10 mistakes that cost startup founders their companies

September 18, 2017

 

 

After having the kind of exit from my last company that no founder plans on, I've spent the last few months in an enforced period of self-reflection, processing, discovery and analysis. I've  had a lot of coffees with founders, CEOs and VCs. I actively picked the brains of entrepreneurship professors from Harvard and MIT and in the process developed a full-blown case study crush on Lew Cirne, along with becoming a fervent advocate of Disciplined Entrepreneurship.

 

When your world has caved in, it takes effort and the brave openness of others to discover that you are not alone. From the founders who shared their stories with me - in every case still raw, however many years had passed - to the detailed academic research by Noam Wasserman, I was genuinely surprised to learn that for certain types of investor-backed companies, a forced exit is the norm for four out of five founder CEOs:

 

"By the time the ventures were three years old, 50% of founders were no longer the CEO; in year four, only 40% were still in the corner office; and fewer than 25% led their companies’ initial public offerings... Founders don’t let go easily, though. Four out of five entrepreneurs, my research shows, are forced to step down from the CEO’s post. Most are shocked when investors insist that they relinquish control, and they’re pushed out of office in ways they don’t like and well before they want to abdicate. The change in leadership can be particularly damaging when employees loyal to the founder oppose it. In fact, the manner in which founders tackle their first leadership transition often makes or breaks young enterprises." Noam Wasserman,  The Founders Dilemma

 

I still believe it makes sense that at the right time the founder CEO steps aside to let a new CEO come in to lead the company to its next phase of scale. But as three-quarters actually end up being forced out involuntarily, clearly there is some kind of mismatch going on around when that right time is. Pragmatically, I would suggest that the right time - whether the founder likes it or not - is when the company is at a growth inflexion point and is thereby strengthened as a result of a smooth transition. But that is rarely what happens. and I don't think it is as simple as saying the majority of founders are just stubborn, growth-averse and wrong.

 

There is robust evidence that shows the superior and more lasting performance of companies where the founder still plays a significant role as CEO, chairman, board member, or owner or adviser:

 

"When the founder is still involved, why are companies more innovative? Why are they able to increase value at a higher rate, willing to make bolder investments, and able to maintain more loyal employees?.......  Three sets of hard-edged practices and underlying attitudes, tracing back to the way the founder had set up the company, emerged consistently. In other words, how founders built their companies on the inside, from the start, influenced their companies’ success on the outside, for a long time. We call these company practices “the founder’s mentality.”  ....... The founder’s mentality is an indicator of a company’s readiness to act quickly, to adapt to change, to retain the ground-level instincts of a founder, and to innovate to invent — and not fight the future."  Chris Zook, Founder-Led Companies Outperform the Rest — Here’s Why

 

There's a significant risk of physical harm to the person who tells an exiting founder that "it's nothing personal". It's nothing but personal. But there are things a founder can do to prepare for, and even mitigate against, too early an exit from their own business. These are some of the most important things to beware of.

 

1. Not fully understanding your three roles


Shareholder - when you founded the company, chances are you, or you and your co-founders owned 100% of a small pie. As soon as you raised money by equity investment, you sold slices of that pie on the understanding that pie would get ever bigger and more valuable. You set yourself on a path where the CEO's primary job is to grow the pie, and soon enough, though your slice was likely now pretty small as a fraction of the pie, at least on paper it was still considerably more valuable than at the beginning. And this is where the beginning of the end comes for most founder CEOs:
 

"Success makes founders less qualified to lead the company and changes the power structure so they are more vulnerable. “Congrats, you’re a success! Sorry, you’re fired,” is the implicit message that many investors have to send founder-CEOs."  Noam Wasserman,  The Founders Dilemma

 

Do not rush into taking investment without truly understanding what you are selling. And do so with your eyes wide open to where it leads 75% of the time. If you are not comfortable with that, revisit your funding plans and growth strategy before you become a pie seller.

 

Employee - whether CEO, CTO or whatever your founder role, you are also an employee of the company. You'll have a contract, some rights, but many responsibilities - including for those of us in the UK, non-competes, non-poaches and other restrictive clauses. There are likely to be a few particularly pesky clauses that boards/investors may use to block you or force you out. This includes the pretty standard "your job is whatever we say it is" clause, which enables a board to reduce their CEO to puppet status, by assigning them a nominal role but insisting they retain the job title. Whether the CEO immediately resigns or not typically depends on how long they have left on their vesting terms (see below). A founder a year or more off vesting is more likely to compromise into a lesser a role and serve their time until they have earned out their equity.

