Founders Posts

I recently wrote that it’s “fair for founders to own about 100% of a startup while employee #1 only owns a few percent.”

My argument was that the dollar value of stock that founders get when they start the company is actually less than the dollar value of stock that employees get when they join the company. The disparity between founders and employees is therefore just a matter of timing.

There’s a corollary to this theorem:

The first 1000x in valuation is the easiest.

The first 1000x in stock appreciation is easier than the next 1000x. Here’s why:

Let’s say the company is worth $1 when you start. To get a 1000x increase in valuation, you only need to grow the company to $1000 in value. So if you join a company when it’s worth $1, you only have to create $999 of value for your stock to appreciate 1000x!

If someone else joins the company after it’s already worth $1000, he has to create $999,000 of value for his stock to appreciate 1000x!

To get a 1000x return on your stock, you either have to create $999 or $999,000 of value. One of these is easier. By 1000x.

The first 1000x is the easiest, because it is easier in an absolute sense.

Seed-stage investors don’t like top-heavy companies: CEO, COO, CXO, CYO, VP of X, Y, and Z. It’s almost an immediate pass. No sophisticated investor is impressed by titles in an early stage startup.

If you’re an early-stage consumer internet company, you don’t need fancy titles, you need founders and employees who get can either build the product or sell it. (One of the founders should be the CEO so you can make decisions quickly.)

There are many exceptions to this bit of advice but, unless you really know what you’re doing (you’ve been starting companies and investing in them for the last 10 years), keep it simple. CEO, founders, engineers, salesmen, marketers. If one of the founders wants to be the President, give him an internal title, but keep it simple for investors.

Thanks to FastIgnite, a startup advisory firm, for sponsoring Venture Hacks this week. This post is by Simeon Simeonov, the firm’s founder and CEO (and formerly a partner at Polaris Ventures). If you like it, check out Sim’s blog and tweets @simeons. – Nivi

The best strategy for not having to fire your co-founders is to not bring them on board in the first place.

One of the most common early-stage startup mistakes is building a weak founding teams. Since a good team is often the closest you can get to a good business plan, this one anti-pattern is the cause of many company failures. Before we dig into why this happens so frequently and what entrepreneurs can do about it, I want to share one of the formative stories from my early days as a VC.

An entrepreneur who should have fired his co-founders

Many years ago, I met a 20-something technical founder who had recently left graduate school with interesting technology in the enterprise search and knowledge management market. Beyond his compelling personality and the technology, he had an impressive approach that allowed him to deliver benefits to users without prior user setup or explicit user actions, using desktop and email client integration. To use a current analogy, it was like Xobni but better.

A week later, he came to Polaris with his founding team. He had three co-founders. They all had grey hair and so-so backgrounds. Over the course of an hour, I learned one of the three was a relative who, after hearing about the idea, pushed himself onto the team as “the business guy” and then promptly brought in a couple of former co-workers as co-founders. The net effect was that a backable founder had become essentially unfundable. I passed on the deal. As expected, the company went nowhere. I am friends with the founder and would like to back him some day.

This is an extreme example, but it underscores the randomness by which founding teams are created. Three disclaimers before we dive into the issues:

  • I’m not advocating that an entrepreneur goes it alone. Much has been written about the costs and benefits of partners when starting a company. I’m advocating for more thoughtfulness about the building of a founding team and more creativity around how to make progress with limited resources. See Venture Hacks’ post on How to pick a co-founder.
  • I’m not advocating that what’s best for the company in an abstract sense should trump personal relationships or commitments that have been made. I am advocating for greater care in making commitments and more openness around the balance between business and personal spheres.
  • I’m focusing specifically on founding teams here, but many of the lessons apply equally well to hiring in very early stage companies (before product/market fit has been proven).

How weak teams get built

Arrogance and ignorance, in small doses, are powerful tools that help entrepreneurs focus and execute against overwhelming odds. In larger doses they make a dangerous poison that kills startups. In most cases, they are the root cause behind weak founding teams.

