Newsletter

Weekly Briefing Note for Founders

17th March 2022

This week on the startup to scaleup journey:
  • The founder's dilemma: Stepping down as CEO
  • How much should founders pay themselves?
  • CEO direct reports need to be 'owners' not just 'helpers'

1. Insights of the week

The founder's dilemma: Stepping down as CEO

As a founder, it seems hard to imagine that the question will ever be asked: Are you the right person to lead the company as it starts to scale? And yet this question is asked more often than not - founders just aren't aware that anyone is asking. As startups transition through the early growth rounds, usually starting at Series A, this is a question investors will ask themselves. It's just part of their job - nothing personal. The root of this lies in the fundamental truth that the skills needed to start a business and grow it to a certain level, and then to expand it to a very large company, are very different. In the early days, founders naturally aspire to lead the business though the entire life cycle from birth to mature company. This image of long-term entrepreneurial success, epitomised by the likes of Jeff Bezos and Mark Zuckerberg, is however the exception rather than the rule.

In the early stages, a startup’s development is strongly connected to the founder CEO, who is usually very hands-on and inwards facing. This is essentially a 'command and control' model with the founder at the centre of everything. As the business matures, the founder cannot make every call, leaving the day-to-day decision making to the senior team and acting more as a conductor. The role gradually shifts to more of a figurehead and statesman/stateswoman, guiding and developing ideas whilst promoting the business. For some founders, whose DNA is heavily aligned with the dynamics of the early creative phase, there is often a dawning realisation that the role of 'scale-up CEO' is just not what they are naturally cut out for. But recognising these differences and acting upon them - hiring a growth-stage CEO - are two very different things. Founders that possess the courage this requires become proactive and put themselves in a position to lead this process. Those in denial may start to feel they are living on borrowed time. Astute boards will hope the CEO initiates such a process themselves. Otherwise, the board will eventually have to intervene.

One of the most interesting examples of such proactivity is the case of Seedrs. In 2017, co-founder Jeff Lynn announced that he was stepping aside as CEO and promoting Jeff Kelisky, the company’s COO, as his successor. After raising a Series A round, Lynn understood the necessity for aggressive growth required a CEO with experience of what had worked elsewhere; someone with a demonstrable record of running a successful high-growth business. What few knew was that whilst Kelisky had initially been hired as COO, the plan was to have him 'graduate' into the CEO role within a year. In fact it only took 6 months. This well-documented story is an inspiration to founders that are struggling with the same dilemma that Lynn initially faced. The success of this plan required a high degree of emotional intelligence and proactivity from Lynn. He initiated the idea with the board and then successfully managed the transition from 'founder leadership' to 'growth leadership'. He says: "I’m a big believer, from a founder’s perspective, in trying to control the timing and the process. If you do it before you’re forced to do it, things can actually work out pretty well for everybody. But, if you get into an acrimonious situation, then it’s not a whole lot of fun for anybody."

How much should founders pay themselves?

This is one of the perennial questions that comes up during funding preparation. It can also be a hot topic with investors, especially during due diligence. Those founders that are underpaying or overpaying themselves should expect to have a discussion on this point with the new lead investor. On the underpayment side, investors get anxious when founders are taking so little out of the business that they have constant liquidity problems living month to month. This is not what investors want as it decreases the personal performance of the individual and consequently adds huge risk to the bigger mission. On the other side of the coin, if investors see the founder taking above market salary, this will raise awkward questions. If the salary is so big that it dilutes the equity incentive then this will turn investors away. The financial model for any forthcoming round should ideally reflect market salaries across the board, so the whole compensation topic just becomes a non-issue.

So, what is the market salary for a founder and how does this align with equity? Seedcamp's recent compensation survey provided some useful insights, not just on salary and equity levels but also on the factors that determine how these evolve over time. Early stage founders across the UK, Europe and US were polled. This included 38 at Pre Seed, 107 at Seed and 40 at Series A. The major conclusion was that only a few variables showed any reliable impact on founder salary or equity. These key variables were: Last Round Type (Pre Seed, Seed, Series A); Geographical Location; and, Number of Co-Founders. Interestingly, traditional indicators associated with company and consequent founder success, such as revenue, number of employees, etc. had zero correlation with the amount of salary or equity that founders held. Between funding rounds, the data showed a salary increase of Pre-Seed – Seed: 28%, and Seed – Series A: 35%. This corresponded with an Equity decrease of Pre-Seed – Seed: 9% and Seed – Series A: again 9%.

