Startups and the Incumbent Problem.

Ideally our society organizes itself around the principles of a meritocracy: we award the “winners” in our society, where by “winning” we mean that in the competition of a fair and equal capitalist market, those who are the best and brightest percolate to the top.

Of course this is the ideal. But in such a huge work force, local factors prevent the best and brightest from percolating up, and local factors entrench the less worthy at the higher echelons. For example, think of a boss who has political connections within an organization entrenches himself and promotes the “yes” men while the people who make valuable contributions to the bottom line are pushed out as threats to the corporate power structure. While it is true that in the long run such inefficiencies would lead to the “creative destruction” of that company, as top-heavy structures built around inefficiencies allowed that corporation to be overrun by startups–including those potentially founded by the workers who were pushed out by that corrupt boss, “creative destruction” also has a negative social effect as other workers who did an excellent job lose their positions because of a boss who doesn’t uphold his fiduciary responsibility to the company.

One interesting thing I’m now watching first hand is the incumbent problem at a startup company I’m now working for.

In this slow economic environment we just got our ‘A’ round of financing, so now we’re in a position to start hiring people. And because the economy is very slow I’m seeing a few excellent candidates come through the door–people who, in my opinion, could potentially do a better job than many of the incumbents that already hold a job at our little startup. And here’s the problem: how do you balance the risk taking of less competent incumbents with the needs of the company to hire the best and brightest? After all, the incumbents were the ones who got us to this stage–even though they may not be the best to take us to the next stage.

I used to hear horror stories about Venture Capitalists firing the founders of a company as soon as the company starts taking off, and I used to look at it from the point of view of the founder–someone I could sympathize with. After all, someday I wanted to start a company, and it’d be terrible if I took all that risk, only to have my dreams and ideas taken by someone with a deep checkbook.

But now I’m watching it from the other side–from the side of a Venture Capitalist who is investing a lot of money into a company and who wants to maximize their return. And sadly, it could very well be that the founder who gets tossed off the company he founded may not be the worst thing for a company–since, quite honestly, the primary purpose of a company is not to entrench yourself with your buddies, but to make a profit. And with a VC-funded company, to make enough money to give a decent return on the high risk investment the VC is making.

I sort of get the feeling that’s one of the primary reasons why a startup fails: because the incumbents don’t know how to deal with the company they’re starting, but they won’t step out of the way to allow knowledgeable people step up to the plate.

3 thoughts on “Startups and the Incumbent Problem.

  1. I’m sure that’s a tough balance — in a perfect world, the incumbents, the new great candidates and investors can work together to manage this balance — perhaps the incumbents would agree that the new candidates have a lot to offer, and they can transition to other roles as the startup grows.

    Then again, group dynamics are tough, and there’s probably a point where this kind of thing will lead to conflict and even founder-firing, although hopefully that’s a tactic of last-resort.

    It’s also true that any founder that’s taken Venture has opted to take that risk (although it’s less true that employees of the founders may have had a good say in the matter).

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  2. There is the side issue that the incumbents have taken significant personal financial risk to get their company off the ground–and by being fired or forced aside, the reward for their financial risk is reduced or eliminated. So how do you balance this, unless the incumbents realize their proper role is to be figure heads long enough to collect the payoff when the company is sold or goes public–and the venture capitalists allow effectively a ‘dead weight’ to hang on at the top?

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  3. what should happen is that the early incumbents are given more sizable option grants at very low valuations that vest over time to reflect the risk that they assume, and their contributions to taking the company to where it is. that’s why at google you may see tons of relatively junior people who are far richer than their boss, or their boss’ boss, or vp’s etc. they had the balls to gamble, so they are rewarded richly for the company’s success. so even if, say, an incumbent was forced out two years into it, at least s/he would have two years worth of vested options for work performed that will continue to appreciate assuming all goes well even if s/he’s no longer with the company.

    unfortunately, a lot of times this type of paperwork isn’t done right cause you’re building an actual product instead of screwing around with paperwork. and vesting doesn’t start until paperwork is done instead of counting time already served etc.

    financial stuff aside, it’s always a tough transition period as the company grows, and only the most level headed and mature typically can deal with it. i think for a ceo or manager, it’s important to continue to stress that it’s for the greater good, and as an employee-owner with significant equity stake, it’s also in his best interest to bring on smarter more senior people as that will only help his stake increase in value. but still, at the end of the day, when you’ve always been the man that everyone goes to, and you’ve pulled countless all nighters, it’s hard to see someone else come in and get attention.

    oh, and hi bill!

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