Author: Noam Wasserman

ISBN:978-0691158303

You've decided to incorporate a company with a partner. Have you already decided how to split shares?

EXCERPTS

[Seth Godin's Shotgun Clause: Any party can at any time offer to buy the other out. The other has only two options; it can either accept the offer or buy the other out for the same offered price per share.]

I felt very disassociated [working for IBM], like I was part of a big machine in which I had no idea where I was going. I realized that I needed to understand the big picture to be motivated.

Each additional person also adds more nodes to the communication network, slows things down, and weakens incentives. Thus, each new cofounder should add important elements to the team—for example, filling in gaps in human capital or having the ability to reduce a key area of task overload for the other founders—that bring more value than is lost by adding the new cofounder.

Solo founding should be pursued by founders whose backgrounds, goals, and startups meet the following criteria: The founder has deep, relevant experience; the founder is driven to keep control of the key decisions; the industry does not demand fast growth; and the idea and its implementation are relatively simple. The opposite decision should be made by inexperienced founders, those who are willing to give up some control in order to attract an excellent cofounder, those founding startups in challenging or fast-growing industries, and those whose startup ideas are complex.

You can often tell from a resume or by asking a few questions where a person comes from and what he or she has done. But there are types of similarity and difference that are not so easy to pick out. A potential cofounder’s resume may not tell you much about his or her risk tolerance, personality, time horizon, commitment level, and value system. Founders tend to neglect these “soft” factors because they are harder to assess than skill compatibility and functional backgrounds, but they can become serious problems for even the most well-matched teams. Assessing soft factors usually requires a lot of time (and skill), often in the form of talking frankly to people with whom your potential cofounder has worked and, even more importantly, “trying before buying”—getting to know each other in actual work settings or preliminary projects before committing to working together. For example, a founding team is most likely to keep functioning effectively over time if the cofounders are personally compatible and have similar (or at least not conflicting) values and work styles.

A founding team is most likely to keep functioning effectively over time if the cofounders are personally compatible and have similar (or at least not conflicting) values and work styles.

The best way to evaluate such compatibility is often to “try before you buy” by finding self-contained work tasks on which to collaborate before committing to be cofounders—a commitment that is very unpleasant to reverse.

EXECUTIVE TITLES: WHO GETS THEM? How do teams assign their top positions? My quantitative analyses suggest that three major factors are (a) each founder’s level of commitment, (b) which founders are the idea people who had the original idea or developed the intellectual property on which the startup was founded, and (c) each founder’s human, social, and financial capital.

Consensus-based teams make decisions too slowly for startups operating in “high-velocity” environments, those in which there is such rapid and discontinuous change (in demand, competitors, technology, or regulation) that information is often inaccurate, unavailable, or obsolete.

My view now is that, as an early startup where the imperative is avoiding making the big mistake, having a group of [equal] partners with divergent views is a good thing. At that point, you’re all very polite and respectful anyway. When the time comes that your business is working and you need to act fast and make decisions quickly to grow and seize opportunities, the best thing is to have a dictatorship. Making the transition at the right time is the elusive challenge here.”

A two-step “consensus-with-qualifications” approach, balancing the efficiency of an autocratic approach with the buy-in of an egalitarian approach. First, the team attempts to reach a full consensus. If consensus is not forthcoming, the CEO and relevant functional VP make their decision, but only after getting input from everybody in a public forum.

Teams should be more stable either when both founders are wealth-motivated (and thus more aligned in their decision making) or when a wealth-motivated founder has joined forces with a control-motivated founder whose skills and capabilities are up to the challenge of being CEO. Before founding together, potential cofounders should assess each other’s motivations to understand the potential sources of role conflict.

The anchoring effect (and legally binding nature) of UpDown’s early one-page equity-split agreement caused major tension within the team when one of the founders wanted to renegotiate the split a few months later. In contrast, putting off the split for several months or more can give the cofounders a chance to learn whose skills and connections will contribute the most to the startup, how those contributions change as the startup’s strategy and business model change, how well each founder gets along with the others, how committed each founder is to the startup, and more.

