In the original “Rich vs. King” post (thanks to everyone who participated in the dialogue there and helped flesh out additional pieces of the puzzle!), I argued that most founders will have to choose between building valuable companies in which they are minor players (being “Rich”) versus being major players in less-valuable companies (being “King”).
As promised, let’s get into some data to examine this “Rich versus King” tradeoff. I’ll present 3 data-graphs, then give my impression of the patterns in each one. Love to get your reactions / rebuttals!
Methodology Note #1: These charts are based on results from several multivariate regression models (using data from 460 private start-ups collected over 3 years) that control for such factors as company maturity, size, revenues, industry segment, and founder backgrounds. The patterns they present are statistically significant (at the p<.05 level or better in the full regression models) even after incorporating the effects of those other factors.
Methodology Note #2: “Company valuation” below refers to the venture’s pre-money valuation. The estimate of the value of the founder’s equity stake is a simple computation of the founder’s equity percentage X the company’s pre-money valuation. Note that these are “paper” valuations, given the illiquid nature of private-company equity, rather than the more realizable valuations possible in liquid public companies.
Graph #1: Value of Founder’s Stake vs. Founder Control
First up is a graph of the value of the founder’s stake (on the vertical axis) versus whether the founder still controls the CEO position and/or board (on the horizontal axis). Because it’s possible that this tradeoff changes as the company ages, I split the sample into a “younger” half (under 40 months old) and an “older” half (40 or more months old).
My impression: Founders trade off financial gains (here, a more valuable stake in the venture) versus control gains (here, keeping control of the CEO position and of the board). They can gain a more valuable stake by being willing to give up control, or they can keep control, not attract the best resources (people, capital) to the venture, and end up with less-valuable stakes. This is true in both older and younger start-ups.
My two cents: Each tradeoff is a valid one, as long as it’s consistent with the founder’s motivations. Founders who value control over equity value should be willing to give up financial gains for the benefits of control (i.e., to remain King). Founders who value equity over control should be willing to make the opposite tradeoff (to become Rich). The tough position is for founders who can’t decide what they want, or are equally motivated by economics and by control; they might tend to make inconsistent choices of co-founders, hires, and investors, and thus risk not achieving either economic or control success.
Graph #2: Company Valuation vs. “Equity Greed”
Next is a graph of company valuation (on the vertical axis) versus the equity percentage still held by the founder (on the horizontal axis). Once again, it is possible that founders only face the valuation-versus-control tradeoff during the earliest stages of company development, when they need to give up the most to attract key resources (people, capital) to their unproven ventures, but that the tradeoff will weaken in more mature ventures. The chart below therefore splits the companies into younger vs. older buckets again.
My impression: Founders who give up more equity to attract excellent co-founders, non-founding hires, investors, etc., are able to build companies that receive higher valuations. This tradeoff still exists (and is, in fact, statistically significant) in older companies, but is slightly less stark than in the youngest ventures.
Graph #3: Company Valuation vs. Founders Remaining
Third, less central to “Rich vs. King” but interesting to me nonetheless, is a graph of company valuation (on the vertical axis) versus the number of founders remaining in the company (on the horizontal axis). This is after controlling in the regression models for the number of original founders.
My impression: Having co-founders can be very good for helping build a valuable company. However, beyond a certain point, having too many chefs in the kitchen can be harmful (for some of the reasons covered here?) and ventures may actually benefit from losing a founder or two.
I see bigger-than-usual causality problems in explaining this factor — did founders stay/leave because the company was/wasn’t doing well, or did the company do better/worse because the founders stayed/left? — but still find the pattern, and the intermediate inflection point, interesting.
Academic aside: In a related finding, a recent working paper by European economists (using a sample of Cologne start-ups) found that, beyond an intermediate inflection point (there, 3 founders), the founding team’s “effort” dropped.
Final Image
The mug below is one of the gifts I got from a section I taught in Spring 2005.
My impression: Now I just need a “No, It’s Good to be Rich” counter-mug to put alongside it, to make my “Rich versus King” shelf complete!