It’s no secret that startup business plans tend to evolve over time, sometimes substantially. Yet, at any given point along that evolutionary path, many entrepreneurs are over-confident that, this time, the plan will succeed. Then they look at the founding team and, if they think they are missing a key role, they may bring a co-founder on board. This process repeats itself up to the point where either the company converges to what it will likely end up doing in the next few months or the founding team gets to a size that makes additions practically impossible.

I recently met an entrepreneur who started working on a consumer social media idea about a year ago. Thinking he was building a small dot-com, he brought on a college buddy who had done Amazon Web Services work as a chief technical officer (CTO). In a few months, the idea shifted toward working with agencies. He brought in a VP of marketing from the agency space, because he was confident that was where the opportunity was. After a few more months, the team realized there was only a services business in the agency space. Now they are pivoting towards expert identification/collaboration in enterprises, and neither his CTO nor his VPM is right for the team.

The entrepreneur in this example is a smart guy. But he didn’t have enough experience to understand what would be required for a co-founder role over the early evolutionary path of the company. He didn’t fully appreciate the opportunity cost of making these early hires given his limited recruiting network and the pre-product, pre-funding stage of the company. Further, he did not know how to evaluate a VP of marketing. He ended up with a communications-oriented exec who — beyond lacking understanding of the enterprise domain — is not very helpful in general with product marketing issues. This is how ignorance hurts.

What VCs think about bad co-founders

Keep in mind that when you recruit or you pitch investors, they don’t get the benefit of the history that might explain your decisions. Let’s imagine what goes on in a VC’s head:

“Shoot, this is a backable entrepreneur and the idea may have legs but the two other founders are B players and a poor fit for the company at this point. I could talk to the lead founder, but I don’t know about the personal relationships on the team and this can backfire. Also, I don’t want word getting out that I break founding teams. This can hurt my dealflow. Anyway, the CEO showed poor judgment in bringing these people on board. Also, there is still a lot of recruiting work to do whether the team changes happen before or after an investment. Frustrating… this could have been a good seed deal. Now it’s too complicated. I’ll pass using some polite non-reason.”

Agile founding teams

There is a principle in agile development that centers on minimizing wasted effort. One of the cornerstone strategies — supposedly one of Toyota’s rules, too — is to delay decisions until the last responsible moment. Because the future is uncertain, the idea is to make decisions with the most information. The emphasis is on “responsible,” because a lot of procrastination is bad too.

Last week, I wrote about how to raise money without lying to investors with this same principle. The logic also applies to building strong founding teams. Because you don’t know what your startup will end up doing, it can be a big mistake to hire the best people for this point in the company’s life.

The obvious solution is to build an amazing team of well-rounded, experienced athletes who can do anything that comes their way. The Good-to-Great companies put the right people on the bus and the wrong people off the bus. If you can do it, more power to you. However, you may have a few problems…

Entrepreneurs Anonymous

I am an entrepreneur, and I have team-building problems:

  • I am not exactly sure what my company will do.
  • I have limited resources and can’t have many people on my team.
  • My recruiting network is limited.
  • My company, especially pre-product and pre-funding, may not be very attractive.
  • I may not be the best person to evaluate people in _______ and _______.

Ten rules for building agile founding teams

Here are some specific strategies for building founding teams. There are no silver bullets. Some of the advice is contradictory and situation-specific. Caveat entrepreneur.

