Startup companies go through a number of phases as they mature from an idea, to a small team, to a growing team, to a small company, to a big company.
And along this journey, the leadership team you need changes. You need little to no leadership structure when you have a small team, you need some sort of leadership structure when your team is growing, you absolutely need a leadership team when you become a “company”, and the leadership team becomes incredibly important when you become a big company.
In the last week, I’ve had several conversations with CEOs in our portfolio who are leveling up their leadership teams and are recruiting executives from larger organizations.
I’ve counseled them to make sure that they hire executives who have a lot of risk tolerance.
High growth companies that emerge from a startup situation tend to be volatile. They have a lot of turnover in their organization, they have moments when the cash balances get low, they sometimes face existential risks.
If you have executives that you need to spend a lot of time comforting and solidifying, that’s not good. Ideally your leadership team is your steadying force and if you are steadying them, then your setup is suboptimal.
It is always tempting to bring in people who have operated at a scale well beyond where you are. And I am not saying you should not do that. You should. But just make sure they can handle the heat in the kitchen because it’s gonna get hot sometimes.
I was talking recently to a friend who advises a lot of boards. I asked him his view on boards overall.
He said that he saw two styles, both of which he found problematic.
The first style is the “rubber stamp board” that does whatever the CEO asks of them.
The second style is the “meddling board” that acts like it is running the business.
He told me he sees very few boards that manage to strike the right balance.
I sit on a lot of boards and have been doing so for thirty years now. I have been on rubber stamp boards and I have been on meddling boards. And I agree that both are problematic.
What I have learned over the years from those not great experiences is that boards must respect the line between governance and management and never cross it. But they also must govern. They must push back on things that don’t make sense and they must exercise the authority that has been vested in them by the shareholders.
This need to strike the right balance exists in many other contexts in our lives. It is the essence of good parenting. It is the essence of good management.
To a large extent boards reflect the CEOs that report to them. Strong willed successful CEOs can often construct rubber stamp boards because that is what they want. And weak ineffective CEOs find themselves with meddling boards who are trying to manage the poorly managed company from above.
Neither of these situations is good. The weak and ineffective CEO should be replaced by the board instead of trying to manage from above.
And the strong willed CEO must have checks and balances placed on them, no matter how well they are doing.
A great board chair can be transformative for a board. They can stop the meddling and force the necessary management changes. And they can stand up to a strong willed CEO and build the trust and respect that can lead to a well functioning board.
This is why I do not believe that CEOs should chair their boards. They should find someone who has a lot of board experience, knows how to strike the right balance, and vest in them the authority to lead the board to the right place.
I have been on boards that do strike the right balance and are chaired properly. It is a pleasure to work on these boards and a well functioning board is a thing of beauty. Every CEO should want one.
I wrote a blog post about this topic in November 2010 that has become one of the most searched on and referenced AVC posts of all time. The numbers in that blog post are long out of date and so I now have a popup on it warning people not to use those numbers. However, the methodology in that blog post remains sound and is used by many startup companies.
He includes updated multipliers for the NYC startup market in that post, which is something many readers have been asking me for over the last few years.
The reality is that these multipliers differ from market to market. They are highest in the Bay Area, high in NYC/LA/Boston, and lower in other parts of the US and in Europe, and even lower in other parts of the world. And, like all markets, they change over time. So it is hard to maintain a valid set of multipliers and I have given up on doing that. A startup could be created to maintain those numbers, or an established company like Carta, which has access to the raw data, could do it.
But even with the vagaries of what multipliers to use, the methodology that I laid out in my initial blog post on the topic is best practice in my view and anyone who is struggling to figure out how much equity to be offering employees would be well served by reading Matt’s post.
I am reading a friend’s book which is still in proofs and so I’m not going to talk about it yet.
But there is one part of the book that really rang true for me and that is when he talks about certain kinds of problematic employees, particularly one he calls The Heretic.
This kind of employee, and we have all seen this up close, is negative about the Company and disses the management, coworkers, the board, the strategy, the workplace, and everything else under the sun. But for some reason the heretic prefers to stay and be miserable than to move on and find another place to work that is more to their liking.
