Friday, April 15, 2011

Lesson #17: Pitfalls to Avoid When Joining Someone Else's Startup

Typically an entrepreneur starts up their own business.  But, from time to time, they will see a unique opportunity to join somebody else's startup, either as investing CEO or team member.   There are five areas you need to assess before making that leap: (1) your fit with the founders, in terms of skillset and personality; (2) management control; (3) equity ownership control; (4) board control; and (5) corporate governance control.  I will tackle each of these points in the following paragraphs.

The fit with the team in terms of skillset and personality is obvious enough.  It is important you can get along with your new partners, giving the long hours you will be working together.  So, if you clash in style or personality, it will never work.  And, it is important that you each are bringing a unique and non-overlapping skillset to the table.  So, if the company already has a strong tech leader and operations leader, maybe you bring strong marketing or financial skills to the table, to balance the team.  You don't ever want to be in a situation where job roles are not clearly defined upfront, to avoid stepping on eachother's turf, especially when empassioned founders are involved.

As for management control, let's say you have been made an offer to become the new CEO of the business.  You need to be perfectly clear up front that you have the final decision making authority in terms of business direction, and that the founders are willing to follow your lead, even if it may be in a different direction than the company was currently heading.  This could even include making a change in management, if the CEO believes the founder is not the right person in that position.  That said, you have to do this in a consensus building way, making sure you support any moves with hard numbers that back up your assumptions.  Since the founders will clearly need an education to make a material move from where they may had been heading, with firm and entrenched ideas there.

Equity control is your option, whether you are willing to work with a majority or minority stake in the company.  Your equity stake is typically dictacted by your level of cash investment and importance of your role in the company.  But, if absolute control of the business is important to you, as a new CEO, for example, make sure you invest enough to get you over that 51% threshold.  Or, if economically you cannot get there, put in a mechanic like super-voting shares to make sure no strategic decisions get made without your support.

Same story holds true for board control.  If it is important to you as a new CEO to control more than 51% of the board, make sure at least 51% of the seats around the table are friendly to you and your cause.  And, that most likely means these individuals will not be the founders or their investors to date, which will most likely be loyal to the founders.  So, get good outside board members or new investors that will have your back.  And, worth mentioning, your board voice is typically in line with your equity position.  So, if you want 51% board control, make sure you are prepared to invest enough to own 51% of the equity.

This last piece about corporate governance is the one that people typically forget about, especially in LLCs.  There are scenarios where you may be the strategy leading CEO, with 51% equity ownership and 51% board control, and still not control the key change in control decisions of the company.  The operating agreement of an LLC, or the charter of a corporation, may have special rules in place around changes in control.  For example, it may require the sole approval of a founder for any change in control, who may veto any deal that you are a proponent of.  So, get your lawyers engaged, and read the fine print in the corporate governance, to make sure nothing gets in the way of your long term desires.

I have run both my own startups, and other people's startups, so have learned these valuable lessons first hand.  Good luck!

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