Start-ups: Money versus Control—Or, Often, Neither
A “Techwise Conversation” with Noam Wasserman, author of The Founder’s Dilemmas
Hi, this is Steven Cherry for IEEE Spectrum’s “Techwise Conversations.”
The word founder,of course, refers to the person who starts a company, but it’s also a word for failure—when a project or a vessel falls or sinks or wrecks, we say that it has “foundered.”
It’s a nice little linguistic coincidence that came to mind recently. The Facebook IPO didn’t exactly founder, but it got off to a rocky start in part because of the greed of its founders. And it’s an important reminder that the great majority of start-ups fail, in large part because of their founders—by some estimates they’re the cause of two out of three failures. Remarkably, that comes as news, because the internal reasons for start-up failures have rarely been studied by management experts.
My guest today has tried to rectify that with a new book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup, published in March by Princeton University Press. It’s based on data collected on nearly 10 000 founders in the technology and life-sciences industries.
Noam Wasserman is an associate professor at the Harvard Business School. He has a Ph.D. from there, but before switching over to the dark side, he was one of us, earning a bachelor’s degree in computer science and engineering from the University of Pennsylvania.
Noam, welcome to the podcast.
Noam Wasserman: Thank you very much, Steven. Pleasure to be here.
Steven Cherry: Noam, I started with a linguistic point, and I’m going to stay with it for a bit. Your book title is The Founder’s Dilemmas. The dictionary says that a dilemma is “a situation requiring a choice between equally undesirable alternatives.” What are the equally undesirable alternatives that founders face?
Noam Wasserman: So the recurring one that I can map out throughout the book, that recurs at each fork in the road that the founders are making decisions that we’re looking at, is what I call the “rich versus king” dilemma. This is where founders, in order to be able to grow the value of their venture, to become richer at the venture level, and at their own personal level, are going to have to be giving up some measure of control that they otherwise would be able to keep. But at the same time, if they were to make the opposite decision to keep that control, they’re going to be harming their ability to grow the value of the venture, to attract the key resources that are needed to pursue the opportunity to its fullest. And that “rich versus king” dilemma is that toughest, most-recurring one that throughout every one of these stages of involving all the key people in the venture, you’re going to be facing as a founder.
Steven Cherry: Yeah, you used the example of Evan Williams in the book. Tell us about him.
Noam Wasserman: Sure. Evan is a serial entrepreneur who, during the first of his real ventures, what became Blogger, he made recurringly “king” types of decisions. He had a vision that he wanted to democratize the world. He wanted to bring his idea as he had envisioned it and be able to realize it, and along the way, because he needed to have control of all of those dimensions, he decided to keep a lot of the decision making within the team all to himself. He decided not to raise outside money, to try to avoid any venture capital or anything that would be inviting people onto the board and taking control away from him.
And then the flip side was that in his second venture, Evan made the opposite decisions at each of those forks in the road. That venture was what was early on called Odeo, then turned later into Twitter. But during the early days of Odeo, he made “rich” decisions at each of those key forks in the road, inviting in the best of the cofounders and giving him a big equity stake, bringing on some high-level talent, head-hunted executives, bringing on the biggest of VC rounds that he was able to raise. And as he’s making each of those “rich” decisions and seeing that those decisions are leading to a very different outcome for him from what he had seen within Blogger, and in the end it was only through going through both of those ventures that he realized which of those decisions was leading him away from the promised land that was what he envisioned.
Steven Cherry: I think what one of the key points in your book is that either of these paths can be a valid one, but once you’ve started down one or the other, “rich” versus “king,” your subsequent decisions really have to be consistent with it—for example, choosing a board of directors.
Noam Wasserman: Yeah, when you talk about valid decisions, to me you can’t judge whether the founder is making good decisions or not without understanding that founder and what makes him or her tick. What are those motivations, and what is that promised land they’re trying to shoot for. And also understanding about the characteristics of the venture: Is it capital intensive? Is there a ticking clock in that industry where there’s a competitive rush and things like that? But once we understand the founder and then take a look at their decisions, the invalid decisions are when you are “king” motivated, the visionary who wants to be having the thumbprint on the idea and bringing it to market, and then you make decisions that take all of that away from you, take that control and the decisions away from you. That’s where I would say that those are the wrong decisions.