Holding off on the split may also provide a strong incentive for the founders of a young startup to contribute and to prove themselves, rather than free riding once the split has been determined.

Equity-split negotiations are usually much calmer when done before the stakes become very high, which generally means before any financing has been secured and an objective valuation has thus been placed on the startup. Negotiating when millions of dollars of financing are on the line leads to very different dynamics and can make it very hard for the cofounders to agree.

A founder’s future contributions, although often the hardest factors to evaluate, are in many ways the most important for determining equity stakes. “Remember,” warns one entrepreneur, “when the pie is split, 95% of the work required for success remains in the future.”

The level of future contribution is also presumed to depend on how much time a founder can or will commit to the startup.

[What to consider when making an equity split:]

1.  Past Contributions: How much has the founder contributed to building the value of the startup so far?

a.  Idea Premium: Founders who contribute the original idea on which the startup is based have made a unique contribution to the venture.

b.  Capital Contribution: Founders who have made larger contributions to the startup’s seed capital should see a proportionate increase in their equity ownership.

2.  Opportunity Cost: What are the founders sacrificing in order to pursue the startup?

3.  Future Contributions: Most of the work required for the startup to be successful will come in the future, but these contributions can be hard to anticipate. How much can each founder be expected to contribute to the value of the startup down the road?

a.  Serial Founders: Members of the founding team who have previously led a startup to a successful exit can be expected to contribute more human and social capital down the road.

b.  Level of Commitment: Founders who are committed full-time to the venture can be expected to contribute more value. c.  Titles: The official positions of the members of the founding team have been shown to influence equity splits, with CEOs receiving a substantial equity premium.

4. Founder Motivations and Preferences

a.  Wealth Motivations should lead founders to prioritize larger equity stakes.

b.  Risk Aversion and Optimism will affect how much priority a founder places on gaining equity versus cash compensation.

c.  Tolerance for Conflict will affect a founder’s willingness to engage in negotiations.

d.  Prior Relationships can affect expectations about equity splits.

While the advantages of a formal agreement are obvious, there can also be disadvantages. For instance, overly rigid contracts can lock parties into arrangements that don’t allow for adjustments as circumstances change, and overly detailed contracts can undermine trust by preventing spontaneous displays of good intentions.

Dynamic equity agreements can make use of a number of approaches, such as buyout terms (in which a founder’s stake might be bought on prenegotiated terms by the startup or by other founders) and vesting schedules. At their core, however, all of these structures are geared to deal with the uncertainties inherent in startups.

Thus, the tension-filled, high-stakes equity-split negotiation is itself a double-edged sword, an experience that can leave the team wiser, stronger, and more unified, or can undermine the trust within the team.

A founder who pushes hard for every last percentage point of equity may leave the other founders feeling they’d better watch their backs, which will make it harder for the team to handle the inevitable unknown-unknowns when they arise.

Vesting is the most common type of dynamic equity agreement. Vesting terms require founders to earn their equity stakes, either over a specified time or when they accomplish specific milestones, rather than owning the equity from the start, as is the case with static equity splits.

Founder-imposed vesting also enables core founders to test whether their potential cofounders intend to stay with the startup for the long term and to set expectations about involvement and roles.

The two major types of vesting are time-based vesting and milestone-based vesting. With time-based vesting, each founder who is actively involved in the startup earns predetermined portions of his or her equity stake as each month, quarter, or year passes. This type of vesting assumes that the passage of time approximates the addition of value to the startup, a valid assumption as long as work proceeds according to plan. But when the work proceeds more slowly than planned, as is often the case, founders can earn full equity stakes well before making the contributions that had been expected of them. In effect, time-based vesting that is too short releases the “golden handcuffs” and increases the risk of losing a founder while the startup is still being built.

Milestone-based vesting is one solution to such a problem, but it can cause its own problems. Team members earn a specific amount of equity for each of a well-defined set of milestones that, if accomplished, would add concrete value to the startup. For business-oriented founders, the milestones may pertain to fund-raising, customer acquisition, revenues, or the establishment of partnership agreements. For technical founders, milestones may be tied to completing a prototype, conducting a successful beta test, or introducing the full initial version.

