Post Category → Employees

Transparency, Risk, and Failure

TL;DR: In the very uncertain, high risk environment of an early-stage startup, the most successful founders are extremely good at practical risk mitigation. One of the most important forms of risk mitigation is to build a culture of transparency and honesty at all levels of the company; meaning people say what they’re thinking/feeling, and do what they say they’re going to do. No politics. No surprises.

Background Reading:

One of the biggest myths, in my experience, about successful entrepreneurs is that they are generally risk-seeking, risk-loving, uber-optimists who fearlessly run right into unknown unknowns, expecting things to turn out for the best. It’s just false. My word for the person I just described is “idiot.”

Yes, they are optimists, but what they’re often optimistic about is their risk mitigation skills. To an outsider, they may look fearless and indifferent toward risk. But in their mind they’re constantly analyzing risks, including seeing risks that others don’t see (the paranoid survive), and actively taking steps to address them.

In the early days of a company, without a doubt one of the largest sources of risk is, to put it simply, people. Co-founders, employees, consultants, commercial partners, investors, advisors, etc. Before your company has become a fully greased and well-running machine with an established brand, market presence, and gravitational pull, it is, in large part, a highly fragile vision of the future; dependent, to the extreme, on a handful of people and their ability to execute toward a common goal. It takes just one “bad” person, or decision, or accident, in that group to bring it all crashing down. 

Each person carries around risks; either risks that originate from them, or risks they know more about than others. Examples:

Co-founders: Are they truly satisfied with their equity stake/position at the company, and committed to the cause? Do they feel like the CEO is the right person for that position, and making the right decisions, with the right input?

Employees: Are they happy with their compensation/position, given the resources and stage of the company, or are they already planning an exit? Do they feel like the company is moving in the right direction? Are there behaviors/activities going on at the company that the C-suite should know about, but maybe aren’t aware of?

Commercial partners: Are their intentions the ones they’ve actually stated at the negotiation table? If circumstances or incentives change, will they try to preserve the relationship or at least reasonably negotiate a fair break, or will they try to maximize one-sided gains?

Investors: Do they truly believe the current executive team can execute effectively at the current stage of the company, and if not, have they communicated their thoughts to the team? If they are planning for changes, are they letting the team know, so the process can be open and balanced?

By working with people with a heavy bias toward transparency and honesty, you maximize your visibility into risks, which maximizes your ability to proactively address them. Risks that take you by surprise are 100x more deadly than those you can see coming. But what does transparency mean, and how do you find it?

Transparency means:

  • Saying what you’re truly thinking, feeling, and planning to do, instead of what may be optimal for you to convey in a short-term self-interested sense;
  • Even if you’re not the best at verbalizing your thoughts/feelings, conveying them in other non-verbal ways – transparent people tend to show more emotion. The perpetually sterile, calculated, always careful not to speak off-script demeanor that all of us encounter in business is the opposite of what you should look for.

It does not mean blurting out your thoughts at random without proper self-awareness or sense of propriety, or conveying more information than specific people really need to know. The “radical transparency” I’ve read about in some circles – for example, the idea that everyone needs to know everyone’s compensation – in my mind is asking for trouble. There is always information that the CEO has that should be heavily filtered before it gets to employee #200, and visa versa. But a thoughtful, respectful, durable culture of transparency ensures that the right information flows to the right people who truly need it and can benefit from it. 

It also does not mean always being the nicest, most agreeable person in the room.  Sycophants and glad handers may keep the peace, but at a cost of smothering you with so much bullshit that you can’t hear the things you really should be hearing. There is an art to conveying uncomfortable information, and people can be trained/coached for it, but it will always still be somewhat uncomfortable.

I’ve been very happily married for almost 10 years (this December!), but I’ll be damned if I ever tell you that hasn’t come with conflict. If anyone ever tells me that they’re in a serious, complex relationship that is completely conflict free, I hear one word in my mind, and one word only: divorce. Small conflicts prevent massive ones. If there is honesty and transparency, there will be some conflict, and it will make you stronger. 

