It’s not undercapitalization, lack of planning, or failure to test the market that most often cause startup business failures, says Noam Wasserman, a 42-year-old associate professor at Harvard Business School. Instead, nearly two-thirds of early stage failures stem from people problems—who does what and how they’re compensated, says Wasserman, who has written a new book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup (Princeton University Press, 2012). I spoke to Wasserman recently about his conclusions on startup failure and how he recommends would-be entrepreneurs increase their odds of success. Edited excerpts of our conversation follow.
How did the book come about?
It grew out of a course I developed when I got into academia, based on my own experience in entrepreneurship and venture capital and out of private company data I collected over 12 years. With the help of three professional-services firms, I got surveys from 10,000 founders of 4,000 startups, plus I’ve done deep dives into research for case studies.
My mission was to map out key decisions that founders must make and bring rigorous data to bear on an arena where anecdotes and rules of thumb and gut instincts rule the day. For instance, we have a preponderance of prominent role models that we assume are the rule in entrepreneurship, but they may really be the exception.
You found research showing that bad personnel decisions—about co-founders, equity splits, hires, and investors—drive most early failures. Let’s talk about partners and co-founders and what goes on there.
The most common source of finding co-founders is people you have social but not professional relationships with—friends and relatives. It’s understandable, but my quantitative analysis shows that these are the least stable of all the startup teams. There are two Achilles’ heels: You already trust each other in the social realm and you assume that will map to trust in the professional realm, which it does not necessarily do. And you’re not going to have the in-depth conversations about competence and skills that you would have with a business acquaintance or a stranger. That’s because you assume you don’t need to talk and you are hesitant to raise doubts because you fear they could blow up the social relationship that is so valuable to you.
Those factors lead to elephants in the room that teams are not going to be tackling. And if things go sour in the venture—if you’ve co-founded with an acquaintance—you’re not imperiling the most treasured relationship. But if you’re co-founding with a brother or a roommate or a spouse, the potential damage is extremely high. This is what I term the “playing with fire” gap.
So should entrepreneurs avoid friends and family when they look for partners?
I’m not pounding the table and saying: “Don’t you dare co-found with your best friend or your brother.” What I say is to do it with the gap in mind and reduce it by forcing the hard discussions and building firewalls that protect your social relationships from your professional ones.
Another pitfall you discovered is the decisions about how and when to split equity within a founding team.
Yes. In my data set, 73 percent of founding teams split equity within the first month of a venture, and the majority set it in stone without allowing for any dynamism within that agreement.
The problem is that early on, entrepreneurs don’t know what their business model or strategy will be. They don’t know what individual roles will be, how much commitment each co-founder will have, and they all share a rosy scenario because they’ve never gone to the bottom of the entrepreneurial roller-coaster.
What do you recommend when it comes to equity splits?
I like to see founders match uncertainties by putting dynamism within their agreements. It’s critical, early on, to take your best cut at a serious discussion about where the company is going, who will be the key players, what are the different ways they’ll be contributing. In contrast to just focusing on the usual rosy scenarios, they should also tackle the expected case and the worst case.
If you hit each of those scenarios and how equity should be changed under them, you can have a dynamic agreement that might include vesting of equity, for instance. A typical agreement might have equity vest over four years, or they might use a milestone vesting plan or a scenario-based one. The idea is that equity is earned over time for those who are still around in the venture.
One common problem you saw is that founders’ early strengths often undermine their effectiveness later on. How does that happen?
Their passion and confidence leads them to overly rosy projections and they underestimate how much funding they’ll need or overestimate the speed with which they’ll accomplish things. I think if there’s a realistic road map in place for the company and the founder does some introspection, they have a much better chance of succeeding.
What kind of introspection are you talking about?
Understanding the true motivation for why you’re getting into this to begin with. I call it the rich-vs.-king dilemma because the two most common motivations are financial gain and control. The king is a visionary who wants to bring something to fruition and have an impact on the world without having to sacrifice the idea or have others twist and turn it. This person is more control-oriented and should think about being a solo founder, bootstrapping the venture, and finding inexpensive employees who are going to be more rising stars than rock stars.
The founder who primarily wants to get rich will do what it takes to grow the venture, including hiring the best employees, finding the best co-founders, [and] giving up control to the investors with the best financial resources, guidance, and networks. They don’t mind imperiling control in hopes that the pie will grow a lot bigger—and their slice, while smaller, will be much more valuable.
If a founder is one type—making decisions that are the opposite of the outcome he wants—that’s the worst-case scenario because you’re being led to a promised land that is not at all what you’ve aspired to.
You studied both small startups that are bootstrapped and higher-potential startups that often attract outside capital. What are the big differences in decision-making?
The smaller businesses are often not as aware of some of the nuances in decision-making and they are playing with fire more often.
For instance, half of tech startups co-found with social-relationship partners—that’s even more common in smaller startups. About one-third of tech companies split the equity equally up front; that goes to 70 percent for smaller bootstrapped startups.
Instead of heading down the most common roads that are most fraught with peril, the smaller companies should be having all the same discussions the bigger guys need to have, and it’s even more imperative that they understand the “head” side of a business, not just the “heart” side.