  1. Network, network, network. Learn how to learn through people. It’s the fastest way to understand a new domain. Value negative feedback. It often carries more information than a pat on the back. Expand your recruiting network, so you get access to better talent.
  2. Set clear expectations. When getting involved with someone, establish the right psychological contract from the beginning. Talk about what might happen if there is a pivot in an unexpected direction.
  3. Go easy on titles. Don’t give out big titles unless you have to and, even then, question why you have to. You can always “upgrade” someone’s title later if they perform well. They’ll appreciate it. On the flip side, big titles can cause many problems when you recruit or raise money.
  4. Structure agreements well. Founders should have vesting schedules with some up-front acceleration. In some cases, you can bestow founding status without giving founding equity with accelerated vesting.
  5. Be honest with and about your team. Get in the habit of discussing team fit with the business plan in an open, non-threatening manner. When you talk to experienced investors or advisors, be honest about the limitations of your team. Most likely they see any warts just as well or better than you, and you can only win by showing you have a firm grip on reality.
  6. Hire generalists early. Hire specialists later.
  7. Hire full-timers reluctantly. You can only have a few of them in the early days, whether they are co-founders or not. Be picky. Don’t fall for the chimera of “If only I hire a __________, then I can _________.” This may be true, but only if the person you hire is perceived to be good and does a good job. The perception of the quality of your team is as important as reality for recruiting and fundraising.
  8. Find experienced part-timers. Sometimes you can get a lot of value out of very experienced people even if they only spend a few hours, or a day, each week with you. The key is to do this over a period of time and build context. Over time, experienced part-time employees can help in the process of building the company. They can help make many decisions — for example, around team-building, financing and the business plan — as opposed to any one decision. This is how I work with startups through FastIgnite. Depending on the situation, I’m an active advisor or co-founder and/or acting CTO. Other people, like Andy Palmer, take on a board or acting CEO role.
  9. Find the right investors. Seek investors who pride themselves on their recruiting abilities and have a track record of helping startups build teams. These investors may see the holes in your team as an opportunity instead of a problem, as long as they feel confident the company is a good recruiting target. Some firms have internal recruiting teams led by experienced former executive recruiters. Examples include Benchmark (David Beirne) and Polaris (Peter Flint). Others, such as General Catalyst and Founders Fund, favor partners who are former entrepreneurs with deep networks and team-building experience.
  10. Fire your co-founders. If you are behind the 8-ball and see your team as a key constraint, you should do something about it. Don’t wait for an investor or someone else to do it for you. The non-CEO co-founders can fire their CEO co-founder, too (or change their role and level of responsibility). This happened at a social commerce startup in the Bay Area I liked. The CEO came up with the idea (kudos to him) but he had enterprise background and provided little value-add. His two co-founders were responsible for most of the progress. It took them too long to reshuffle things. By that point, they’d made a bad impression in front of too many investors. The team fell apart eventually.

If you successfully apply these strategies, you stand a better chance of going after the right people at the right time and bringing top talent on board.

You may not even have to fire your co-founders.

We received a lot of good questions and feedback on How to pick a co-founder:

Is two co-founders the only way to go? How do we split up the company? Who’s the boss? How do I know when to compromise on a co-founder?

So Naval and I recorded a 40-minute interview to answer your questions, explain how to pick co-founders in detail, and describe not only what to do, but how and why to do it.

The interview comes in two versions: Mini and Pro.

Mini

The Mini version of the interview is free. It includes the first 5 questions of the interview — audio and transcript. Voila:

Audio: Mini interview with chapters (for iPod, iPhone, iTunes)
Audio: Mini interview without chapters (MP3, works anywhere)
Transcript: How to pick a co-founder (Mini) (PDF)

Pro

The Pro version is $9. Fuck that, it’s free. It includes the full interview, with all 16 questions plus:

  • A nicely-formatted 48-page transcript. Here’s a sample.
  • An MP3 you can download for your portable device or media player. Here’s a sample.
  • Chapters, so you can jump to the part of the interview you want. This only works on iPods, iPhones, and iTunes. Here’s a sample.
  • Your money back if you don’t like the interview.
  • THAT AWESOME FEELING OF BEING A PRO.

Questions

Here are the questions we cover in the interview:

  1. How many co-founders?
  2. How do you create a history together?
  3. How should you divide up the company?
  4. Who’s the boss?
  5. Do you even need a CEO?
  6. What skills do you need on the founding team?
  7. Why do you need aligned motivations?
  8. Should I compromise on a co-founder?
  9. Why should I partner with a nice guy?
  10. How can I tell if the other guy is a good builder/seller?
  11. How do I convince someone to partner with me?
  12. What if my co-founder needs a salary?
  13. Where do I find a co-founder?
  14. How do I start a business with family?
  15. How do I start a business with friends?
  16. How many co-founders? (Redux)

[Read more →]

Update: Also see our 40-minute interview on this topic.

Picking a co-founder is your most important decision. It’s more important than your product, market, and investors.

The ideal founding team is two individuals, with a history of working together, of similar age and financial standing, with mutual respect. One is good at building products and the other is good at selling them.