An interesting counterpart to this study is the version need in a non-profit environment (a 501 c 3 charity, which has no owners and exists by the grace of the IRS because it serves the public good).Often a nonprofit hits rocky shoals when it suffers from “founders syndrome”. The founder and visionary who identified the need and summoned the physical and financial resources to meet the need becomes so strongly identified with the mission that the organization begins to implode. There comes a point when the operation of the firm and its continuance draws on different skills than those used to create the firm. If the founder continues to lead the organization regardless of reaching acceptable results, if no voice can be raised in objection or as an alternative to the founder’s vision, then organizational survival becomes questionable.Whether the firm is for- or non-profit, the founder can become a liability over time. RSD
Agreed, RSD. If anything, I think the non-profit sector may provide even clearer examples of many of the patterns discussed here from a for-profit perspective.In a related realm, in the class I teach, the definition of entrepreneurship that we use — Howard Stevenson’s “The pursuit of opportunity without regard to the resources currently controlled” — probably applies even more to the resource-poor non-profit cases we teach than it does to our for-profit cases.Given this, two follow-up questions:1. In studying the private start-ups that I do, there are no publicly-available data sources on founding teams, executive backgrounds, financing histories, board composition, etc. (Thus, I have to collect my data firsthand.) To your knowledge, are there data sources on 501(c)(3) charities, their founders, evolutions, etc.? 2. You highlighted a couple of ways in which the charities often mirror for-profit start-ups. What would be the biggest ways the founder dynamics would <>differ<> in those organizations?
Responses to your answer…1.) It’s relatively easy to do the same research in the nonprofit sector. The IRS form 1023 is the organizing document submitted to the IRS for review and approval. It’s accompanied by the Articles of Incorporation which are filed with, but neither approved nor disapproved by the state. The documents are public documents. If you ask a nonprofit for a copy of said materials the request cannot be refused, though the organization can charge a reasonable fee for photocopies. To the best of my knowledge there is no physical location where the millions of start up applications dating back 80 years or more are filed other than the IRS. The annual financial report, the 990, is also a public document. An organization must provide its most recent 990 upon request (or face fines by the IRS for each day it fails to do so.) Those documents are also available for public view on-line at http://www.guidestar.org which is a researcher’s dream.2.) The biggest differences in the founding of a nonprofit vs a for-profit are essential differences regarding motivation and expectations. The purpose of a for-profit firm is primarily to create a financial return for investors, generally through the fulfilment of a vision identified by the founder. (In this case, vision is a management term, not psychic phenomenon.) The purpose of a nonprofit is to create public benefit. The founder of a for- profit is primarily motivated by a vision of success as measured by wealth, professional accomplishment, industry leadership, scientific breakthrough, or other notable outcomes accompanied by positive cash flow and a return to investors. The founder of a nonprofit is primarily motivated by a compelling mission of community impact. Success is measured by impact, a yardstick that can become very specific. For example, in Detroit the Gleaners Food Bank formerly measured its success by the number of tons of food collected and distributed. This raw measurement places value on the mass and assumes that a mass of solution eradicates the problem, in this case the problem was defined as lack of food. With experience and study the organization’s board of directors re-examined its stated mission. Today, with the encouragement of its funders, the Food Bank measures success by the number of nutritionally-complete meals served. The problem has been redefined from ‘lack of food’ to ‘lack of nutrition’. Big difference!Here’s an example:When Richard and Betty James borrowed $500 to establish the James Spring & Wire Company in 1945 they had two goals. The first was to fulfill the founder’s vision, and the second was to see if there was a market for that vision. Richard James wasn’t motivated by creating happiness for children and adults, but he accomplished that while at the same time selling 300 million Slinky toys. Thanks for asking! R. Sue Dodea, St. Clair Shores, MI
The graph is what I would expect to see. In my opinion, it has less do with choices made by the Founder(s) than it does with the potential of the business and hence, the ability to fund its growth. I think it is very rare for a startup to be in a position to have multiple funding options. For example, how many startups can bootstrap their way to greatness today? Few, I’d say. The risk of being eclipsed by a well-funded fast-follower are just too great. You would also be hard pressed to find any investors willing to hand over millions in financing without asking for some measure of control. So to me, the decision is often less about “Rich Vs King” than it is “Grow Vs Die.” Interestingly, the graph shows the founder is “better off” keeping the CEO slot (the real control) and giving up the Board. That fits with my experience that early round financiers usually ask for Board seats and don’t look to replace the Founder/CEO (unless it is obviously needed). Hence, the valuation jumps with the Founder giving up the Board but remaining CEO. Founders with control of both haven’t likely been able to secure “professional” funding. In my experience the process goes something like this:Early in a Company’s life, or in a “marginal” business, the founder is going to have a lot of control over a business with a small valuation. If the business has limited potential, it could very well remain at this stage forever.If the Company has real potential and is successful in securing funding beyond the seed stage, it’s valuation immediately jumps significantly and the founder(s) give up some control to the Investors. Typically, in the early rounds, Investors want Board seats unless it is obvious to everyone (including the Founders) a CEO is needed.In the middle rounds, the founder-CEO is evaluated and may or may not be replaced as a condition of additional funding. It all depends on how well he/she has performed.As the company grows and matures and “late” rounds of financing are sought, you are typically dealing with larger institutions with less risk tolerance. At that stage bringing in an outside CEO is most seriously considered if for no other reason than to help position the Company for an IPO.