While this approach aligns each additional award of equity with the addition of value to the startup, it is effective only when the team can (a) define objectively when each milestone has been achieved and (b) clearly link the achievement of each milestone to the founder(s) responsible for achieving it. If the milestones are more subjective, milestone-based vesting can increase the tension and conflict as the founders disagree over which milestones have been achieved. If the achievement of a milestone is dependent on the efforts of several founders, only one of whom will receive an additional equity stake when it is achieved, the others will be motivated to focus only on those milestones that affect their own equity stakes, increasing the tension within the team and reducing its ability to achieve milestones.

In fast-changing companies, adopting rigid milestones can be hazardous and should be done carefully. Down the road, necessary changes in the startup’s strategy may render obsolete a milestone on which part of a founder’s equity depends, requiring another round of tension-filled negotiation over equity stakes and milestones or else leaving that particular founder feeling cheated or creating destructive rigidity as he or she continues to pursue an obsolete milestone.

As with all high-powered incentives, vesting terms should be designed with such unintended consequences in mind. Boards and founders should “stress test” their tentative milestones against a variety of scenarios, assessing whether each milestone would work well in all the scenarios and adjusting milestones that, in some scenarios, might cause misalignment.

Splitting the equity too early is a recipe for continual renegotiation. If the business is still amorphous and the team composition is in flux, the founders should hold off negotiating the equity split. At the same time, an external event (such as an investment offer) or the need to provide a key cofounder with clarity about equity stakes (e.g., if he or she is being offered another opportunity) may force the team to split earlier than they want. In such a case, the dynamic element described below takes on even greater importance. When things start to solidify, the founders should engage in a detailed attempt to match the initial split to each founder’s expected long-term contributions.

As the founders begin to agree on particular terms, they should document those agreements in writing to avoid later misunderstandings or miscommunication.

Founders who treat the negotiation as a “transaction” and try to maximize their own short-term deals may poison the relationship and lose in the long term, securing a larger slice of a smaller pie or increasing the chances that there will be no pie at all.

It is possible that careful negotiation will arrive at the same equal split that a quick handshake could have secured. Yet when the time comes for the first round of financing, quick handshake splits are associated with lower valuations than negotiated splits (even negotiated equal splits). Why? One reason is that the equity-split negotiation often acts as a trial by fire: If the founding team survives the negotiation, it is often a stronger team able to tackle tough issues. Better to find out sooner that the team has insurmountable difficulties making tough decisions together than to find that out after each founder has sunk a lot of time and money into a doomed startup.

Rather than succumbing to their natural optimism, founders should structure their equity split on the assumption that some aspects of the startup (such as its business model or strategy) and their founding team (such as the founders’ roles or levels of commitment) will change. They should (a) define how foreseeable scenarios should affect the equity split and (b) “plan for the unforeseeable” by including buyout terms or similar means by which an underperforming cofounder’s equity can be reclaimed by the other founders. Such terms encourage each founder to continue contributing and, failing that, let the remaining cofounders redeploy the under-performing cofounder’s equity in order to replace him or her. Each founder is protected and so is the startup overall.

Founding teams who want to avoid the potentially disastrous consequences of an early and static equity split should do their best to devise a compensation plan (including the equity split) that (a) reflects each member’s past and expected contributions as accurately as possible and (b) motivates each cofounder without seeming unfair to the others. Teams should also keep in mind that the deal is never completely done. Circumstances will change, and the equity split and compensation may need to change, too, in order to accomplish what these essential tools are meant to accomplish.

However, with teams who are just getting to know each other, jumping too soon to define roles can be a big mistake, for if the roles are not allocated well and then have to be reassigned, tensions will be heightened rather than reduced, and the quality of work produced by the reassigned founder is likely to suffer.

Cofounders who have no previous acquaintance, either social or professional, need to align rewards with the relationship decision they have made; that is, with the lack of a prior relationship. The key here is for the cofounders to grasp how fully they do not know each other. Resumes, online bios, and even third-party recommendations can’t tell you what makes a person tick and what contributions he or she will make, or fail to make, in the unpredictable growth of the startup, nor can they tell you a person’s commitment level or whether he or she has what it takes to persevere through the scariest parts of the entrepreneurial roller-coaster ride. Such teams have much to gain by holding off their equity split until they have learned a lot more about each other, although they may pay a price for this benefit by sacrificing some of their ability to attract key cofounders.

