How to ensure your founding team is investable and set up for growth
People make a business successful. This is one thing experienced founder CEOs and investors agree on. Female founders are particularly good at people-related issues, yet, according to Noam Wasserman, author of The Founder’s Dilemmas, 65% of high potential startups fail due to people-related issues - specifically in the founding team.
Investors aren’t looking for the perfect team – they’re looking for an investable team.
Knowing this, investors pay particular attention to the founding team during the due diligence process. But the due diligence process itself is a feature of raising investment that’s often overlooked by founders, putting them at a significant disadvantage.
The people-related decisions founders make early in the life of a business can become significant issues later - in 65% of cases sinking the business. Often, founders are oblivious to this, instead choosing to focus their decisions on validating the product, market, and business model.
Whilst investors are concerned with these three areas during due diligence, they are equally concerned with the team.
When raising pre-seed investment from family, friends, or angel investors, too often the ‘due diligence’ is negligible. This early willingness to invest in the ‘team’ may be based on them being ‘impressive’ or ‘likeable’. They’ve likely had previous successes as entrepreneurs, rockstar careers, or graduated from a prestigious university.
However, the criteria of pre-seed investors are different to venture capital firms. If the founder doesn’t understand what is required at each stage of growth and funding, it can lead to complacency when anticipating team-related issues.
Accomplished venture capital firms will assess the founding and management team with greater rigour than pre-seed investors.
Founder Tip
To be prepared as a founder you need to be aware of four key aspects:
1. The people-related decisions you’ve already made – and how they could influence an investor’s decision
2. The risks posed to founding teams
3. What you can do to anticipate and manage those risks
4. Your role as a founder and CEO in tackling people-related issues
To be prepared as a founder you need to be aware of four key aspects:
1. The people-related decisions you’ve already made – and how they could influence an investor’s decision 2. The risks posed to founding teams 3. What you can do to anticipate and manage those risks 4. Your role as a founder and CEO in tackling people-related issuesThese decisions and risks are what venture capital firms are looking at when examining your founding team and deciding whether to invest. To ensure your team will pass the test you need to be able to provide documented evidence that you have fully considered your team implications. You’ll be asked to share these documents with investors through a ‘data room’ created for due diligence.
You may find you’ve made a few risky decisions here and there. Don’t be disheartened. There are ways to manage any risks they pose.
What I will warn against is trying to keep them quiet. If an investor gets the feeling that ‘something isn’t right’ it’s harder to come back from that place than, to be honest upfront. As a member of the due diligence team, I’ve seen first-hand the impact of non-disclosure.
EXAMPLE
The founder CEO hadn’t disclosed that their father had funded their first business. After wrapping it up, he then gifted the IP to a new startup. He made the founder the CEO and sole shareholder on the CAP table.
This back story wasn’t disclosed upfront. Instead, weeks into the due diligence process when something didn’t add up, it was uncovered. This ended up undermining our confidence in the founding team. The product and market looked viable, but we chose not to invest.
What investors are looking for in team due diligence
When I am speaking to investors about the most common challenges their founders’ encounter, they consistently raise:
Dynamics between co-founders
The right support, including board members and talent.
Unsurprisingly, good investors will be anticipating these issues as well as undertaking standard checks during the due diligence process. The founding team may be required to show evidence of how they plan to mitigate certain risks as a condition of investment.
Savvy investors understand that investment is not a transaction. When they choose to invest, they are also choosing to enter a relationship. One that will endure for as long as the business does, with a founding team who will dictate the success of the business.
Investing in exceptional founding teams
Investors who are committed to backing exceptional founding teams are looking for individuals who complement one another, work well together, and who will make sound decisions for the business. These are all people-related decisions where female founders are particularly skilled.
They want to see that motivations are aligned, and the allocation of roles and rewards are appropriate and reflect the stage the business is in. They also want to see that the team is aware of their own strengths and shortcomings and anticipate how they will need to evolve for the business to reach its full potential.
They will take time to get to know the leaders: to understand their motivations, values, level of self-awareness and appetite for personal growth, risk tolerance, and level of commitment.
They will consider interpersonal team dynamics; relationships between individual team members, how they communicate and their approach to decision-making. As well as considering the level of willingness the team displays to have honest and sometimes difficult conversations in anticipation of potential future issues.
EXAMPLE
I recently completed a team due diligence on a company with three core team members. Two of them were co-owners. The founder and primary shareholder’s focus was on building out a scalable technology solution for which they were seeking investment. The other two team members ran the non-scalable bricks and mortar side of the business that provided a solid revenue and customer base.
Reviewing the team’s psychological tests and personal statements I had initial questions as to whether they’d be suited to and even enjoy the fast pace and pressure of scaling the business.
