Bottom Line: Young firms are valued significantly higher and attract more financing after their founders relinquish some power.
In the two years after Lew Cirne founded Wily Technology in 1997, he assembled an experienced executive team, hired 50 employees, and raised two rounds of VC funding. But he also had to relinquish three of five board seats to his investors, who promptly decided that Cirne should be replaced by a CEO with a stronger business background. CA eventually bought the firm for US$375 million — a far larger haul than Cirne could have brought in, as he admitted. But the founder was still chagrined about the early decisions he made that led to his ouster.
Whether in Silicon Valley or any of the other startup hubs around the world, Cirne’s dilemma is all too familiar. To grow their firms, founders desperately need financing, skilled employees, and the kind of “social buzz” that makes investors reach for their checkbooks. But the more investors or key hires who come aboard to provide much-needed resources, the more autonomy the company founder must surrender. Founders face a trade-off between retaining control and increasing the value of a young firm.
According to a new study of more than 6,000 high-potential U.S. startups that launched between 2005 and 2012, how one navigates this early-stage founder’s dilemma has a profound impact on the firm’s long-term value. The more power retained by founders, the author discovered, the less valuable their companies are.
Founders face a trade-off between retaining control and increasing the value of a young firm.
For every additional position of power a founder occupies (being both CEO and chairman, for example, as opposed to controlling just one of those roles), the company’s value decreases by between 17.1 percent and 22 percent. The author also found that startups whose founders retain an additional level of power see a 35.8 percent to 51.4 percent decrease in the amount of financing they raise, depending on which variables he used to measure a founder’s control.
But this trade-off effect kicks in only after three years, at that delicate stage in which founders’ technical expertise or visionary outlook typically become less crucial to growth than the resources a firm has attracted.
Not only do these findings have major implications for how entrepreneurs should set up and structure their firms, but they also carry lessons for the people who want to work at or invest in a promising startup. Investors who seek to maximize their returns and potential hires who want to be part of a fast-growing enterprise should do their due diligence on founders to understand their motivations and determine whether they’ll be willing to cede power at the appropriate time.
But the author also discovered a potential downside to ushering founders out the door: heightened risk. Bringing VCs into the picture can ratchet up the pressure to “swing for the fences,” he notes. And replacing a charismatic or creative founder–CEO can give investors pause. Stakeholders and employees looking for security rather than growth spurts should seek out founders who refuse to step down and instead, in the words of Cirne, remain “parent of my baby.”
Source: “The Throne vs. the Kingdom: Founder Control and Value Creation in Startups,” by Noam Wasserman, Strategic Management Journal, Feb. 2017, vol. 38, no. 2