My friend states in his book that you have to part ways with heretics in your company, regardless of how talented they are, how connected they are, and even if they are protected in some way. You have to find a way out of the heretic mess.
I agree with this advice and I have seen this play out in many ways. The worst way is to let this behavior go on unchecked. As painful as parting can be, and it can be incredibly painful depending on the circumstances, letting this behavior stand is worse.
I woke up sick this morning and could not fly to Toronto where I was planning to do a session at Collision with Matt Glotzbach, CEO of our portfolio company Quizlet.
I sent some emails to let people know I could not make it and went back to bed and slept for another few hours and I feel a bit better.
I do this to myself a few times a year when life gets hectic. The good news is that Memorial Day Weekend is upon us and that means some much needed R&R.
Speaking of Matt Glotzbach, here is a video that Matt and Quizlet’s founder Andrew Sutherland did three years ago to introduce Matt to the Quizlet community. It does a great job of showcasing Matt’s personality and strengths (and Andrew’s too).
In evaluating leaders, at the top of a company, or in the ranks of company leadership, an important quality that I look for is followership. Specifically, will the team line up behind this person?
Of course, leaders have to have other qualities. They need to have domain expertise if they are leading a specific function, they need to understand the needs of the business and the sector that it is operating in, and many other things too.
But what I have learned is that followership is super important. If the team doesn’t line up behind a leader, it is extremely hard for them to be effective.
For internal promotions, it is relatively easy to see followership and promote people who have it. You can also help people develop the management skills (listening, communicating, etc) that lead to strong followership.
When hiring someone from the outside, determining if they will have followership is harder. You can reference for this quality. But to some extent followership is a function of the culture of the organization. Someone who had strong followership in one kind of organization may not find it in another one.
It can take a leader some time to develop followership, particularly if they are hired from the outside. The team will need some time to figure out this new person, how they operate, and how they feel about them. But if a new leader has not developed the followership they need to lead the organization, or a part of the organization, within six to nine months after joining, then it is likely that a change will need to be made.
When developing your own organization and internal leaders, you should be very specific about followership and the need to develop it on your team. You should help mentor and coach younger managers on how to develop it and you should move quickly on leaders who don’t have it and won’t develop it on their teams.
It is always so impressive to me to see what leaders with strong followership can accomplish, when everyone is lined up behind them and delivering on what they ask of the organization. That is what I would wish for every organization, but sadly many don’t have it and they underperform as a result.
Many of USV’s portfolio companies use an OKR process to create this rhythm in their teams. What I have learned from watching these companies and listening to how the teams talk about the OKR process is that to some extent it is “form over substance” in that the process is ultimately more important than the specific objectives and key results that flow through the process.
I am not saying that teams shouldn’t be thoughtful in setting objectives and committed to hitting them. They should.
But I am saying that the regular setting of objectives (quarterly is a time frame most companies use) and the weekly or bi-weekly reporting against them is the most valuable thing that comes from the process. It sets the heartbeat and keeps it. And that is so valuable.
Many VC firms, including USV, use a weekly team meeting, often on Mondays, to align the group, report on the week that has past, and focus on the week to come. That weekly cadence allows us to be responsive to entrepreneurs, come to relatively quick decisions as a group, and stay in sync.
Public companies report on a quarterly basis. That rhythm sets up a cadence of setting expectations (guidance) and reporting on results (earnings reports). It is not entirely different from the OKR process in a few important ways. It creates a cadence that is super valuable for execution and performance.
I am a fan of all of these processes. They set a cadence and rhythm for an organization and force decision making and provide for timely execution.
The best companies master this and working in those organizations is fun and rewarding. Setting objectives and meeting them on a regular basis is a virtuous system that brings out the best in people and teams.
High growth companies need to have a strong finance function. You can’t drive a car (or a plane) without some instrumentation. Most importantly, you need to know when you are going to run out of gas (or electricity).
The mission critical things that must be done in the finance function are mostly accounting related functions; pay bills, make payroll, keep track of expenses, maintain the books and records of the company. These are “must dos” and you need a person who has an accounting background to do most of them. But these are all “looking back” functions in the way I think about the finance function.
