The Team
Investors start reading a business plan by skimming the executive summary; then they jump to the section in the back entitled “Management.”
Our research showed that investors are extremely reluctant to invest without knowing their risk concerning “adequate management.” The issue is what “adequate” means. This chapter will clarify this issue and will help the founders decide what additional talent they will need.
Each group of people that starts a company has a core team around whom the company is built. Only a few of the original group are founders; most are additional talent that the leader feels will be needed soon after funding is closed. The core team should be picked very carefully, because its business and interpersonal style becomes the foundation for the company’s culture and, like yeast, grows the value system that becomes the mark of that start-up.
The founders should pick the most outstanding talent that can be found. These people will represent the company to investors of the seed and subsequent rounds of funding. The company people must make an excellent impression—not from a slick, smooth point of view, but rather from their track records and skills and by their depth of experience in the areas most important to the sustainable competitive advantage of the company. Don’t settle for a few average employees—this is the wrong place to compromise.
Experience. Do I have a chance to attract venture capital if I do not have prior start-up experience? We found that venture capitalists generally gave the same answer to that question: They say that if it’s a good idea, a new enterprise will always be welcome, along with the person who thought it up, but the chances of raising venture funds will certainly be increased if the founder has prior experience with a start-up. However, most start-ups are not led by people with years of prior experience in new businesses. VCs will be frank and tell the leader if his or her experience needs to be supplemented by that of others with track records in start-ups: “How do you feel about being CEO?”
The CEO’s goal is to stack the deck in the start-up’s favor, and to get the needed capital at a fair price. If the founders believe that start-up experience will improve the company’s odds significantly, they must find it. For instance, ask venture capitalists for leads to people wanting to be CEO of a start-up. Venture capitalists get hundreds of résumés from people who are looking for a start-up. Founders can benefit from those contacts, even before asking the venture capitalist for money.
I am a technologist (or a young person), not a businessperson. I think my idea can be a big success, but I don’t know if I should proceed or not. What should I do? Start-up advisers and angels are asked this question by people from many backgrounds. They told us their answer is always the same: Get started on the trail to getting your business financed. Complete your business plan as soon as possible; let that be the pacing process that you use to answer your important questions. Follow our guidelines for the early stages and this will raise the key issues you need to deal with. You can always get good people to listen to a good idea. And during the process you can attract the management talent you will need.
Now let us address a key issue for investors—completeness.
By the end of the first multimillion-dollar round one of financing, the CEO will be expected to have filled all the key functional positions that report directly to him. Venture capitalists are particularly concerned if VP of marketing or VP of sales or VP of business development positions are not filled at that stage, particularly if the CEO is the lead technologist or idea person with little business experience.
The investors see a race to finish the first product or service or web site as soon as possible. Incomplete management teams slow that race down and a window of opportunity may be missed. When a key person is missing, the CEO must take time to find, recruit, and train the new member of the executive team. That pause will probably delay introduction of the start-up’s first product, increasing the risk for investors, who will in turn price round one accordingly, with more dilution to the founders.
What is the best sequence in which to add people? When should we hire a sales-person and a finance manager? The order in which start-up founders added to their executive teams varied, but we discerned this pattern:
Venture capitalists and the start-up’s chief financial officer are seemingly in the same camp, with the same goals of success. However, an experienced CFO is frequently an antagonist to some of the venture capitalists. They are most likely to argue over the need for capital, the price at which it is to be sold, and the degree of control over spending and hiring; which investment bankers, attorneys, and new investors the start-up should do business with; what class of risk should be used to invest surplus funds; and how much leasing and borrowing the company should do.
In a nutshell, we found that many venture capitalists are reluctant to turn over control of financial policy to a strong CFO. As investors, they want to keep close reins on their new child, particularly when it (inevitably) starts to steer off course from its original business plan. That is understandable by most CEOs.
Such control by VCs is not necessarily in the best interests of the entrepreneur and his core team. Some angry CEOs told us that investors had pressured them into dropping R&D projects so that the company’s financial statements would look good enough to get the IPO done. Others told us that venture board members virtually took over running the company’s financial affairs when a weak controller succumbed under the pressure of bad times. Other CEOs told of being threatened with expulsion and blackballing if they did not go along with the terms and conditions of the proposed next round of financing (the dreaded “washout,” which severely diluted the employees’ equity but did less damage to the prior venture capitalists because of the antidilution clauses in the contractual clauses included in their preferred stock).
Needless to say, the founders and CEO had better be prepared to fight for the start-up’s and their own interests. It is easier with a strong CFO on board as early as is reasonable.
Lately we have been seeing proportionately more CEOs adding a full VP of finance instead of a controller. And the CFO is being brought on more quickly than in prior years. This may reflect the experiences of successful IPO companies, many of which attracted an experienced CFO early, near round one time. This was noticeable for companies that raised more than $20 million of capital. And the shortage of experienced start-up CEOs may be shifting more power to them, allowing the CEO to choose a stronger VP of finance. Boom times call for quicker IPOs and thus quicker times to hire a CFO that can take the start-up public quickly.