 

Director - in UK Law, as in most countries, it is one board director one vote. Founders often look shocked when I explain that this means you can own more than 50% of the company, but on a board of five, you only have 20% of the voting power.  Directors have hiring and firing power over the CEO, and depending on your articles of association, a problem or under-performing director can be extremely hard to remove (unlike the CEO). Your investors will appoint a director and multiple rounds can mean multiple investor directors. 

 

Do not make this situation more problematic by making unnecessary or poor director appointments yourself. The board steers the strategic and overall direction of the company - but particularly at the early stage this can get lost due to lack of relevant skills, excessive governance, or unhelpfully aggressive scrutiny of the CEO. To enable a startup company and the CEO to grow, the board must deeply understand the business, the market and the customer - and ideally, bring access to networks and customers that the founders cannot reach alone.

 

2. Carrying passengers
 

Passengers kill you from exhaustion, distraction and resource depletion. If you're fired (or "get resigned") due to passengers, it's generally because you've been carrying them for so long, you've become blinded to the toll that inefficiency is causing you and the business. Passengers tend to come in three forms:

 

Co-founders - if the founder equity split was wrong at the outset, this can be an end-to-end horror story with no escape. Never casually split your pie and always get proper, vesting co-founder agreements. Yet this happens all the time. I think I'd be seriously tempted to start again if 50% or 33% of my shareholding was dead-weight. I applaud but mostly commiserate, those founders who I spoke to that struggled on despite a co-founder who wouldn't help, but wouldn't go away.

 

Premature/non-contributing hires - in the early stage company, right up to nailing product market fit, your hires are either building product, shaping/validating/supporting product or they're selling the product. I have now become belligerently insistent that there should be no place in a startup or pre-market fit company for expensive, non-contributing hires like FDs, HR and hands-off CTOs. You can't afford them and they can't help you enough to justify their cost.

 

Greedy consultants/advisors - I have worked with a few amazing mentors/advisors who have been extraordinarily generous with their time and wisdom. Maybe it's the semi-psychotic glint in my eye, or maybe it's my age, but despite having encountered a fair few waste of time/money/oxygen consultants, none have ever had the audacity to ask for 10-15% of my company. But many of you have had this experience, especially on the local circuits - so if you too encounter it a) run, b) point them at this fabulous resource for optioning advisors.

 

3. Fudging your original numbers

 

You never expect that Excel spreadsheet you created when your business was three months old to come back to haunt you years later. But early assumptions, unless tested and validated in or out, stick around and become concrete. They shape the narrative and can get irreparably absorbed into the commercials. You can even find yourself being held accountable for failing to meet a number you randomly pulled out of thin air 4 years earlier. Don't risk it.
 

Fudging numbers includes working your projection backwards from the "right number"; pricing your product according to what you need to make your model work, not what the customer will realistically pay; failing to properly drill down into market size; assuming one-off spend patterns will be indicative of recurring revenue; and underestimating the time required to make additional units (people or customers) financially productive.

 

4. Raising what you can get, not what you need
 

So many founders, myself included, find themselves in the vicious circle of raising too little, too often and from too many sources. Investment soon dictates the plan, not the other way round. I spent the best part of 4 out of 5 years raising money, at the cost of my full focus on the business and ultimately my job.
 

Rather than seeing investment as the start-line, look for all the ways - especially sales/customer funded development - that will let you get as much traction as possible without it. That way so can raise for what you need, rather than settling on what is available according to the "typical" stage you are at.

 

5. Marrying the wrong investor

 

I can't decide if taking investment is more like getting married or prostitution. Either way, you should be entitled and fully prepared to say no if it doesn't feel right. When meeting individual investors, keep it as boring and soul-destroyingly unsexy as possible:  IOD, banks, lawyers, accountants offices, rather than bars, breakfast, dinner.

 

Down the line, listen for red flags and walk if you don't feel safe/comfortable. I walked away from an investment and the 11th hour and with £200 left in the bank when in the space of a single conversation I was asked to fire my husband "in case of pillow talk" and my female chair for being "too aggressive". When I turned down that money I genuinely believed I had killed the company, but in all good conscience knew I had still done the right thing.


It may be you have great investors, but will still need to channel communication in order to keep contact volume and flow manageable. I found that being overly welcoming to ad hoc investor input can soon lead to you drowning in conflicting opinions, often less informed than your own, especially if you do not have a single gatekeeper helping you channel and process that input.

 

6. Misinterpreting sales data

 

One of the highest risk errors a founder can make is over-optimism around sales. It is so easy to over-promise based on what you want to hear, or indeed what you do hear ahead of that elusive purchase order. But never tell your investors or board that a sale is closed or nailed until you have the paperwork. A sale that falls apart can cost you your credibility and ultimately your job.