While it is not surprising that hierarchy and division of labor affect equity splits, it is less commonly understood how their absence can also affect equity splits. Overlapping, nondistinct roles make it harder for cofounders to determine the value that each has contributed or will contribute to the startup and therefore make it more likely that the team will decide to split the equity equally. An unequal split would not be well aligned with such uncertainty about who really deserves what share.

Founder-CEOs receive a CEO premium (i.e., an additional amount of equity for being CEO) of 14 to 20 percentage points. The premium for founder-CTOs is lower—5 to 8 percentage points—but also highly significant from a statistical perspective. The idea premium may also be, in part, a premium for adding greater value to the startup by initially articulating its vision, attracting other cofounders, and completing other critical early tasks often performed by the idea person.

Relationships, roles, and rewards are all sensitive issues that most teams try to avoid discussing.

To attract the best hires, for example, founders have to give up not only enough cash compensation and equity ownership but also some level of control over operational decisions; skilled people usually don’t like to be told what to do.

To attract the best investors, founders have to give up significant amounts both of equity and of control over many board-level decisions.

When hiring nonfounding executives, high-potential startups that relied relatively heavily on the founders’ personal networks received valuations that were 37% higher than those received by startups that barely tapped the founders’ networks. Playing such a central role in hiring executives can give the founder-CEO a closer initial relationship with his or her direct reports, though at the cost of having to spend more of his or her own time recruiting those people than if an HR function or third-party recruiter were handling the task.

More broadly, hires can come from a variety of weaker ties, including executive-search firms, want ads, cold submission of resumes, and other sources beyond the networks of the founders and other participants in the startup.

For founder-CEOs, though, relying on such weak ties can make it hard to judge an individual hire’s cultural fit with the rest of the organization and, overall, hard to keep turnover low.

Creating job postings is often the first time a startup has to concretely define job requirements and think about the differences between various positions or roles, making such postings the startup’s first real job descriptions.

But in a fast-growing startup, the demands will grow more quickly than most people can learn and the startup must decide whether to leave a crucial task in the hands of a founder or loyal early employee who can’t really handle it or to replace that person with someone who can handle it.

When some founder-CEOs sense that one of their employees is underperforming, they immediately act to remove the person. One said, “Knowing for sure that someone has to go is hard, but I have learned that if I start thinking someone needs to go, they need to go. It is always the right call to upgrade when you realize someone can’t or isn’t succeeding.”

Early-stage startups therefore tend to seek generalists who can pitch in wherever needed. Even if a hire is assigned to a specific function, there is high “option value” in being able to move that person to another function as the work dictates.

During this fluid stage—and especially for functions that are still evolving—hiring specialists who excel at specific tasks but cannot, or would not want to, contribute to other tasks can be a big mistake.

As the organization grows, it usually tries to improve its efficiency by starting to formalize processes and structures.

He had worked at Oracle and at IBM. He looked great on paper. We brought him in and he talked a good game. Then he just sat there for three months. He didn’t do anything. He didn’t hire anyone. He didn’t come up with a plan, he didn’t create a strategy. He wasn’t comfortable creating something from nothing. Building something from nothing requires a different skill set.

Divide between “doer” and “manager”.

When you hire senior people in larger companies, they’re successful because they can manage a team. They won’t necessarily be effective on an individual level. I realized that in an early-stage company, there’s no such thing as a manager. Everyone is a contributor, including the CEO!

The benefits of hiring experienced people include the following:

• Skills, contacts, and credibility—Experienced hires are more likely to bring human and social capital to the startup and to provide it with reputational advantages.
• Hiring leverage—By hiring experienced people, then delegating to them the task of hiring their own employees, founders can both leverage their own time and foster cohesion within each department in the startup.
• Stability: Mr. Right versus Mr. Right Now—Experienced hires lower the probability of having to upgrade the team in the long run; their relevant experience usually helps them scale more smoothly with the growing organization. If a startup can attract a Mr. Right, who will be able to excel in the position through multiple stages of growth, rather than a Mr. Right Now, who can do the job now but will be out of his or her depth in the next stage of growth, that will save the startup a lot of trouble and disruption. “High-growth companies change so much every quarter! That amount of change isn’t normal and people can’t be trained for it unless they’ve been in another [startup or small company].”