However, when I interviewed the team and asked how they saw their roles unfolding as the company grew, I was reassured to notice their level of self-awareness. They had thought ahead about their future roles, personal boundaries and when in the business’s growth cycle they would hand over the reins.
Investors accept that the product, business plan, and financial projections they are investing in are based on untested assumptions. There is a mountain of tough decisions ahead for the founding team.
What is most critical is that the founding team has what it takes to continue to navigate this uncharted territory.
The basic checks
There are some basic checks investors will make on the team during the due diligence process such as criminal, fraud, or bankruptcy. They may choose to confirm employment and education records. Or assess reputation risk, speaking with previous business acquaintances to uncover a propensity for questionable moral or ethical judgement.
Getting more into character and capability, they may take references from previous employers or colleagues or ask the team to undertake aptitude or personality tests.
Lastly, they’ll be looking for legally binding contracts between founders and the business that protect the intellectual property of the business, such as document shareholding, salaries, commissions, and bonuses, and protection for the business against common employment issues. These are all documents commonly requested to be submitted to the data room for due diligence.
However, these are hygiene factors when deciding whether to invest. If you want to be in the 35% of companies not to fail for people-related issues, let’s examine some of the risks many founding teams face.
Which team-related risks do you have?
A lack in any one of the areas highlighted below poses a people-related risk to the business. Wise investors will dig deeper than the basic checks to anticipate and prevent the issues they commonly see arise. Wise founder CEOs will assess their founding teams for common risks and mitigate them.
Here are some examples of those risks. Do you recognise any of these scenarios in your team?
Team members
The founding team between them don’t have the technical expertise, experience, or network to get the product or business through the next stage of business growth to secure the necessary revenues or next round of investment.
The founding team are not aligned in their motivations which distracts them from achieving the growth potential for the business. Specifically, motivations around driving and maintaining control of the business versus building wealth. For example, one founder wanting control may obstruct decisions around bringing in investors, establishing a Board, or incentivising and attracting the best possible talent through shareholding.
Founders are family members, in a romantic relationship, or were friends (but never colleagues) before co-founding the business. The values they prioritise in their personal relationship differ from those they prioritise in their business relationship, creating tension in the team. They tend to avoid difficult conversations or confrontations such as addressing underperformance to maintain their personal relationship. If one is forced to leave the business this significantly disrupts the business.
Roles and responsibilities
Founders allocate themselves C-Suite titles from the outset, roles are undefined, operate in isolation, or overlap such as co-CEOs. Individuals in these roles don’t have the skills to effectively execute and lack accountability. Once given, titles are hard to take back as status and power are not so easy to relinquish.
Reward and recognition
Equity was split early and evenly without the use of criteria such as past contributions, opportunity cost, future contributions, or founder motivations [1].
Consideration of the need to relinquish equity to attract talent has also been overlooked. Decisions cause resentment and disengagement amongst the founding team.
[1] Criteria from p150 of The Founder’s Dilemmas, Noam Wasserman
Anticipating future business needs
Founders have not anticipated the need for succession planning and are therefore unprepared, stalling business growth.
They are not aware of their own limitations and those of the team (“epistemic arrogance”) which can lead to blind spots without built-in accountability.
They have not identified the challenges they will have to overcome in their own development to stay ahead of the growth of the company.
Investors who truly invest in the founding team alongside providing financial capital will address these kinds of risks with the founder through the due diligence process. In some circumstances, an investor might require the founders to directly address these risks as a condition of investment.
If you recognise some of these risks are present in your business, there is good news. There are many ways to both mitigate risk and show the evidence for going through this process. Individual risks may not be a deal-breaker but if many risks are evident this could give an investor cause for concern.
Mitigating Risk – Becoming Investor-Ready
To mitigate team-related risks you first need to know yourself. You then need to be aware of the decisions you are making and the unintended consequences they could have on the future of your business. Then you’ll want to pay attention to how you make decisions and be prepared for the consequences.
As experienced founders come to learn, very few of the decisions they make will have clear right or wrong answers. There is always a trade-off and every decision you make sets you on a path.
How you make a decision is as important as making them. Effective decision-making isn’t simply being fast and confident. It is a process of learning to gather information, varying perspectives, identify options, set criteria, and anticipate repercussions.
Many of the founders I work with come to me wanting greater clarity and focus. Robust decision making is at the heart of this.
Know yourself
There are two things you should know about yourself when founding a startup as they will have a significant impact on the trajectory of your business. Not knowing these things, you can find yourself in an uncomfortable position. Ask yourself these two crucial questions:
Q1: Is it more important for you to retain control of your business or to accumulate wealth?
This will inform the options you consider when making decisions.
If you are someone for whom retaining control is critical and you bring in co-founders or investors who are wanting to assert their own influence on the direction of the business, you are likely to end up in conflict.
Q2: Are you someone who is exceptionally confident or optimistic?