And of course, if you’ve struggled to find, attract, and retain people who are honest and trustworthy, a very good place to analyze the problem is a mirror. Company culture is very much a reflection of the people who started it. Be the person you expect others to be.  And if you want transparency, don’t penalize people when they act accordingly.

At the end of the day, transparency is the foundation of trust in relationships, and the data is universally clear that virtually nothing helps teams, businesses, and broader networks thrive (and minimize serious conflict) better than trust. In the world of startups, there are hundreds of sources of potential failure that you are constantly battling against, and that you can’t do a lot about. Very very few risk mitigation tools are in as much of the founders’ control as the culture they implement in their team from Day 1.

Do the intentional, hard work up-front to recruit/engage people who say what they’re thinking, and do what they say they’re going to do, and you’ll maximize your chances of survival. You’ll also keep your legal fees way lower in the process.

Vesting Schedules – Beyond the Standard

TL;DR: The standard 4-year with a 1-year cliff vesting schedule is not the only option. Companies can use a number of alternatives to better align incentives, and even select for employees/founders with more loyalty and interest in long-term commitment.

This is not a post explaining what vesting schedules are – I make it a point to (try to) not duplicate content that others have already written about 10x on the web. See this post for a quick run-down.

Most people know that the “market standard” vesting schedule is 4-years with a 1-year cliff. That’s standard for employees, but also quite common for founders. I occasionally hear founders say that a founder team shouldn’t subject each other to a cliff, but generally I think that’s a bad idea. Some kind of cliff is a great way of ensuring that anyone there on Day 1 intends to be there for some meaningful amount of time. If they balk at a cliff, it says something; not entirely clear what it says, but it certainly says something of significance.

Advisors tend to have shorter schedules, like 1-2 years, because their grants are smaller and tenure tends to also be shorter. At least a 3-month cliff is always a good idea for advisors, in my opinion. If they balk, it, again, says something.  Making small, reasonable requests in any kind of relationship, and observing the response carefully, can be a great way to gauge a person’s personality, motivations, and perspective; even if you consider the request itself immaterial and easy to drop. 

However, for companies that feel like the standard approach doesn’t fit their context, or align incentives properly, there are a lot of smart alternatives that we’ve seen our client base adopt. Here are a few:

Milestone Vesting

Instead of vesting based on time, you set it to occur upon certain milestones. These can be any number of things: achieving a certain financing, a certain revenue level, hitting a sales quota, etc. Whenever we see milestone vesting, the milestones tend to be contextualized for the individual. And certainly it only makes sense to have milestones that the individual recipient of the stock actually plays a lead role in achieving.

The benefit of milestone vesting is it can, when it works, better align “earning” equity with actually delivering results, as opposed to simple tenure based on time. However, the challenges that arise are (i) in the drafting – getting people to agree on reasonable milestones, (ii) in deciding when they’ve been achieved – who ultimately decides? the Board? the CEO?, and (iii) when circumstances change and ambiguity arises as to whether the milestone has been met. And of course, it is just more of a hassle to have to track milestones for vesting purposes as opposed to just letting the clock tick.

My strong suggestion to clients whenever they go with milestone vesting is to stick to milestones with objective, unambiguous metrics. Stay away from anything that depends on someone’s opinion – like “doing X to the satisfaction of Y person.” You’re just asking for trouble if you go there. Something like “achieving $X in cumulative customer revenue” will result in far far fewer disputes. And remember to use milestones that the stock recipient plays a significant role in helping the Company achieve. That too will prevent arguments over unfairness or bad faith as to person Y being responsible for why person X didn’t get their vested equity.

Longer Schedules (5-6 years)

There is a lot of value in attracting employees who intend to be with your company for the long-haul, as opposed to those who hop between employers. The sense of long-term thinking and loyalty that a long-term employee can bring to key projects can be hugely important strategically. I’ve always found the “perk wars” of certain tech ecosystems to be somewhat counter-productive, as they tend (in my mind) to select for employees with more mercenary personalities, as opposed to people who want to be there for much more important reasons.

