Post Category → Hiring

It’s Not Introvert v. Extrovert. It’s Whether You Can Sell.

TL;DR: People from various intellectual/technical backgrounds tend to over-value IQ and undervalue EQ; meaning that they neglect just how crucial communication/sales skills are for executives/founders, especially a CEO.

I spend a good amount of my time training lawyers not only on how to use technology effectively (because lawyers are second only to doctors in sucking at tech adoption), but on the key ‘soft’ skills that underly client satisfaction. As a profession, lawyers dramatically over-value their credentials and under-value basic human skills like the ability to charismatically start, lead, and end a serious conversation. But when you step back and analyze how lawyers perform throughout their careers, it becomes extremely clear that far less ‘intelligent’ lawyers are the employers of lawyers with significantly better credentials.

Why would that be? Because for lawyers, legal skills get you a job, but communication skills get you clients. And without clients, no one has jobs. