation they become a Chief Executive Officer and have legal duties and overall responsibilities that are much more extensive than they have had in their previous jobs. The CEOs role is to act as the link between the internal organization and the external environment, including customers, advisors, directors, and investors. A CEO also needs to adopt a decision-making perspective that incorporates the needs of various stakeholders. It is the rare individual who can thus transition from founder to CEO without outside guidance and so a founder is strongly advised to seek and listen to advice from seasoned business professionals to increase their chances of personal and corporate success. This article has highlighted seven issues that a person needs to consider when making that transition.
[1] “Seven Surprises for New CEOs”, Michael E. Porter, Jay W. Lorsch, and Nitin Nohria, Harvard Business Review, October 2002, 82 (10), p. 62. (I have kept the gender in the quote as it was written by the authors).
[2] Founder’s Guide to Governance, Michael J. Robinson, FriesenPress, Altona, Manitoba.
[3] Ibid.
[4] These duties, which include a Fiduciary Duty and a Duty of Care, are discussed in detail in Founder’s Guide to Governance, Michael J. Robinson, FriesenPress, Altona, Manitoba, forthcoming.
[5] Including Amazon, Apple, Dell, and Microsoft.