This result is not suprising for the average founder. Giving up ownership means 1) a huge influx of cash and 2) a CEO who specialized in being a CEO.But consider the following two possibilities:1. What if the cash influx is not used efficiently or effectively? This would mean that the company would be valuable in the short to medium-run, but in the long and very long run it would have mediocre valuation.2. What if you, as founder, are a highly effective CEO? Then anyone else you bring in will only do a worse job than you.Thus, the “Rich versus King” phenomenon makes sense, but it may be possible to predict special cases where “Rich versus King” does not hold.
I think this is a very interesting space you are researching and thanks for making your work available. The big takeaway for me, which I think is the right one, is that founders often have to tradeoff between control of the venture and optimal growth/profitability of the venture. I know we are seeing a small snapshot of the work in the numerical analysis, and that you would qualify it in a lecture or a book. That being said, graph1 as it stood alone raised a few issues for me: 1) I don’t see how X is a continuous axis. It seems like it should be a bar graph, not a linearly interpolated line graph. 2) Also in graph 1, I hope people don’t convert this into a decision tree -<> if I want to build a more profitable company, I should give up control of the board…<>3) On a related point, would it make more sense to have the valuation of the company as the X axis, and the 4 states as the Y axis? Then you could represent each $value as a distribution. For example, at 50 million: 80% gave up board and CEO 10% gave up board only7% gave up CEO only3% kept board and CEO. This would reinforce the (I think better) way of looking at it that <> if I’m looking to build a 50 million dollar company through a standard (?) venture model, I know that most founders end up ultimately giving up both CEO and board.<> This is rather than interpreting it as <> if I want to build a 50 million dollar company, I need to give up the board and my CEO role <>. Thanks, Shreyas
Thanks for the input about how to visually present the data, Shreyas. You’re right about the first graph’s containing discrete data points rather than continuous data. I might have been too worried about nuances, but the problem I had with showing it as a bar chart (using pairs of bars, with one representing the value in a younger company and one representing the value in an older company) is that the graph would seem to be making a comparison <>within<> each pair of bars (e.g., the Kept/Kept value of a younger company vs. the Kept/Kept value of an older company) whereas the comparison I wanted is <>across<> the 4 data points within each company type (i.e., for the younger companies, comparing Kept/Kept vs. Kept/Not-kept vs. Not-kept/Kept vs. Not-kept/Not-kept). However, I’m open to any other suggestions about how to display that data.Regarding your “distribution” idea, that would be a different chart from the one I meant there, but I really like the idea on its own. If it doesn’t get too complex, it could be quite informative. Oh, and yes, regarding this being “a small snapshot of the work,” I am currently working on the fuller treatment of the phenomenon and data, in the form of a journal paper I’m writing right now. :->Thanks again for the input!
I wonder how the rich versus king phenomenon plays out over a longer time period and a more dynastic view of kingship.For example, I took a look at the companies on the Dow and noticed that a number of these companies that have been in business for 50-100 years or more had rich and regal founders.Could it be that short-term VC returns are maximized by deposing the king, but to build an enduring company requires something more?
Very interesting and relevant discussion. On the analysis side there is a big problem from my point of view: If you take on equity investors BY DEFINITION a new round of financing occurs. The likelihood that this is a positive round meaning HIGHER FIRM EVALUATION and higher FOUNDER (Prior investor) evaluation very high (I am missing data hear). This means that by definition you see the effects presented in the graphs. You could control for these effects (e.g. at least a dummy for rounds that changed ownership structure vs. ones that had no such effect). I am not to sure though if you have data on the rounds that were proportional increases in equity. I think in this regard the questions raised regarding long term viability are very relevant. Very interesting research overall…
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