The power of two

Two is the right number — avoid the three-body problem. Think Jobs and Wozniak, Allen and Gates, Ellison and Lane, Hewlett and Packard, Larry and Sergei, Yang and Filo, Omidyar and Skoll.

One founder companies can work, against the odds (hello, Mark Zuckerberg). So can three founder companies (hello, @biz, @ev, and @jack). In three founder companies, the politics can be tough — gang-up votes, jockeying for board seats, etc. — but it’s manageable. Four is an extremely unstable configuration and five is right out. When 4-5 founder companies work, it’s because two founders dominate.

Two founders works because unanimity is possible, there are no founder politics, interests can easily align, and founder stakes are high post-financing.

Someone you have history with

You wouldn’t marry someone you’d just met. Date first. Guess which pair of famous co-founders is in this photo:

Go through something difficult, like a Prisoner’s Dilemma or a Zero-Sum Game. If being ethical was lucrative, everyone would do it!

One builds, one sells

The best builders can prototype and perhaps even build the entire product, end-to-end. The best sellers can sell to customers, partners, investors, and employees.

The seller doesn’t have to be a “salesman” or “business guy”. He can be technical, but he must be able to wield the tools of influence. Bill Gates and Steve Jobs aren’t salesmen, but they are sellers.

Aligned motives required

If one founder wants to build a cool product, another one wants to make money, and yet another wants to be famous, it won’t work.

Pay close attention — true motivations are revealed, not declared.

Criteria: Intelligence, energy, and integrity

It’s not the kid you grew up next to. It’s not the person you like the most. It’s not the hacker most willing to work for free.

It’s someone of incredibly high intelligence, energy, and integrity. You’ll need all three yourself, and a shared history, to evaluate your co-founder.

Don’t settle

If it doesn’t feel right, keep looking. If you’re compromising, keep looking. A company’s DNA is set by the founders, and its culture is an extension of the founders’ personalities.

Pick “nice” guys

Avoid overly rational short-term thinkers. There are bounds to rationality. Partner with someone who is irrationally ethical, or a rational believer that nice guys finish first. Be especially careful with the “sales” guy here.

What you don’t know

Business founders who don’t code use bad proxies for picking technical co-founders (“10 years with Java!”). Technical founders who don’t sell also use bad proxies (“Harvard MBA!”). Learn enough of the other side to have an informed opinion. If you’re not seriously impressed, move on.

FAQs

What if the right guy already has his own startup? Convince him to work on yours part-time — he’ll drop his idea once yours gets traction.

Breakups are hard

If you’re going to fall out with your co-founder, do it early, recover the equity into the option pool to keep the company going, and recruit someone else great to fill the missing slot. Build in founder vesting (a.k.a. the “Pre-Nup”) to keep the breakup from getting messy. Building a great company without a partner is like raising kids without a…

Nearly everything I’ve written on this topic applies to dating and marriage. Coincidence?

Go forth and multiply.

Update: Also see our 40-minute interview on this topic.

This post is by Naval Ravikant. If you like it, check out his blog and Twitter.

We’ve updated the presentation in A quick and dirty guide to starting up. The new presentation includes the notes that accompany each slide.

I’ve also included the new presentation below. Watch it in full screen mode for maximum pleasure. The full screen button is at the bottom right of the embed and it looks like this: .

(Slides: A Quick And Dirty Guide To Starting Up (pdf))

Here are some of my favorite quotes from the presentation:

“We are faced with insurmountable opportunities.” – Pogo

The most important thing: idea intelligence connections experience determination.

Ideas, and therefore NDAs, are worthless.

“… as in all matters of the heart, don’t settle.” – Steve Jobs, on picking co-founders

Co-founders are the biggest failure mode for startups.

“If you are facing in the right direction, keep walking.” – Buddha, on focusing your time in a startup

Markets are relatively efficient, so your first product is probably wrong.

Naval recently presented A Quick and Dirty Guide to Starting Up to Girls In Tech:

(Slides: A Quick and Dirty Guide to Starting Up (pdf))

Here are some of my favorite quotes from the presentation:

“We are faced with insurmountable opportunities.” – Pogo

The most important thing: idea intelligence connections experience determination.