What is even more important in a high growth situation is the ability to look forward, to project, and to make sure that the company doesn’t run out of money.
In order to look forward, you need to know where you are, and that requires a solid baseline derived from looking back. So one feeds the other. But they are different.
Looking forward requires modeling and it requires the ability to anticipate. An example of this is “we are going to get a big order from a new customer next month, let’s put that revenue into the model.” But if you don’t anticipate that it may take up to ninety (or more) days to collect that revenue, then you have messed up the modeling and that is the sort of rookie error that could lead to an unexpected cash crisis.
There are many reasons why a company needs a forward looking projection to run the business but avoiding the unexpected cash crisis is number on on that list in my view.
In my experience, the people who are strong at the looking back function are often not strong at the looking forward function. You may need different people to do these roles. In a large company, there are entirely different departments that do these functions. There is an accounting department and there is a financial planning department (often called FP&A).
If you are a small company and have limited resources, you will often attempt to get both the look back and the look forward from the same person. If you aren’t getting what you want in doing that, don’t be surprised. I would rather see a small company outsource the accounting work and staff for the planning/modeling work. Accounting is a bit of a commodity, many people can do it well. Seeing the future from around the corner is most definitely not commodity and if you have someone who can do that well, hold on to them, pay them well, and make sure they are happy and rewarded in the job.
Because looking forward is really where it is at in the finance function at the end of the day. That’s where the good stuff and the bad stuff mostly happen. And when it is done well, it is a thing of beauty.
Many people in startup land believe that the answer to the challenges around forcing departing employees to exercise vested options is to simply extend the option exercise period to the maximum (ten years) allowed by the IRS.
It certainly is one of the techniques that are available to companies and one that a number of our portfolio companies have adopted. Another option, and one that I prefer, is for a market to develop around financing these option exercises (and the taxes owed) when employees depart.
However, if you are thinking about extending the option exercise period for departing employees, you should understand that it will cost your company something.
Here is why:
Options are worth more than the spread between the strike price (the exercise price) and what the stock is actually worth. They have additional value related to the potential for the stock price to appreciate more over the life of the term of the option.
There is a formula that options traders (and companies that issue options) use to value options. It is called the Black-Scholes formula.
If you click on that link, you will quickly realize that the math used in the Black-Scholes formula can be complicated. But fortunately, there is a neat little web app that I frequently use to estimate the value of an option. It is here.
So let’s say that your company is issuing options at $1/share (your 409a) but your most recent financing was done at $2/share. Then a four year stock option is worth roughly $1.25/share.
If, on the other hand, you offer a ten year option exercise period to your employees, the value of the option rises to $1.52/share, reflecting the longer period of time that the stock could appreciate over.
That is a 20% increase in the cost of issuing stock options. You could mitigate that by reducing the number of options you issue to incoming employees by 20% but that might make your equity comp offers less attractive to the “market” because incoming employees won’t value the longer exercise periods appropriately.
Stock based compensation costs are real costs even though many in startup land think of options as “free” because they don’t cost cash. The accounting profession has attempted to estimate these costs and companies do put stock based compensation costs on their income statements. If you go with ten year exercise periods instead of four year exercise periods, expect those expenses to go up significantly. Twenty percent is just the amount in my example. It could be larger, possibly as high as fifty percent (or more) if your exercise price is a lot closer to the current value of your stock.
This extra value of a ten year stock option versus a four year option is known as “overhang” by investors. It is the cost of carrying a group of people who have a call option on your stock but don’t have to pay for it for a long period of time. Generally speaking investors don’t like a lot of overhang in a stock.
All of that said, employees are the ones who create value for shareholders. They need to be compensated for that. And I am a fan of both cash compensation and stock based compensation. I like to see the employees of our portfolio companies well compensated in stock. That has a cost and everyone should be well aware of what it is. Longer exercise periods increase that cost. I would rather put more stock in the hands of the employees of our portfolio companies than give them longer exercise periods. But regardless of where one comes out on that tradeoff, it is important to recognize that it is a tradeoff. There are no free lunches, not even in stock option exercise periods.