At the same time, there are also downsides to hiring experienced people. They include these:

• Bigger paychecks—At their current jobs, experienced candidates are probably earning more than junior candidates, making it more expensive to lure them to the startup and increasing the startup’s “burn rate.” Letting payroll get out of hand can cause not only dissatisfaction and turnover but also lawsuits.

Cultural control—With bottom-up hiring, founders will be more in control of the culture they want to create. People lacking years of experience at established companies do not have such strong expectations of how a company should run and so are more open to the founder’s blueprint.

A startup hires inexperienced people hoping they will prove to be “rising stars” who can master new skills and grow into their roles. In contrast, experienced hires are expected to be “rock stars” who can contribute a lot of value right from the beginning.

Cash-poor startups usually cannot afford to pay salaries and bonuses comparable to those paid by large companies. To compensate, startups have to use other financial (and non-financial) inducements, the most prominent of which is equity.

When designing compensation packages, startups can choose from contingent alternatives (i.e., performance-based bonuses) and noncontingent alternatives (salaries) and can tie financial rewards to individual performance (i.e., a bonus tied to the specific employee’s performance) or to the startup’s collective performance (most prominently via equity stakes in the startup).

“ideal compensation package” depended on the function: Salespeople were heavily motivated by performance-based compensation while software engineers primarily wanted to count on their monthly paycheck.

Founders who want to retain more equity for themselves tend to offer a smaller equity stake to potential hires, preferring either to balance that with some other carrot (higher salaries if they have the resources, or intangible benefits) or to take the chance of losing the hire and having to hire a weaker candidate. Such a founder is often able to retain more equity but may build a team that is weaker or less motivated to build equity value. The founder thus increases his or her chances of ending up with a King outcome. On the flip side, founders who prefer to build a more valuable startup, even if their percentage of it is lower, will make the opposite decisions and increase their chances of ending up with a Rich outcome.

It is crucial for founder-CEOs not only to diagnose and correct the problems that arise from hiring the wrong person, but also to anticipate when a decision that was good at the time may need to be rethought because the startup has arrived at a new stage of development. In the fast-paced world of startups, founders can’t afford to become entrenched in a particular way of hiring but must expect their startup’s hiring needs to change. For example, before hiring young employees during the early days of the startup, the founders should already be planning for the day when they will have to either replace those young hires or else hire more experienced people to supervise them; before building a team of generalists, the founders should already be considering how they will adjust when the startup requires the quality that can be provided only by specialists; before crafting a compensation package for the earliest hires, the founders should already be anticipating how different stages will require different packages. As we have seen throughout this chapter, the data indicate that each stage of a startup’s evolution is marked by important changes in its hiring needs.

“The worst problem with a bad hire is that they get into the organization, they become friends with people, and then it’s, ‘Why are you firing my friend?’ ” The result is that many founders become hesitant to hire—or make sure to “hire slow”—for fear of making a mistake. But linking rewards and roles can help solve this problem; for example, a highly contingent compensation structure for salespeople can turn off those who aren’t confident in their skills while encouraging weak hires to leave. As Dick observed, “A salesperson will leave if he’s not doing a good job and therefore not getting paid what he wants. If he doesn’t work out, it solves itself quickly. It’s ‘hire fast, fire fast.’

“cash-flow positive” (when incoming cash is greater than outgoing cash)

When Jim Triandiflou and Mike Meisenheimer started Ockham Technologies, they quickly attracted the attention of Monarch Capital Partners, which offered them $2 million. But they decided not to take the money and instead seeded the startup with $150,000 of their own money. “We just felt that we should go sell something [first],” Jim explained. “We knew we’d make the company more valuable by doing that and first getting some validation of our idea.”

You should start small and grow it on your own. It is possible to get away with this if the business can bring in customer revenues very early; for example, by consulting or by getting customer prepayments.

