Startup management challenges & transitions

By Bipin Parmar

Bipin Parmar provides some thoughts on defining your company's startup status, and the various roles, challenges and transitions that a founding member of the management team might come across.

The Chilli has previously published definitions of major milestones and objectives that a startup must meet or surpass. As a result, our team has received a huge amount of feedback in the past year. Most confirmed that life is rarely perfect and often tough in the startup ecosystem. Startups, especially at the S1, S2, S3, R1, R2 stages (see The Chilli startup definitions) operate in an environment of uncertainty and chaos - surprises are never in short supply.

It's true that it is not always possible to achieve the stated S1, S2, S3, R1 and R2 milestones in a nice orderly fashion. Chicken and egg and catch-22 situations abound. For example, the product may be ready but there are no customers in the pipeline; or you have secured a firm customer commitment before the product is fully developed. At other times, a patent is prepared for filing, but a decision is made to pull the filing.

Startups are chaotic in nature which is precisely why we issued our definitions to allow companies, investors and advisers to place clear, somewhat definable marker posts in these uncharted lands. Like painting tracks on the ground, they give people some guidance about where to run. Without markers, one it would be difficult to know if one has arrived at the destination.

Imagine you are sailing a stormy sea and you see the S3 marker. You may miss it by a wide mark as you may be some considerable distance from it, but you know you have to pass this marker if you are to reach your destination.

Sometimes, to avoid major hazards you may have to go a few steps back and wait for the conditions to improve before passing the marker. You may decide that with the current resources and conditions, you can reach an S3 marker quicker, and will then later proceed to R1 when time and resources are right. So regard them as your compass. The milestone definitions of S1, S2, S3, R1, R2, R3, USO1, USO2, USO3, USO4 are equally important in setting out the management objectives, challenges and expectations of each new phase.

Management transitions

Most entrepreneurs, founders and managers in a startup company recognise that as the company grows and achieves its major milestones, the management objectives, goals and style have to change to meet the next set of challenges. This is irrespective of whether you're developing a new more stable product, getting some pilot customers, establishing your company in the chosen market place or raising another round of capital.

This is where definitions can be used as a guide for identifying not only the next set of objectives and milestones, but also the requisite management skills for the startup executive team. Each of these major objectives requires a different set of management skills, style and method of delivery. It is very rare for the original founders and management team to have all the necessary skills and experiences to do this effectively and in a time- and cost-efficient manner, while at the same time take care of all the daily operational chaos.

These challenges are not only in the realm of the startup world, but are also present in the larger corporate world. Imagine a career which started off in engineering, later moving to marketing and then to sales, then finance, and later on human resources and general management. Such a cycle of transition can take up to two decades to fully materialise for an individual, a luxury that no startup can afford.

Startups have a fixed amount of limited time (no more than five to seven years) in which to become fully operational, sustainable and profitable. Therefore it is inevitable that a new management team will have to be brought in at each stage of the company's growth. A management team which was born out of engineering may be good at getting the first product out of the door, but will be clueless when attempting to win new customers. Conversely a team that is good at selling may not be sufficiently conversant with the finer operational processes and accountability to deliver steady cash flow and a strong balance sheet.

An executive that has had the luxury of corporate trimmings of business class travel, administrative support and built in infrastructure may find the S3, R1 phases of a startup to be akin to poverty, but could make an excellent manager of an R2, R3 or pre-IPO company. Each phase requires a different hand on the tiller, and very rarely will the captain have sufficient experience to handle more than two or three phases of startup growth.

Planning ahead

Founders and initial management teams have a real bug bear with this, as passing on management control to a new set of managers is wrongly perceived as a demotion, not to mention the loss of control of the decision-making process. But at the same time they recognise that for the company to succeed, a new management team has to be brought in at critical junctures. One way to address this dichotomy is, from the outset, during S1-S3 phase, to make a conscious decision to split the role of the founders into three distinct functions, namely founder shareholder, initial management team and company employee.

As new investors are brought in, especially VCs (see Uncle Thakur - negotiating the term sheet), there will be more people involved in decision-making. Many of us have bought shares in a utility or a public company, but we never have a say in the way those companies are managed - all we can do is attend the annual general meeting and if you are not happy, you just sell the shares.

The situation in a startup is slightly different. Your role as a shareholder - albeit a major shareholder - gives you some influence in how the new management team is chosen, but only on the basis that you will slowly relinquish your second role, namely the initial management team role. Your best strategy is to plan out your third role - as a normal company employee - and if you are smart about it, you can negotiate this role at the beginning, during the term sheet negotiations.

AVOID "It's my way or the highway mentality"

Having said that, care has to be taken that you and your fellow founders do not end up in "childish management mode". Basically, 'It's my way or the highway - if I cannot have the role I want, I will mess everything up, even if this means that I completely de-value my shares in the company and jeopardise its overall future.'

Normal term sheets and service contracts have built-in clauses of good leaver, bad leaver provisions (see UT, negotiating the term sheet, section about warranties and indemnities). External investors will not take this kind of behaviour very lightly and sometimes take very drastic measures, including termination of employment, forcing a relinquishment of shareholding, and a ban on any relation or communication with the company, its employees, customers, investors or partners. Although, these clauses may not be legally enforceable, you wouldn't want to spend your hard earned cash on legal costs.

Carve out a new role from the outset

A lot of founders who have worked on technology/product development (Chilli R1) end up in a CTO or business development role. Some take up the opportunity to try something they would have not contemplated earlier, like the role of mentor for new employees, training, or a non-executive directorship. Sometimes the best move is to negotiate a good leaver package, similar to severance packages, where you are able to maintain your first role, namely as a significant shareholder, but decide to part company and contemplate doing another startup, this time not repeating the mistakes from the past and taking with you some very valuable lessons.

Many entrepreneurs have recognised this dilemma and are in their third or fourth startup, each time maintaining a significant shareholding and building new ventures on goodwill and strong relationships. Some entrepreneurs argue that it is futile to start something, only to see someone else take control of it. That depends on the original objective; was it to build something of value, sell it or keep it? There is always an alternative if you want to remain in total control, and that is to steer your business towards being a lifestyle company (LSC), where you will have to trade-off control against external cash injection. If you can manage your business with normal bank loans and internally generated cash, then you may be able to avoid relinquishing control, but then the value of the business you have created will reflect this.

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© Chilli Publishing Ltd 2004

13JAN2004