Ideas, and therefore NDAs, are worthless.

“… as in all matters of the heart, don’t settle.” – Steve Jobs, on picking co-founders

Co-founders are the biggest failure mode for startups.

“If you are facing in the right direction, keep walking.” – Buddha, on focusing your time in a startup

Markets are relatively efficient, so your first product is probably wrong.

If there’s demand, we’ll turn this into a slidecast.

“If you want to improve your chances, you should think far more about who you can recruit as a cofounder than the state of the economy. And if you’re worried about threats to the survival of your company, don’t look for them in the news. Look in the mirror.”

Paul Graham

Our previous vesting hacks have discussed getting vested for time served, acceleration upon termination, and acceleration upon a sale. This article is a collection of four vesting microhacks you can use to supersize your vesting.

1. Reclaim a terminated co-founder’s unvested shares.

A terminated co-founder’s unvested shares are typically cancelled. The resulting reverse dilution benefits the founders, employees, and investors ratably.

Instead of canceling the shares, divide them among the remaining co-founders and employees ratably. You should argue that,

“Cancelling a terminated co-founders shares puts a lot of pre-money into the investor’s pocket. Those shares should be distributed among the founders and employees who created that pre-money valuation.”

This argument will carry more water if you offer to put a portion of the reclaimed shares into the option pool to hire a replacement for the co-founder.

Reclaiming a terminated co-founder’s shares does not create an incentive for co-founders to terminate each other. Co-founders have an incentive to terminate each other even if the shares are cancelled. In our experience, this incentive is never a factor. Founders are almost always allowed to vest in peace unless they are incompetent, actively harmful, or clash with a new CEO.

2. Run screaming from the right to purchase vested stock.

Some option plans provide the company the right to repurchase your vested stock upon your departure. The purchase price is ‘fair market value’. Guess whether the definition of fair market value is favorable to you or the company…

fmv.png

Founders and employees should not agree to this provision under any circumstances. Read your option plan carefully.

(Props to Suzie Dingwall Williams who already brought up this microhack in the comments.)

3. Accelerate your vesting upon hiring a new CEO.

If you are having trouble applying any of the other vesting hacks, trade those chips in for six months of acceleration upon hiring a new CEO. Investors are usually eager to bring in “professional” management. They should agree to this term because it aligns your interests with theirs.

4. Keep vesting as a consultant or board member.

If you have a lot of leverage, you may be able to negotiate an agreement to keep vesting if you are terminated but retained as a consultant or a board member. For example, the company may terminate you but keep you as a consultant to help decipher your spaghetti code.

Some companies have been known to sneak this term into their closing documents. We’re not big fans of that approach.

Again, if you are having trouble applying any of the other vesting hacks, you may be able to trade those chips in for this one.

What are your vesting micro-hacks?

Submit your vesting micro-hack experiences and questions in the comments. We’ll discuss the most interesting ones in a future article.

“During the whole funding process they said, ‘We’re interested in you guys because of your management team; we think you’re fantastic…’ Two weeks later they pull me into the office – before even the first board meeting – and say, ‘We want to replace you as CEO.’”

Mark Fletcher, Founders at Work

Summary: You made a commitment to the company by agreeing to a vesting schedule — the company should reciprocate and commit to you by granting acceleration upon termination.

Over time, your continuing contributions to the company will become relatively less important to its success. But the number of shares you vest every month will stay relatively large. Founders generally make their greatest contributions at the early stages of the business but their vesting is spread evenly over three to four years.

As your relative contribution to the company diminishes, everyone at the company has an incentive to terminate you and benefit ratably from the cancellation of your unvested shares. Nevertheless, in our experience, founders are allowed to vest in peace unless they are incompetent, actively harmful to the business, or clash with a new CEO.

You will probably be terminated if you clash with a new CEO.

By definition, a new CEO is hired to change the way things are and provide new leadership to the business. That he might clash with founders who previously ran the business is predictable. The CEO usually wins any disagreements or power struggles — he is the decider and he decides what is best.

The investors, board, and management will almost certainly agree to fire your ass if you continuously clash with a new CEO and you will lose your unvested shares upon termination.

Accelerate your shares if you are terminated.