For businesses with tangible assets, such as capital equipment or accounts receivable, which can serve as collateral, debt financing is an option. But high-potential startups in the technology and life sciences industries rarely have such assets, so debt financing is rarely an option for them.

Out of principle, I do not include family in business/financial transactions or pursuits. The fact is, money stands to be the very thing that can dissolve the strongest of relationships. [Hmm. Ture, on the other hand, if you make it, you're left with a bigger equity share. Think about Jobs vs. Bezos. The fist was funded solely by venture capital. The latter was funded by himself and family first. They both created one of the world's largest companies though the second was much richer and had the company under his control.]

One way around this can be to treat an investment from a friend or relative as a gift rather than an investment; that is, with no particular expectation of being paid back. As one founder put it, “To avoid any problems, just ask them to close their eyes and donate money to you.”

“Angel investors” refers to a wide range of individual investors who invest their own money and usually don’t already know the founder. They invest at an earlier stage of startup development than do venture capitalists, often with the goal of attracting VCs to invest in a subsequent round of financing. [They don't require you to present the financials.]

Venture capitalists are professional investors who focus full-time on investing in high-potential startups. They receive business plans from the founders of young startups, evaluate the plans, meet with the founders, perform due diligence to investigate the startup’s team and potential, negotiate investment terms with the startups in which they want to invest, then help build the startup (often as board members) in the hopes of exiting from their investment at an appropriate time.

VCs raise capital from limited partners (LPs), most of which are large institutions—foundations, university endowments, public pensions, and the like—that invest in a wide portfolio of assets and allocate a relatively small percentage of their capital to venture capital. The VCs have a fiduciary duty to those LPs and are evaluated on the financial returns from their investments.

In fact, the more reputable, experienced, and well connected the VC firm, the more unfavorable the terms an entrepreneur will accept in order to secure an investment from it.

Investors may also have a powerful impact on ownership within the founding team itself. The most common impact is when VCs insist that the equity held by founders and nonfounding executives must vest—that is, be earned back—over a preset number of years or after the achievement of predetermined milestones, in order to provide “golden handcuffs” to keep them working for the startup.

For instance, at an early Web startup, the venture capitalist insisted, as a condition of the A-round and as a way to incent the founders to keep working at the startup, that the two founders’ full equity stakes had to vest, effectively returning their economic ownership to zero and forcing them to re-earn their old stakes.

A less common, but still very important, way in which investors can affect founders’ stakes is when the investors insist on reallocating those stakes to more closely match the individual founders’ contributions. Investors want the most important members of the team to own the largest equity stakes in order to both retain and motivate those members. Investors will therefore assess whether the “right” founders have the largest stakes and, if they detect too great an imbalance, will often insist that the founders reallocate their equity as a condition of the financing round. One founder said, “I was the cofounder of a startup and as part of the Series A, the investors actually required my stake to be increased. They felt the original founder’s equity was lopsided and wanted to ensure incentives were properly distributed across the team.”

Although many board decisions are decided by majority rule, investors may negotiate “supermajority” or veto rights that give them extra power when deciding specific issues, such as whether to sell the startup.

In the same way that liquidation preferences give investors more ownership rights than they would have based strictly on the percentage of equity they own (as we saw above), supermajority or veto terms can give them greater control rights than would be indicated by their percentage of ownership.

Gaining control of the board is the most direct way for VCs to gain control over decision making. A less direct but still powerful way is by “staging” their investments; that is, committing small portions of capital sequentially, rather than committing up-front the full amount of capital that will be needed by the startup. VCs know that they will have the most leverage over a startup when it needs their money to grow or just to continue operating.

Before the initial round of financing, a VC firm’s due diligence might reveal risks that it wants addressed before it agrees to invest; the VC may therefore require such changes as a condition of its initial investment.

If the VC decides to reinvest, it will try to provide enough capital for the startup to achieve its next major milestone.

Founders who are particularly concerned with keeping control of their startups should also fight back most strenuously against protective provisions that give investors extra voting rights and drag-along rights that determine who can authorize the sale of the startup to another company.

