Start Your Startup – Give The Right Shares To The Right Partner

We have talked about good news, bad news, and how entrepreneurial teams both prepare and respond to it.  Entrepreneurial ventures are risky.  Lots of things can and do go right or wrong, and management never has total control.  So how do you deal with uncertainty?  How do you make up your mind when your decision may save your company or wreck it and there’s no way to be sure which it will do?  How do you deal with plain old luck, good and bad?

The best way – and perhaps only rational way –to deal with uncertainty is to form hypotheses and run tests.  Take a simple example.  You are starting a new software venture.  You have lots of experience in the industry and have identified a compelling solution to a big problem.  You are technically trained, but you need to hire a Chief Technology Officer, or CTO, to develop the software and manage a team of engineers.

You find a great candidate, offer her a job, and give her 20% of the company stock, retaining 80% for yourself.  But suppose that in three months you realize you have made a huge mistake and you need to replace your CTO.  That happens more often than you think.

If you did not have your CTO agree to a vesting schedule for her 20% share, that is having the CTO earn the shares over time, you will have put your venture at risk.  Now 20% of your company is owned by someone who isn’t doing anything for you – you’ve fired her – and she’s probably pretty angry.  Not to mention that you have that much less stock to allocate to a new CTO or other new hires.

Similarly, if you have made a bad key hire, you are likely to need more time to test the market.  If you only raised enough money to get to an alpha or beta version of your software, then you are guaranteed to run out of cash when the CTO fails to produce.  Now you would need to raise money after messing up a critical team decision.  That may still be possible if other elements of your venture are compelling enough, but it won’t be fun.

Every time you hire someone, you are running an experiment. You don’t know for certain that the person you hire will work out, but you have a hypothesis that they will and you are running an experiment by hiring them.  You must structure a deal that provides lots of upside for that CTO, but protects you and the company if she doesn’t work out.  Moreover, a person joining your company is also running an experiment to learn more about you and your idea.  They have a hypothesis that your business will work out and that they will be a good fit, but they don’t know that for certain. By agreeing to work for you, they are testing that hypothesis. If they agree to a vesting schedule – say, 20% of the stock vests after six months and the rest over the next 36 months – then they are demonstrating their belief in themselves.

So every decision made in a company must be made anticipating good news – hiring people who can make good news happen – and bad news – creating a cushion to cover mistakes or putting a stock vesting schedule in place.  It’s like a decision to buy fire insurance on your house.  You hope your house doesn’t burn down and you work hard to protect it.  But, if lightning strikes, you’ll have money to rebuild or buy a new house.

There are three simple questions that entrepreneurial managers can use to help anticipate changes and manage those possibilities: 

  • What can go wrong?
  • What can go right?
  • How can I manage the balance between risk and reward?

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Resources of these articles are: Harvard Business School

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