 

Early adopters do not represent the mainstream customers you need to get traction and sustainable growth. Their feedback may or may not be useful - you have to map it back to the mainstream, a much tougher market. You have to understand if your early adopters, and then the first of your mainstream customers are really getting value, and how. That will help you predict likely churn and retention rates, and critically if you have hit product market fit.

 

You must stay brutal about managing the cost of acquisition, even early on. That 'sale at any cost' will kill you and chasing more of the same on that route is not just a distraction, it is driving you further away from replicable, growth-enabling traction.
 

7. Spending your money on the wrong stuff

 

In product terms, build first, think later is really costly. I am really really frugal - yet I wasted good money (great money, it was mine) on UX design and front-end development, with no validation that a front end component was even required. The rush to build must be resisted - I am currently trying to follow my own advice....

 

Expensive hires too early and other forms of premature scaling will kill the company or get you fired/"resigned". The pressure for this early scaling is usually from your board/investors/peers/own ego - if you do not yet have product market fit, resist this with every fibre of your being. It won't help you and will rapidly deplete resources. If you do have product market fit, prepare to be one of the 25% of founder CEOs who don't get forced out and at least give serious consideration to whether your skills are still right for the next stage.

 

Beware of people who love spending your money - maybe it's a PA buying expensive wine for the office, maybe its those folks who always fly into London City Airport and book their flight the day before. Or perhaps it's all those 'good idea at the time' SaaS products that no one remembers to cancel. No one else will ever be as careful with company money as you were, so build in checks, processes and clear rules so it doesn't spiral out of control. Extravagance on the part of others may seem a tolerable price to pay for growing up until it gets you fired. Investors like frugal. and when it gets tough you'll need as much runway as possible to be able to adapt, at which point every penny counts.
 

8. Legals

 

Vesting terms - back to point one. Will a founder CEO most likely comply or resign when forced into a reduced or barely existent role? Vesting is absolutely standard in venture deals. It is based on the idea that the founding teams must re-earn their original equity ownership by contributing to value creation and pie-growing through sweat equity, typically over a four-year period. The claw-back rate over that four years can be negotiable, but a board typically knows that a non-vested founder is very unlikely to jump, and the remaining shareholders will benefit even if they do. So they will, therefore, likely apply most pressure to a founder CEO at this point. A vested founder owns their shares in full and - even if resigned or forced out - becomes simply another name on the share cap table.

 

9. Disconnection from the information flow

 

Running a business can become a massive distraction from growing, and more importantly, validating a business. Whereas in the early days you may have been continuously drinking from a fire hose of information - and more than capable of rapidly adapting to that information - the business of managing investors, process, people and money can lead to disconnection from the critical information flow.

 

The most important thing that a startup has to achieve is product market fit - this was my biggest mistake and I've written about it here. You have to get from early adopter sales to mainstream, repeatable sales to satisfied customers in a commercially sustainable way. In retrospect, I think proving product market fit is your single most important job as a founder CEO - so much so that in future I'll probably be OK with stepping aside as CEO once I have it.  

 

But disconnection from the customer and the information flow, especially if down to premature scaling and excessive board/investor management, can lead you to overlook the signs you need to be on top of to recognise and resolve product/solution/market fit issues.

 

10. Burnout and breakdown

 

Entrepreneurs are an unrelenting bunch, so it's probably no surprise we are prone to depression, anxiety, sleeplessness and addiction. So sleep deprived, stressed and full-on falling apart was I when I came into this year, I pushed myself beyond my physical and mental limits. Hit by a debilitating attack of Labyrinthitis, I got through the second worst meeting of my life thanks to a double dose of anti-psychotics. After the worst meeting of all, a few months later, I actively willed my plane to crash all the way home, because in that moment it really seemed like the least awful way out. That was a very dark and lonely place, but one I now know that many other entrepreneurs recognise.

 

"Emotional difficulties aren't a sign of weakness. It’s just a fact that the entrepreneurial lifestyle often lends itself to reduced resilience against mental health issues."  Amy Morin, Forbes

 

Taking care of your own mental and physical health is essential before you can worry about that of your team. Yet this is where the personal, inextricable link between founder and company becomes problematic - it can feel like there is absolutely no way out. Ideally, we'd all have someone on the inside of our working world trying to relieve a little of the mental pressure that we put on ourselves - but the reality is that we spend most of our waking lives mainly in the company of employees, board, investors and clients. For the most part, these people - however well-meaning - are literally invested in you carrying on, even if it is becoming all too apparent to you that you can't. It is not fair or realistic to look solely to them for support.

 

So try to maintain a few old relationships - those friends or family members who don't give a damn about the entrepreneur, founder or CEO version of you, but just take you, feed you and forgive you for who you are. If you didn't abandon them completely along your way, they'll be the ones best placed to catch you when you fall and will likely patch you back together ready to do it all over again.

 

 

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