The clear correlation between salary levels and funding stage gives founders a strong rationale for a salary bump at Seed and Series A rounds as part of the use of funds. Investors will be more inclined to support larger steps if they are tied to performance. Picking KPIs that are relevant to the next phase of the business is obviously key. This is especially relevant in the pre-revenue phase. Aligning some form of variable compensation to revenue as the business starts to build commercial momentum then becomes viable. But boards and investors can easily fall into the trap of incentivising revenue growth above all else in the Seed to Series A transition. This can sometimes be a huge mistake. Any revenues prior to product-market fit are not necessarily those that should be scaled and could make the company a hostage to fortune. This is where savvy early-stage boards and investors really come to the fore. They look for variable compensation plans that incentivise building the optimum platform for long-term growth, not just the quick early wins.

CEO direct reports need to be 'owners' not just 'helpers'

Building out the executive team is a critical undertaking for any startup CEO. The timing will vary depending on the type of business model, but for most it will begin during early scaling. Up to that point the founder will have relied on a handful of individual contributors - especially in product development - to build the MVP and engage with early adopters. At this stage you are designing and running experiments - not (yet) building a company - so flexibility is just as important as specialism; early hires often wear multiple hats. But at the point where clear commercial traction starts to bite and the organisation needs to ramp up at executive level, inexperienced CEOs often stumble. Investors, who have seen this all before, then get anxious.

Executives are the functional heads - sales, marketing, product, customer success, HR, etc., that report directly to the CEO (in the US, ‘VPs’).  A founder CEO that can quickly demonstrate the ability to attract one or two high calibre executives will significantly boost investor confidence. Their personal stock will immediately rise - often disproportionately so. In his recent blog, VC Jason Lemkin says founders often take too long to decide on these critical hires. Founders will either prevaricate over the possibility of promoting one of the ‘incumbents’ (sometimes out of misplaced loyalty), or believe they can simply get away with a more junior role. But this is a time where you need ‘owners’ not just ‘helpers’. As Lemkin says, “Help is terrific, and appreciated, of course.  But a great VP of Marketing or Customer Success does so much more.” They will take full responsibility for implementing systems and processes that deliver consistent growth, and, as 'owners', will expect to be held accountable.

For founders that have worked for high growth businesses in the enterprise, none of this is a surprise. They will know the special types of operators being described here and the amazing impact they can have. These VPs not only pay for themselves with the growth they unlock but will unburden the CEO from operating minutia. Investors at Series A and beyond will expect the use of funds to cover such critical scaleup roles. Some will also expect to see a pipeline of prospective hires during due diligence. These new recruits will be leaders in their own right (some will potentially be future founders), capable of filling out teams beneath them over time. Above all they are 'accelerators'; they make things happen faster because they are truly proactive. They understand that momentum is everything and are able to ‘pull’ the company towards the next milestone. Who are your 'owners'?

2. Other pieces really worth reading this week: 

Adjust valuation expectations and fundraising timelines
From the Angular Ventures weekly update, VC David Peterson assesses the shifting landscape on valuations. "Late stage investors are worried about overpaying. Early stage investors are worried about investing too quickly and needing to go back to their LPs too early. There’s still a lot of money out there chasing amazing companies, but the result of all this is likely a slight slowdown. (This is already happening.) Fundraising may take a bit longer and valuations may be a bit lower. Adjust accordingly."

Tech Rout in China
Bloomberg News provided a stark assessment this week into the Chinese market, where tech stocks lost $2.1T this Wednesday alone. For founders seeking Chinese VC investment these are uncertain times. "Chinese tech had morphed into fear in recent days as investors turned their attention to the risk of sanctions should China offer aid to Russia for its war. That triggered a 11% slump in the Hang Seng Tech Index on Monday, its worst daily drop since the gauge’s July 2020 inception. JPMorgan Chase & Co. analysts have even labeled some Chinese internet names as “uninvestable”"

How to think for yourself
Having just re-read one of the great essays of legendary investor, Paul Graham, we must recommend again. Not just because of the subject matter (so close to the hearts of founders) but his compelling writing technique that we can all learn from. "Another place where the independent- and conventional-minded are thrown together is in successful startups. The founders and early employees are almost always independent-minded; otherwise the startup wouldn't be successful. But conventional-minded people greatly outnumber independent-minded ones, so as the company grows, the original spirit of independent-mindedness is inevitably diluted. This causes all kinds of problems besides the obvious one that the company starts to suck. One of the strangest is that the founders find themselves able to speak more freely with founders of other companies than with their own employees."


Happy reading!

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