This will inform how you make decisions.
If you are exceptionally confident or optimistic in the businesses’ potential you may give away too much to investors and co-founders and upon a smaller exit, find the plate empty once others have taken their slice of the spoils.
Understand your decisions
Each team-related risk identified above was a product of a decision the original founder or founding team made, consciously or otherwise. Often founders aren’t aware of the decisions they are making and choose to make quick decisions and/or avoid a difficult conversation.
Top-level decisions are:
Who to found with
How founding team roles are defined
The split of equity and rewards
When, who, and how to hire
Who to take investment from and when
Founder succession
Anticipating related issues and managing them
There are two parts to anticipating related issues and managing them. First is setting the criteria with which to assess your options and decide which route to take. Second is being aware of the unintended consequences, ‘cons’ or risks associated with that decision and being proactive in mitigating them.
Even if decisions were made long ago - co-founders recruited, roles, and equity split - they should not be seen as ‘done’. You should regularly assess the decisions you make for your business and revisit them when circumstances change or more information comes to light. Scaling businesses change fast, and the right decision six months ago may not be what the business needs today or for the next six months.
If you have gone through an intentional process of assessing your options and identifying the risks associated with the direction you have taken, re-assessing that decision should be simple.
Risk Assessment Exercise: Does your founding team have the technical expertise, experience, and network to get through the next stage of growth?
Example taken from Which team-related risks do you have - above.
Assess your team
Do you have the human, social, and financial capital within your founding team appropriate to take your business through the next stage of growth?
Human capital includes technical knowledge, career experience, and experience of the entrepreneurial journey as well as the ability to think in different ways.
Social capital is your reputation and credibility. The relationships you hold as a founding team as well as connections in your target market, industry contacts and potential customers.
Financial capital is the financial security of your founding team. Can they maintain a roof over their heads and food on the table? This might include savings or sources of revenue such as consulting work.
Other questions relating to who to found with are whether to have co-founders or go solo, and whether to found with friends, family, ex-colleagues or strangers.
Do you have the human, social, and financial capital within your founding team appropriate to take your business through the next stage of growth?
Human capital includes technical knowledge, career experience, and experience of the entrepreneurial journey as well as the ability to think in different ways. Social capital is your reputation and credibility. The relationships you hold as a founding team as well as connections in your target market, industry contacts and potential customers. Financial capital is the financial security of your founding team. Can they maintain a roof over their heads and food on the table? This might include savings or sources of revenue such as consulting work. Other questions relating to who to found with are whether to have co-founders or go solo, and whether to found with friends, family, ex-colleagues or strangers.
Mitigate the risk
Your chosen founding partner(s) may not provide the human, social or financial capital your business needs to get through the next stage of growth. To address this, you might bring on complementary or co-founders or investors to fill the gaps. You might outsource work, find partners, or hire team members. Establishing formal relationships with advisors or board members are also options.
When adding founders, it is important to assess the cost of doing so against the benefit of the human, social or financial capital they bring. If you haven’t directly worked together previously, you would do well to find something to work on together before making a commitment.
Your chosen founding partner(s) may not provide the human, social or financial capital your business needs to get through the next stage of growth. To address this, you might bring on complementary or co-founders or investors to fill the gaps. You might outsource work, find partners, or hire team members. Establishing formal relationships with advisors or board members are also options. When adding founders, it is important to assess the cost of doing so against the benefit of the human, social or financial capital they bring. If you haven’t directly worked together previously, you would do well to find something to work on together before making a commitment.
Become investment ready
Investors are looking for:
1. A skills, capabilities, and experience gap assessment for the business (including diversity).
2. Existing and projected organisational charts.
3. Target advisor or board member profiles, ideally with a wish list of names against each.
Investors are looking for:
1. A skills, capabilities, and experience gap assessment for the business (including diversity). 2. Existing and projected organisational charts. 3. Target advisor or board member profiles, ideally with a wish list of names against each.The key to making good team-related decisions is the data you draw on when making those decisions. For many founders, and some investors, people feel too messy, too unpredictable and so they focus instead on decisions relevant to validating the product, market, and business model.
Taking time to build self-awareness and team awareness and establish communication practices aren’t ‘nice to have’ or ‘fluffy’ but important data-gathering activities that can be approached in a structured way.
It is the role of a Founder CEO to establish practices to build that awareness and lead a robust decision-making process.
Next steps
Founders should equally be conducting due diligence on their investors. Like the team due diligence approach investors go through there are hygiene factors founders should use to shortlist investors they want to work with.
For example, one question to ask a potential investor is “How likely are they to coach the founder-CEO to success when challenges arise versus replacing the founder as CEO?”
We’ve done some of the hard work for you and investigated investors with a difference; those interested in both female founders and investing for impact as well as growth.