But those same decisions could be made by a more “rich”-oriented founder—someone who is fine with having others coming on board and shaping the idea and leading it away from what that original vision was. And if a “rich”-oriented founder is making those other decisions, those could be perfectly valid ones. And so without understanding the founder, and in particular without the founder understanding himself or herself, that is where we have to be able to judge whether these are the best decisions or not. But you’re absolutely right that when you are in touch with what is that promised land you’re shooting at, if you can go in a line and be consistent with all the decisions that you’re making, that they will lead you closer to that promised land rather than away from it, that is a way that you are able to increase the chances that you are going to get to it.
Steven Cherry: One of the interesting things I found in your book was that the average founder ends up neither in control nor very wealthy, and that’s true even when start-ups are successful.
Noam Wasserman: Yeah, well, when you talk about the average founder, it depends also how you are going to be judging how much is wealth or not. What I find in the book is that the amount of wealth that a founder is able to build is going to vary dramatically by how much of that control they kept, versus how much they went and attracted the best resources and brought other people on board.
Steven Cherry: Tell us about the puzzle of the missing private-equity premium.
Noam Wasserman: Sure, this is…that’s actually going back to some research that helped spark my interest in this arena. That was research that was first done in 2000 by Bart Hamilton, and there was a follow-up a couple years later by two other researchers that were looking at the financial payoffs from people becoming entrepreneurs. And taking a look at the assumption that if we’re looking at risk-reward trade-offs, if entrepreneurship is a higher-risk way to go compared to just having a relatively stable job within someone else’s company, we would expect that entrepreneurs would be able to have higher payoff in the end.
And what they found is that there wasn’t. That, at best, it was a wash, when you were not even risk-adjusting things. And then when you go and you risk-adjusted the payoffs of someone who kept a corporate job versus the closest equivalent that we could get to within becoming an entrepreneur, that actually the entrepreneur made less than the person who had kept the corporate job, when you go and you adjust it for the additional risks that the entrepreneur took. And what they led to title one of those papers was exactly what you were referring to now of asking, “Why do we have this puzzle of there not being a premium for making this risky choice of becoming an entrepreneur?”
But that was about as far as they got with it—just posing that question. And what we can go and do a deep dive into, through my research, is then seeing how the other sets of motivations, and in particular the motivations that in the data that I show in the book are the two predominant motivations within the entrepreneurial sector, the motivation to go and be able to build something you had control over. The visionary bringing the idea to market as being the first of those motivations—the “king” types. And then the second of those motivations being the more “rich” type of motivations, the more financially driven, that those other papers had been assuming the preponderant thing, that it’s people who are trading off between the two of them that are going to become less rich, that it’s because of that control side, they’re using that other motivation that’s driving their decisions that’s going to lead them to not having that private-equity premium that was that puzzle that those papers had found.
Steven Cherry: Now, your data comes in part from case studies like Evan Williams and Twitter, but it’s mainly from something called CompStudy, which is an annual survey that you’ve run for a dozen years. How does it work?
Noam Wasserman: CompStudy is something I started in 2000, and I survey start-ups— private companies within the two industries that you refer to, within tech and within life sciences, those happening to be the two predominant industries within high-potential start-ups when we do any kind of measure of the fundraising or the IPOs or anything like that. So those are the two that I focused on. And I do these annual surveys, where the key way that we motivate people to participate in them is that, early on, I noticed that start-ups were lacking a critical piece of data when it comes to making decisions about their teams. That piece of data was: What is the market when it comes to compensation for the senior hires that I’m trying to bring in, the key holes that I’m trying to plug by bringing in a CTO or anyone else within the C level or VP level executives.
And what I decided to do was to be able to help them—give them deep, solid data where they would be able to see what is the market for these key hires, and then, when they’re making hiring decisions, being able to know, when I am cash poor, am I going to be killing my burn rate by going and overbidding for some of that talent out there? Am I going to be losing people because I’m not bidding enough? Or am I going to bid too much and going to harm my venture because of that? And also, when we have people on board, when we’re trying to retain the key players, understanding could they be cherry-picked because we’re underpaying them? Are there other ways we’re going to be harming because we don’t understand what the market is?
And so I take the compensation part of my survey, and we create a pretty deep-dive set of slicing that the participants have access to. They’re able to get in and do position-by-position analyses of compensation, the cash, the bonus, also on the equity holding side, and be able to see for my stage of maturity of the venture, for the geography, for my industry segment, for founder versus not founder, all these different ways that we want to see what is the market for a particular person, that they’re able to get the compensation data that they need. It’s only available to participants, and in exchange they fill out my survey, and it gets into all of these organizational factors, the early backgrounds that the founders are bringing to the table, the ways in which they built their ventures and the key decisions, a bunch of the fund-raising background that they have, the boards of directors that they built.
