Founders’ Biggest Mistakes Are About People

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Entrepreneurs applied for more than 4.5 million new federal tax-identification numbers from January to October 2021, the largest number since 2004.

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About the author: Noam Wasserman is dean of Yeshiva University’s Sy Syms School of Business and former professor of entrepreneurship at Harvard Business School. He is the author of “Life Is a Startup: What Founders Can Teach Us about Making Choices and Managing Change.”

The founders of start-up companies today are doing a lot that’s right. But they’re also doing much that’s wrong, and the consequences of their actions for the global economy in the decades ahead are likely to be considerable.

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Entrepreneurship is booming. Entrepreneurs applied for federal tax-identification numbers to register 4.54 million new businesses from January through October last year, up 56% from the same period of 2019 and the largest number since 2004, according to the US Bureau of Labor Statistics.

On the plus side of the ledger, these entrepreneurs are still taking risks and making tough decisions. They’re still pursuing innovation and seeking solid sources of financing. They still take on the responsibilities of creating products, services and organizations where none existed before.

As a result, founders are performing well when it comes to developing products and securing financing. For example, crowdfunding and special-purpose acquisition companies, or SPACs, have emerged as viable alternatives, giving founders more leverage and flexibility for raising capital.

That said, the most common mistakes in launching a new enterprise have nothing to do with products or financing, but, rather, with the decisions that founders make early on about people. Yes, people. That’s what my research has found. I analyzed data on 10,000 founders for a book published a decade agoThe Founder’s Dilemmas, and have found that these mistakes still persist today. In fact, the biggest reason for the famed high rate of failure in startups is the early decisions about people that go awry.

Indeed, 65% of the failures of high-potential startups are due to “people problems,” including frictions between co-founders or tensions between the founders and other team members, a study by Bill Sahlman of Harvard Business School and Michael Gorman of McKinsey revealed 40 years ago. Almost the same exact result came out in another study 20 years later, this time by Steven Kaplan and Per Stromberg in the Journal of Finance. My own long-time studies of entrepreneurship suggest that such a study conducted now would likely show the same pattern.

Here, then, are the three main mistakes founders keep making about people:

They partner with co-founders like themselves, Sociologists have a word for it: homophily. Humans like to associate with people similar to themselves. Two techies or two business people are far more likely to found a tech startup than a “one and one” team that includes a business person and technologist. But if the partners have the same backgrounds or skills, they seek similar roles. Such overlap can cause tensions, leave unfilled gaps, and weaken the team. Founding teams need different—and complementary—abilities and mindsets in order to overcome the inclination toward homophilly.

If one partner is good at “inside” skills, such as operations and product development, they’re better off if the other is stronger at “outside” skills, such as sales, marketing and business development. Otherwise key functions are neglected. Few founders are talented enough to do everything well. Even those who are and try to do everything themselves will slow down the startup. Finding co-founders who are different from each other is difficult but essential.

They split ownership equally, Founders often split equity equally, even though they often contribute to an enterprise unequally. Such splits are ill-conceived, because they usually mean the founders avoided or delayed tackling, early on, the typically difficult conversation about ownership and contributions. That conversation should delve into the differences in how much value each partner brings to the startup. It’s rarely a 50-50 proposition. One member of the team is invariably doing more than another, but with an equal split, that most central member of the team will be receiving less equity than earned and feeling short-changed. Robin Chase, a co-founder of Zipcar, split equally with her co-founder and came to regret it. When she visited my class to discuss her co-founder dynamics, she talked about her “stupid handshake agreement” that had caused her “years of angst.”

The arrangement that results from this difficult conversation should also take into account how the division of labor between partners could change over time—as it all but inevitably will—and how the equity split should acknowledge the existence of uncertainty and thus include dynamic elements. Facebook is a classic case in point. Mark Zuckerberg negotiated a bad early split with co-founder Eduardo Saverin that resisted a belated fix. When Zuckerberg later sought to reclaim Saverin’s 30% of the business and shrink Saverin’s role, he ran into significant legal problems. Calling this situation, in which Zuckerberg gave up billions of dollars of equity value, a cautionary tale is an understatement of the first order.

They want to be king (or queen) as well as rich. The precedents set by the likes of Steve Jobs and Bill Gates mislead first-time founders into assuming that they, too, can be both king of their company and rich. Not only do the data show that those founders are outliers, but even they failed to be both rich and king in their first startups. For Gates, Microsoft was his third attempt at founding, and Jobs was never “king” or CEO of Apple for its first twenty years.

Even when they are able to remain kings in control of their ventures, founders do not realize what they have to give up as a result. Among the founders of 6,130 startups I studied, the ones who remained as CEO and controlled the board of directors held equity stakes only 52% as valuable—approximately half!—as founders who gave the reins. And they have to beware that a founder-CEO’s success at leading a fast-growing startup can actually accelerate his or her own obsolescence and replacement—the paradox of entrepreneurial success.

Usually the rich-versus-king dilemma rears its head even before the actual founding. Founders should remember that passion and confidence are great early strengths, but can also become great weaknesses. They’re well-advised to weigh the recurring tradeoffs involved in keeping control of a company versus bringing onboard people with the savvy to grow its value: Should they go it alone or find a co-founder who will also want to call the shots? Self-fund a company or accept funding from outside investors who may want to share key decisions?

The people conundrums that founders confronted decades ago still exist today because human nature, with all its attendant biases, has remained largely the same. Counteracting those biases can pay big dividends for founders and for society alike. The smartest founders will understand that business is business, but it’s personal, too.

Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected]

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Credit: www.marketwatch.com /

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