Completeness, Lawsuits, and Time. Investors do like to see that two or three of the core team have worked together before. This reduces the risk to the investor by speeding the first product to market and reducing the time wasted in learning to get along with each other.
It takes time for people to learn to work together. We found all management lamenting how long it took for the culture to form, gel, and begin to function creatively. Few business plans acknowledge the slip time associated with this “working with strangers” phenomenon.
Investors do not like lawsuits or even the likelihood of legal entanglements. Classic law cases of the 1980s set the guidelines for fair play. The complete Linear Technology team left National Semiconductor together, got round one monies almost immediately, and were promptly sued by their former employer. (Chapter 5 tells how to avoid this painful problem.)
Most start-ups begin recruiting by using the buddy system to recruit team members through the first three rounds of funding. This reduces the mistakes caused by hiring a stranger, takes much less cash than using recruiters, tends to cement the start-up’s culture, and creates a spirit of togetherness and participation by new employees. Unlike the era of the 1980s, lots of recruiters, expensive newspaper advertisements, and for-fee-web-site hiring services are now being seen well before IPO time, reflecting the continuing shortage of qualified leaders.
By definition, all start-up companies are short of talent. Most start-ups solve this problem in part by the frequent use of contractors and outsourcing to experts such functions as public relations. These part-time personnel fill in for missing skill sets, and the company pays only for what it gets. Such personnel are widely available in the larger metropolitan areas and are regularly used in the life of emerging companies long after they go public. This phenomenon appears to have become a way of life for rapidly emerging high-tech companies. It is now common for the stock option plans of start-ups to allow shares to be granted to key contractors. As Don Valentine of Sequoia Capital put it, “Because of the start-up talent shortage, we now get the core management to focus on specific jobs in the business and, as venture backers, dig into our talent bank of related people to provide missing skills on an as-needed basis. It is an important way to use a venture backer, so pick your investor wisely and ask about their people resources.”
Venture capitalists themselves make extensive use of part-time talent, often called “technology experts” or “due diligence associates.” Venture firms can be helpful in recommending part-time consultants to fill any series of jobs that the start-up needs done.
Contractors are common in engineering; they get paid by the hour, day, month, or project. Consultants are more often used in other functions. Some open and close the financial statements each month. Some run the personnel department for the early months. Still others work on market research or sales training. These contractors are usually highly experienced former operations professionals. Their compensation often includes equity in some form, ranging from grants to purchase stock to issue of stock warrants, as well as cash compensation.
These part-timers range from the recently unemployed to the financially independent person. The latter are called “stand-in executives.” They may have just finished a successful start-up and cashed in at IPO time. Saratoga Venture Finance calls such people “49ers” (from the idea of financial independence gained by American pioneers in the California gold rush of 1849). The part-time work schedule gives both parties a chance to look each other over, possibly for permanent employment (without an expensive recruiter’s fee). This part-time-to-permanent arrangement is frequently done deliberately, both by 49ers interested in becoming start-up CEOs and the executives who hire them as contractors.
Recruiters are used as in larger companies—sparingly, but when the hiring is going to be hard or needs to be very fast and thus is critical to success. A growing number of venture firms are keeping an active roster of possible VP and CEO résumés in a personal computer database, just to be able to supply needed talent to their start-ups.
However, investors and founders have encouraged the use of recruiters in order to keep a start-up on plan. Bodies are needed—fast—to get the work done before a competitor arrives. CEO recruiting continues to be tense, due to the shortage of that pool of talent, and VP work is steady for recruiters who specialize in start-ups. Be sure to include their fees (15 to 33 percent of annual cash compensation) in your business plan financial forecasts!
We believe that the pattern of high-tech start-up hiring practices we have described is commonly used. It is aimed at one goal: hiring as complete a team of competent professionals as the start-up can attract, as soon as possible, in order to execute its business plan on time and within budget.
The president of a very successful start-up was asked for advice on what to do to be a successful start-up, and he answered, “Hire the best people you can find!” Investors agree with him—the better the people, the less risk there is likely to be. The CEO should be able to translate management strength into negotiations that mean less dilution for the CEO and the founders, leaving more shares for more top people. As one veteran put it, “A players attract A players.”
Interestingly, top-quality people often emerge from bankruptcies. Prior bankruptcy experience is valuable; failure has its rewards. Mature investors have seen six out of ten of their children go under. They know that it was not all the fault of every employee; the big breaks account for a lot of the outcome. Therefore, according to a number of wealthy, successful investors with whom we spoke, top managers from defunct companies are actively recruited to new start-ups. We would say, “It is better to hire a leader who learned from mistakes than it is to hire someone who was just lucky.”
In the end, the CEO will want to be able to present a solid core team to attract the first rounds of funds, while avoiding the sacrifice of too much quality or too many shares along the way. Compensation (equity and cash) for this team is discussed in Chapters 7 and 8.