Steven Cherry: It takes an hour to complete, so I guess people really want that data. And it goes way beyond just compensation. There’s really a ton of interesting data that your book gets into. For one thing, altruism ranks high for women, for example, which, that’s no surprise, I guess, but it’s slightly higher for women entrepreneurs than nonentrepreneurs, and that’s not true for men. But then it’s a little bit true after the age of 40?
Noam Wasserman: Yeah, one of the intriguing things: There are two sides to the motivational data that you’re talking about. One thing that I had found surprising was, on the one hand, how stable that data is by the decade of life, that there’s much more flux in the nonentrepreneur motivations as they’re aging from their twenties to their thirties to their forties than there is among the entrepreneurs. As they’re going through the stages of life, they’re pretty rock solid what the top motivations are. But there are some key changes along the way, that first there are some gender differences, then there are also the decades of life ones. Where for women during their twenties, the altruism is already in their top four of motivations, and that doesn’t appear in the motivations for men until two decades later. So the women are catching on a lot earlier to what really counts in life, and then the men are the latecomers to that.
Steven Cherry: Well, it’s a really rich book, and people are going to just have to read it, I’m afraid. Noam, one last question: Your official biography mentions that you’ve completed something called Daf Yomi, if I’m pronouncing that right, and this is where a lot of people study the Talmud, the Jewish Bible, including its commentaries, one page each day, everyone starting and ending on the same day, and it takes about eight years to do it. First of all, that must be a wonderful thing, and I’ve never heard of it before, although I’m a bit envious. Although I could do it myself, of course, and in fact there’s a cycle starting later this year. But I’m wondering if there’s any connection between your study of the Talmud and your studies of business and innovation?
Noam Wasserman: It definitely has some ways in which it does inform the research that I do. Within the book, for instance, there are a couple places where I draw parallels to some of the Talmudic dilemmas that they face. Some of the ways in which they’re trying to make sure that decisions that are being made are set up to succeed, where normally the very common decisions are going to be fraught with peril.
So, for instance, to give you an example, one of the things I look at within my data on boards of directors is seeing the preponderance, especially during the early days of a start-up, of having an even number of people on the board of directors. Having four people on the board is a very common size, for that board. And also within that board, it’s also very common that it is a split board: two founders, two outsiders, or some other way in which those even numbers are a key issue. And in delving into it, both in the case studies that you refer to and in my data, finding that those are a problematic way to be architecting the board.
When I go back in the Talmud, there’s a book of the Talmud that talks about court cases, that talks about architecting the decision-making body that is a court, that has major parallels to that decision-making body, that is a board of directors. And one of the key things, the first of the analyses that they do in laying out the numbers of people who should be on each of these courts, there’s a smaller court for if it’s monetary cases, bigger courts for if it’s capital cases, they go through a whole variety of sizes of courts. And what I had noticed is that every single one of those sizes is an odd-numbered size of the court, ranging from 3 up until 71. And when you go and you look at a whole bunch of the reasons that are given for that, it’s because of the decision-making properties that come with the odd number of people.
A bunch of the problems that I’d seen cause gridlock within even-numbered boards of directors, and that’s one of those parallels that I draw briefly to in terms of thinking through the ins and outs of architecting that board. There are other things within the Talmud about succession between one of the founding kings of the kingdom of Israel to his son that has some parallels to founder/CEO succession. There are also parallels that we can draw from Genesis to how architecting a founding team, the tensions involved in it, and so there are a couple of other small ways in which in the book I bring these in, but in big ways that it shaped my thinking, by seeing a bunch of those time-honored lessons about how to avoid early common decisions that cause problems—that the Talmud was grappling with that millennia ago, and now how that has definitely informed a bunch of my research and a bunch of the recommendations that I’m coming to in terms of founders and what they should be doing also.
Steven Cherry: Well, maybe that’s your next book: Project Management Lessons From the Talmud…
Noam Wasserman: [laughs]
Steven Cherry: Well, very good. It’s a fascinating area, and a fascinating book, and thanks for the chance to talk about it.
Noam Wasserman: Sure, no, thank you for the opportunity, Steven.
Steven Cherry: We’ve been speaking with Noam Wasserman of the Harvard Business School and author of The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup. For IEEE Spectrum’s “Techwise Conversations,” I’m Steven Cherry.
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