Monday, June 22, 2009

Shooting the CEO

Many investors have a systematic approach to gauging the performance metrics of a startup, and fairly formulaic methods for influencing the company through its various growth phases. One of the most painful phases is the transition from startup CEO (and often founder) to a more experienced "hired gun." This is dangerous because the founding CEO's DNA will have permeated the company’s and the new hired gun will not have the same sense of ownership, responsibility, and DNA around the company. Done well, it can take a company to a whole new level, done poorly it causes cancer.

There is no doubt that the CEO of a Venture-backed startup has a target on his back, far more so than one in a public company. When a CEO misses targets and milestones, they are likely to be replaced. If they start shooting executive team members they will often be seen as shifting blame or be criticized for making bad hires--it's hard to win when you're the boss ;-)

There are generally three sure-fire ways to get fired:

1. Fail to meet plan
2. Don’t follow BoD decisions
3. Make bad hires, or have a lot of exec turnover

These are easy ones to catch, but there is a fourth that's more nebulous, but it's often the question foremost in your investor's minds--can you scale?

Very few CEOs can scale from founder to IPO and beyond--even fewer should! The sign VCs watch for is lack of a decision, which is of course a decision in its own right. If you have a lot of balls in the air chances are you will have trouble deciding which one to play with--indecision; or inability to focus will get you fired and it will look very much like your company simply outgrew your ability. Typically founders like to do everything themselves, and this is a guaranteed way to NOT scale, but it's also a very lovable characteristic of founders.

Now any good entrepreneur knows you succeed by getting others to share your vision and help you succeed by doing what you can’t do yourself. We also know that in order to have one successful strategy we need at least two alternates--sometimes it takes five irons in the fire to get one hot. So a certain amount of parallel processing is necessary--the critical step is quickly culling the paths that won’t work and focusing everything on the one that will. It is this focus that leads to success. It’s the willingness, determination and drive to bet the company on the path that you believe will win. Your VCs can help in this decision. They see a lot of companies and have a perspective on many markets--but beware, if it's not your decision then it's unlikely to be the right decision, and even if you listen to your investors, success has many generals but failure has only you ;-)

Shooting the founding CEO is a very risky move in startups because the company’s DNA is invariably the founder’s. If the company is too embryonic it can stunt or kill the growth or give it cancer. Generally it's better to surround the CEO with strong partners who can overcome shortcomings and build the strongest team from there--maybe the future CEO may be among them, but if not the DNA will be enhanced anyway and a new CEO can come in later if needed. My personal preference is for the first-time CEO, and to find a way to help them find success. Some of my investors did that for me, and I think it's critical that VCs do this in order to nurture the entrepreneur and grow more valuable CEOs and companies. At the same time, it's our job to create superior returns for our LPs so we had better not be teaching on their nickel unless the result is a superior one. I argue that this is more often the case than not, since the founder CEO who gets this treatment forms a far better working relationship with the investors and avoids hiding the ball but shares the problems and weaknesses so they can be fixed.

It’s a shame that entrepreneurs don’t get to shoot their investors, but please don’t shoot me, I’m just the piano player…..


Suhas Krishna said...Hi Larry, Long time reader of your blog. Very interesting and educational. Being part of a startup in this field from ground-up and a budding entrepreneur, your viewpoints present great insight on the bigger picture.

Krishna - Thanks for the comment – please post questions or propose topics anytime!

Monday, June 8, 2009

What makes a good entrepreneur?

Well first don't be good, always be great--if you can't be great, be lucky--and if you can't be lucky then get out of the kitchen and let someone great cook instead!

A few years ago I pitched an IPO to a large institutional investor--now many people say that bankers are dumb--actually they aren’t, they just like looking at things simply. In fact really good operational CEOs succeed because they can break complex problems down into simple forms and make clear decisions. This is a lot like good bankers--which is not to say that there aren’t some dumb bankers, in fact I have a list in my head, but it might look a lot like a list of people who said “no” ;-)

So great entrepreneurs have the following characteristics (as distinct from great CEOs, BTW):

1. They make money for everyone around them.

2. You can’t do it alone--they understand the value of partners: business partners, channel partners, people who shared a common vision and a drive for a common goal.

3. Deep domain expertise in the market they are attacking--clear understanding of the customer and their problem and often invented the solution out of sheer frustration with what was, and could clearly see what should/could be.

4. Shift happens--Understand the mechanics of change, and adapt quickly to market shifts, change plans and be flexible in order to achieve their objectives.

5. Comfortable with ambiguity--as distinct from CEOs who want to make a clear and final decision, entrepreneurs like to leave their options open and remain flexible to optimize their outcome. If not done correctly this can also be a fatal flaw.

6. Integrity--entrepreneurs are not game show hosts or promoters (there is another name for these people). True entrepreneurs are open, direct, honest (albeit with a great flair to see the good in any situation and spin any event). Honesty in pitching does not usually get you funded this time, but it has a way of getting you funded next time ...

7. LUCK, LUCK, and more LUCK. Don’t underestimate the power of luck. Most great entrepreneurs have this X-factor in abundance, and instead of ego, they have luck, and luck is better at turning lead into gold than any business alchemy.

Now in other countries entrepreneurs are spurned, and sometimes despised--many bankers who act as early stage investors end up suing the entrepreneurs because they “lied.” At best they may destroy their reputations and ensure they can never raise money again. Generally this is because the investor's ego is bruised and they want to prove that they were in fact not wrong in investing, they were misled. Perhaps they also want to claw back some of their money. Creating massive penalties for failure is bad for any ecosystem, clearly if someone lies and misleads investors deliberately there should be penalties to discourage such behavior (I'm thinking Enron here)--but most times what is clear in hindsight was by no means obvious at the time. When an entrepreneur plans to change an industry with a revolutionary new idea, chances are overwhelmingly high that they will fail. Change is difficult and very very risky, which is why the rewards of success are so massive (Google). Because they are so rare, 1 in 10 VC investments are winners, and these are by people who focus entirely on this high risk area, not bankers or angels.

To many bankers when an entrepreneur presents a financial plan, it's etched in stone and when they miss it’s a grave sin. Missing numbers is of course a sin, but when you are creating a new market the financial analyst approach is to work out your production capacity and determine how many products you can produce, then validate that against comparable companies and their sales capability to see if you can meet the expected market needs, thereby defining the boundary conditions for revenue. This approach works in a commodity business, if you are selling fish from a fish farm--there is a defined market for all commodities, a production cost and a market price--but if you are creating something new or different, none of this works--the market has to buy into the vision, your technology has to work in the way the customer wants it to, and you have to be lucky. Did I mention luck?

Any CEO who has had a great success will then face a bifurcation point--his ego will try to dominate his humility. If he keeps ego in check and credits the power of his team and luck, he will likely succeed again. If he lets ego dominate, he is unlikely to be a good repeat CEO ... perhaps he will become a VC instead or something that rhymes with banker ... ;-) Being the least experienced investor in the group, I thought I’d opine on the market ;-)