Founders who are less concerned with control rights than with maximizing their financial value should be willing to accept the provisions listed above and instead fight to maximize their ownership stake overall and in various exit scenarios, thus increasing their chances of achieving a Rich outcome. In addition to the liquidation preferences described above, they should fight to minimize secondary terms, such as the investors’ anti-dilution protection (which protects the investors’ ownership stake in a subsequent down round of financing) and the dividends that investors can accrue.

Dealing with investors can be daunting, particularly for new entrepreneurs, but there are several strategies that founders can use to gain leverage. Jim Triandiflou deliberately waited until his startup had a solid product, cash flow, and customer contracts before approaching VCs, judging correctly that this strategy would result in higher valuations. He also avoided working with a single VC firm, in order to avoid the control over decision making that a single VC with two board seats would have. Instead, he split the first round between two VC firms, each of which took one seat on the board. “Two guys from the same firm can monopolize decisions, and not giving any one person or group control is critical,” Jim explained. “My having board control is less important than my making sure someone else doesn’t have it.”

For FeedBurner’s Dick Costolo, gaining leverage in a VC negotiation meant having appealing alternatives. In one round, he had gained leverage by getting competing term sheets from different VCs. In another round, he put off approaching VCs until he had received acquisition offers from Yahoo and Google: “Having the potential acquirers involved changed the dynamic with potential investors. It kept acquirers from wasting our time with stupid offers and prevented a lot of back and forth with the VCs on harsh terms.” Dick also made sure that he negotiated with VCs well in advance of running out of cash: “If we take it down to the wire, the VC will sit on it for a few weeks until they know we don’t have money, have to sign their term sheet, and have to take their terms.”

A liquidation preference is a term agreed to in the initial financing deal between venture capitalists and entrepreneurs that governs the division of profits in the event of the venture’s acquisition or liquidation.

In large companies, a high percentage of new CEOs come from inside the organization. For instance, in a broad study of 1,035 large-company succession events, 81% involved inside successors. Promoting an inside executive is seen as healthy for the organization and gives the board confidence that the new CEO will fit with the organization and its culture. One notable exception is when the organization has been performing badly and requires dramatic changes; in such cases, an outside hire is much more common.

In startups, however, the new CEO almost always comes from outside the existing executive team. The new CEO is usually being brought in to make major changes, whether in the organizational culture (e.g., moving from Lew Cirne’s “family culture” to a professionalized one), in the strategy (e.g., altering the founder’s original business idea), or in the team (e.g., replacing cofounders or early hires who aren’t performing well). In short, the new CEO is being hired to do what the founder-CEO either could not do (for lack of skills or knowledge or because of deeply ingrained mental models or schemata) or would not do (given his or her nonwealth motivations or his or her attachment to longtime participants or to the original strategy or idea).

In large companies, the replaced CEO almost never remains on the executive team and generally leaves the board of directors as well.

If the founder initiates the change and wants to remain in the startup, he or she is almost guaranteed to receive a C-level position, but if the board initiates the change, the chance of receiving a C-level position plummets. Founder-CEOs with technical backgrounds are most likely to move into the CTO or VP-engineering positions; founder-CEOs with business backgrounds are most likely to move into the VP-business development position, followed by the VP-marketing position.

As we discussed above, founders who can’t see much difference between their own capabilities and those of their potential replacements will find it harder to support their own succession, but wealth-motivated founders who see distinct, material differences will be more likely to do so.

“What helped me get through the shock was the realization that the world’s best speedboat captain isn’t able to pilot an oil tanker. It’s not who’s the best flat-out leader, but who’s best suited to the tasks at that stage of development.”

When the founder triggers the change, he or she is less likely to leave the startup immediately, more likely to play a central role in the search for and choice of a successor, more likely to remain in a senior executive role, and more likely to remain on the board of directors. Triggering one’s own demise as CEO is wrenching but, for some founders, is worth the price if it can ensure their remaining a prince of the realm after relinquishing the throne.

Founders who consistently make control decisions are more likely to reach what I call the “King” outcome, in which the founder retains the throne but does not rule as big and rich a kingdom as might otherwise have been possible. Founders who consistently make wealth decisions are more likely to reach what I call the “Rich” outcome, in which the founder generally loses the throne but sees his or her venture pursue its business opportunity to the fullest.

