I visited with an early stage company recently—or I should say they visited with me—and it had many of the features an early stage VC likes to see in an entrepreneurial team. Vision; energy; a variety of skills; belief; and passion. They had a completed first generation product and had engaged with customers early in the process to gain feedback to adjust the product and business model to solve real problems at a price that made sense. The accelerator that had helped them had served them well.
They were beginning to engage with VCs to explore next-round early stage venture capital financing. They had been coached to approach this correctly—they weren’t meeting with me to raise money, but to establish a relationship that could lead to a future funding decision. Since VCs fund only 1% of what they see, the odds are that a company which pushes a VC to make a funding decision too early will get a “No.” It’s hard to convert a “No” into a “Yes.”
The Company’s seed funding was also structured well. It was in the form of notes that would convert into the Series A venture round on the same terms as the VC investor in that round. I have written about this elsewhere, but seed notes that convert into a discount to the Series A price create undesirable misalignments of interest among investors. Anybody who wants a fuller explanation of this can follow this link:
It was a first meeting and it was a young team with holes in their experience. They had never raised VC before, but had a lot of ideas about what that entailed. They had never scaled a company; living through that process provides experience, at the visceral as well as intellectual level, that can’t be obtained in any other way.
And this is where we ran up against what I consider to be a real problem. There were five team members in the room, none over the age of 30. They had a variety of skills and experience—some more than others—but each had a title with a capital “C” in it. There was the CEO; the COO; the CMO; the CFO; and the CTO. They were the only five employees in the Company—I say employees, but they weren’t being paid much and were really in it for the equity and the experience.
I like to have a conversation early with a founding team, prior to investing, to gauge the self-awareness of each team member on this issue.
Companies go through distinct phases from formation to exit (or demise): start-up; early adoption; growth; maturity. Each phase requires different skills among the executives and managers, and many people in the founding team may not be able to (or want to) make the transition from one phase to another.
For instance, the person who is relentless at opening doors to gain early customers in the start-up phase may not be good at recruiting and managing a sales team in the growth phase. There is nothing wrong in this; it is normal across all functions of a company—sales, customer service, marketing, finance, development—for producers to either develop into managers or to remain producers.
An early executive who can’t make the transition to the next phase may be a valuable employee, but if he or she has a title with a “C” in it the only way the employee can be retained is with a demotion. Entrepreneurs often take their identity from their role in the company and it’s a real blow to their sense of self to take a demotion. It’s challenging to remain a happy, loyal and dedicated employee after a demotion and difficult for other people in the company to know how to maintain or alter relationships with the demoted person. Sometimes a demotion works, but more often it doesn’t.
My solution to this dilemma is easy: don’t hand out too many “C” titles early in a company’s development. This retains an upward pathway for people who perform. People whom the company outgrows but remain valuable individual contributors don’t have to be demoted to be retained. The founding team should be motivated by equity, anyway, not the pomp and perquisites of management.
This particular team hadn’t been well coached on this issue. They seemed offended when I brought it up. I was glad to know this early on, because if this is going to be an issue, it should be surfaced before an investment is made. I told them that getting a VC to invest in a company with five people, all with “C” in their titles, will be an obstacle. I’ll be interested to see if they come back again, and what they have to say about this subject when they do.