50% to 100% of your unvested shares should accelerate if you are terminated without cause or you resign for good reason.

Cause typically includes willful misconduct, gross negligence, fraudulent conduct, and breaches of agreements with the company. ‘Clashing with the CEO’ is not cause. Good reason typically includes a change in position, a reduction in salary or benefits, or a move to distant location. Detailed definitions are included in the Appendix below.

Make sure you receive this acceleration whether or not your termination or resignation is in connection with a change in control of the company, such as a sale of the business. You can clash with your acquirer too.

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Justify acceleration with the reciprocity norm.

Acceleration may cause consternation among your investors but it is easy to justify:

“A founder’s most important contributions generally occur in the early stages of a business but he earns his shares evenly over time. If I clash with a new CEO and he terminates me, I should receive the equity I earned with those contributions. Which will make me much more comfortable with hiring a new CEO.

The founders agreed to a vesting schedule to demonstrate our long-term commitment to the business. You have told us that the founders are critical to the company — that we are the DNA of the business. Acceleration demonstrates the company’s long-term commitment to our continuing contribution.”

This argument is an application of the reciprocity norm which requires your opponent to be fair to you if you are fair to him. Your vesting schedule locked you into a commitment to the company — that was fair — now acceleration locks the company into a commitment to you.

It is even easy to justify 100% acceleration if you are the sole founder of the business:

“Right now, I own 100% of my shares. After the financing, I will have to earn these shares back over the next four years — I’ve agreed to that. But if I’m removed from the business, I lose the right to earn my shares back. In that case, I should walk out the door with the shares I came in with.”

Avoid unfair termination with a democratic board.

As usual, the best way to avoid unfair termination and avoid hiring a bad CEO is to create a board that reflects the ownership of the company with hacks like making a new board seat for a new CEO.

Acceleration for co-founders can do more harm than good.

If you have a team of founders, acceleration upon termination can do more harm than good.

A co-founder with acceleration upon termination who wants to leave the company can misbehave and engender his termination. If the company decides to terminate him without cause to avoid possible lawsuits, your co-founder will walk away with a lot of shares. In California, it is actually very difficult to prove cause unless an employee engages in criminal activity.

If you trust your co-founders absolutely, you should negotiate as much acceleration upon termination as you can. Otherwise, you need to decide which is worse: the expected value of misbehaving co-founders who leave with a lot of shares or the expected value of leaving a lot of shares behind after your termination.

What are your experiences with vesting upon termination?

Submit your experiences and questions on vesting upon termination in the comments. We’ll discuss the most interesting ones in a future article.

Appendix: Definitions of ‘Cause’ and ‘Good reason’.

Your lawyers will help you define cause and good reason. Definitions that we have used in term sheets in the past follow. Note that the definition of good reason below assumes the company plans on hiring a new CEO at some point:

    “Cause” shall mean the occurrence of:

  1. The willful misconduct or gross negligence in performance of his duties, including his refusal to comply in any material respect with the legal directives of the Company’s Board of Directors so long as such directives are not inconsistent with a party’s position and duties, and such refusal to comply is not remedied within ten (10) working days after written notice from the Company, which written notice shall state that failure to remedy such conduct may result in termination for Cause;
  2. dishonest or fraudulent conduct, a deliberate attempt to do an injury to the Company or the conviction of a felony; or
  3. breach of the Proprietary Information and Inventions Assignment Agreement entered into with the Company.
    “Good Reason” shall be deemed to occur if:

    1. there is a material adverse change in employee’s position of employment causing such position to be of materially less stature or of materially less responsibility, including without limitation, a change of title or responsibilities normally associated with such title, without employee’s consent (other than, with respect to the Founder(s), a change, in connection with the appointment of a new CEO, to an executive officer level position with normally associated responsibilities that reports directly to the CEO or the Board of Directors),
    2. there is a reduction of more than ten percent (10%) of employee’s base compensation unless in connection with similar decreases of other similarly situated employees of the Company, or
    3. employee refuses to relocate to a facility or location more than sixty (60) miles from such employee’s principal work site; and
  1. within the one (1) year period immediately following such event the employee elects to terminate voluntarily his employment relationship with the Company.