Tt turns out that the value-seeking founder’s “smaller slice of a larger pie” is generally greater than the control-seeking founder’s “larger slice of a smaller pie.” [Data?]

Thus, before joining the startup, those potential participants also need to assess whether the founder’s motivations—and the corresponding decisions he or she will make in response to the inevitable sequence of founding dilemmas—may conflict with their own motivations.

Wealth-motivated hires should try to work with wealth-motivated founders. If the founder-CEO is control-motivated, we would expect the hires to be attracted for other reasons: the founder’s compelling vision, the chance to “change the world,” the excitement of working in a startup, or other nonfinancial considerations.

Founders who want to keep control should prefer slower growth; at the least, the startup should be growing no more quickly than the founder’s ability to learn the new skills required for each new stage of growth.

In turn, the founder’s growth goals should affect the type of financing used by the founder.

In contrast, founders who want to maximize startup value should be open to faster growth if that’s where the best opportunity lies. In some industries and in some stages of the business cycle—for example, in industries without drastic competitive pressures and during down parts of the business cycle—founders often have more control over the startup’s growth rate. In industries with intense competitive pressure or during boom times, on the other hand, the founder’s only choice may be “grow fast or die.”

Similarly, founders who want to keep control should strive to begin startups that have low capital-intensity or that require few or no resources beyond those the founder already controls. Founders who want to maximize startup value, on the other hand, should be open to pursuing ideas that require high capital-intensity and to attracting the necessary resources.

Capital intensity can be affected by which activities the founders decide to include within the boundaries of the firm. For instance, a startup could decide either to carry out all core tasks internally or else to outsource some of them.

Founders who begin their startups with more resources—that is, who made pre-founding career choices that enabled them to develop more of the human, social, and financial capitals needed to pursue the opportunity—will have a higher probability of achieving the entrepreneurial ideal.

Potential founders should be avid savers, adopting a low “personal burn rate” even when they are receiving comfortable corporate salaries so they can accumulate as much seed and post-seed capital as possible. Such founders should enjoy greater bargaining power when they negotiate with resource providers. An entrepreneur’s initial investment of financial capital can help eliminate liquidity constraints and might affect the startup’s ultimate level of success.

Moreover, the positive signal sent by entrepreneurs who invest their own resources should improve access to outside resources. Combined with a solid resource base, such positive signals should help attract better cofounders and hires.

Founders splitting equity can include terms for buying out cofounders if irreconcilable differences arise within the team or can structure dynamic equity splits that adjust to future changes. [Seth Godin's brilliant "shotgun clause": Each cofounder can at any time offer to pay the others out by the price of his choice. The other cofounders have a choice; they can either accept the offer and sell their shares OR they can buy the share from the offer for the offered price. The initial cofonder has to sell if the others decide to do so.]

A founder who is equally motivated by wealth and control motivations, and thus lacks clarity about what to decide regarding a specific dilemma, may use a secondary motivator, such as intellectual challenge, as a tiebreaker, which might lead to different decisions than those made by a founder who uses yet another motivation—say, altruism—to break the same tie.

Founders may create corporate partnerships with companies that have complementary resources or companies to which they can outsource important tasks. These founders will thus face “whether to partner” dilemmas.

For instance, crafting a corporate partnership may cause a founder to give up control of some decision-making power (because the startup will no longer be doing everything in-house) and of some financial gains (which will now have to be shared with the partner), but might increase the founder’s chances of retaining a moderate amount of control (because he or she didn’t have to take as much capital from outside investors) and of securing at least some financial gains from his or her hard work (by staying focused on the core of the business, remaining nimble, getting to market and scaling the business more quickly, or keeping costs down). In this sense, corporate partnerships may be a way to achieve “75% Rich, 75% King.”

“If one does not know to which port one is sailing, no wind is favorable.”

Some founders may be more risk-averse than others, preferring to take the safe option (such as a “sure” acquisition offer) rather than taking a chance on a risky future (such as building more value before selling).