I’ve certainly applied that thinking to how I recruit for MEMN.  Honestly, if whether or not we offer free lunch or doggy sitting will influence your decision to work for us, I’d prefer you not.

Companies that deeply value long-term commitment will often consider having longer-than-standard vesting schedules; maybe 5 or 6 years. Of course, for this to work you generally need to provide an appropriately larger equity stake.  Someone might ask why not, instead of one grant with a longer schedule, simply committing to do another grant after the standard 4-years?

It’s true that you can do that, and the standard approach is to provide ‘fresh’ grants to employees, for retention purposes, once their original vesting schedules run their course. However, (i) a grant made years later will have a higher exercise/purchase price (for tax purposes), so it’s actually tax favorable to do an earlier grant with a larger schedule, and (ii) there’s something about a longer schedule that just signals a person’s long-term commitment better, particularly if coupled with back-weighted vesting (see below).

Back-Weighted Schedules

If you’re looking to use vesting schedules as a way to gauge long-term commitment, back-weighted vesting is definitely an option worth considering. The concept is quite simple. Instead of vesting in equal installments over a schedule, the back-end of the schedule provides more vesting than the front-end. So instead of 25% vesting per year, Year 1 may be only 10%, but Year 4 may be 40%. There is definitely some logic to this idea, because the value someone delivers to their employer tends to go up over time, as they’ve become integrated into the culture, moved up in rank, taken on more responsibility, etc.

A longer-than-standard schedule with back-weighted vesting is one of the strongest messages you can send as to how much significance the Company places on loyalty and long-term employment. And as I mentioned before, if someone really balks at the idea, pay attention to what that tells you, because it definitely tells you something.

For key hires, the standard doesn’t always fit. 

I hear it all the time: “just go with what’s standard.” I understand that approach, and it’s sometimes driven by an attitude that all of this legal mumbo jumbo doesn’t matter. Except for when it does.

For strategic hires, particularly in the very early days of a Company when your core team will totally make or break you, non-standard vesting schedules can be a valuable tool to align incentives, and “filter” for people who may not be as committed to the cause as you think they are. Remember: when someone says “no” to something you think is reasonable, it may not be fully clear why, but it tells you something. And that something can be very important. 

Fatal Errors in Early Startup Hiring

I don’t pretend to be an expert in HR or tech recruiting, at all. However, being a VC lawyer gives you a deep inside view into a lot of what goes right and what goes wrong in early-stage hiring for startups; particularly what goes wrong, because that’s usually when lawyers get called in. Lots of data points to notice patterns. While there are a whole lot more issues that I’m not covering, below are a few key recruiting errors (tactical, not legal) that I’ve regularly seen Founder CEOs make as they start trying to expand their roster.

Hiring Sociopaths

Well that escalated quickly, didn’t it. Very very very^2 few people are so talented that they can make up for having a toxic personality. What is toxic? Someone who either (i) can’t control their own emotions, or (ii) seems to somehow regularly trigger other peoples’ emotions, in a bad way.

The early days of a startup are chaotic. You need personalities that will absorb some of that chaos, and make it easier to manage, not harder. Character and values are at least as important as the person’s skillset. When I hire lawyers, I pay at least as much attention to subtle cues in a person’s behavior as I do to their analytical skills; their facial expressions, manner of speaking, how they react to others, how they describe other people and themselves. I’ve seen what it’s like to work in places where there is even just 1 super toxic personality. It ruins everything, and can sink a company.

That doesn’t mean emotions in general are bad. Emotion often means you care about something. It’s OK for people to get emotional about stuff; better than people who are disengaged and stoic all the time. But there’s a world of difference between getting emotional because you care about something v. just because you can’t control yourself, or don’t want to. Blind reference checks help a lot.

Hiring “Big Company” People

Jeff Bussgang’s “jungle, then dirt road, then highway” metaphor is valuable for understanding how you can go wrong in hiring people who aren’t the right fit for a startup environment. A Series C or later company operates extremely differently from how a seed or Series A company does. Later-stage companies have higher salaries, more narrowly defined roles, more predictability, more formality, more perks. Earlier stage means lower salaries (but more equity), more flexible and broad roles designed to ‘just get it done’ (whatever ‘it’ happens to be that day), more unpredictability, and closer-knit/more casual culture. “Highway” people usually can’t handle the jungle, or even the dirt road.

Problems arise when a company has raised a seed or Series A and suddenly wants to present themselves as one of the big dogs by hiring someone with a very impressive resume and title. That person will very often want a compensation package that strains the company’s budget, and a level of resources and order that simply isn’t appropriate for early stage. Talent can come in the form of a lot of different cultures and personalities. Make sure you’re hiring talent with realistic expectations for your company’s stage. Salary v. equity expectations are often a valuable signal here, and can select for the right or wrong people.

And a big thing to watch out for: I’ve known of VCs who subtly push founder CEOs to hire “big company” people sooner than they are really needed, to create a greater sense of urgency in needing to raise a new round, that they lead. If an investor has put some seed or Series A money in your company and wants to lead your Series A or B, they have an incentive to shrink your runway by filling your payroll with high-salary people earlier than is appropriate.  More payroll means you’re forced to close your Series A (or Series B) sooner, and at a lower valuation, than you otherwise would’ve wanted; increasing their ownership. Be mindful of this dynamic, and ensure you have a total grasp of what your talent needs are and aren’t. 

Hiring Too Fast

You see far more companies that die because they hired too fast, and eventually couldn’t keep up with payroll, than the converse. Successful entrepreneurs know how to be scrappy and resourceful; seemingly magically figuring out a way to achieve results with far fewer resources than other people could. That should apply to hiring as well, and it’s often achieved by ensuring that you aren’t hiring “big company” people (see above) with (i) unrealistic salary expectations, and (ii) such specialized skillsets that they leave needs unfilled that require hiring more people.

Hiring extremely talented, flexible generalists appropriately suited (and compensated) for early-stage is often how resourceful CEOs keep their early-stage company “default alive” instead of “default dead,” to use Paul Graham’s language.  As a general matter, at early stage someone who is really good at X, Y, and Z is more valuable, and a much safer hire, than someone who is world class at just X.

Hiring Friends or Family

If you build anything that starts getting traction, there will come a time when people start suggesting their friends and family to fill job positions. In some sense, this is not a bad thing. Recruiting from your existing roster’s network is actually a very smart and common way to find quality candidates without needing to pay recruiters. The danger, of course, lies in the psychological tendency for immature founders to hire people simply because they like them, rather than because those people actually have the talent and skills the company needs. 

Only go down this path if you are 100% comfortable saying ‘no’ over and over again, because you’ll need to. Frankly, if you’re CEO and don’t know how to say “no” when you need to (often), you’re going to face much bigger problems than hiring. 

Friends and family are easy to hire, but they’re much harder to fire because of the emotional and political dynamics surrounding the personal relationship. And hiring people because of existing relationships, instead of because of merit, is also a fast way to create an insular, mediocre mono-culture of people who are all buddies with each other, as opposed to a performance driven one. As a resource-strapped early-stage company trying to navigate chaos, you can’t afford to have a low performance culture. Hire for merit from Day 1.

As I said, there are dozens of big mistakes companies make in hiring, and I’m sure there are fantastic blog posts out there from experts on the subject. The above is just a few really core tactical blunders VC lawyers see founder teams make, because we’re usually called in to help the team clean up the mess from a legal perspective.

In the early days, hire extremely talented, flexible and mature team-players with realistic expectations about startup life, not too early, and not just because you like them or they are someone’s friend. It’ll save you an enormous amount of headaches… and legal fees.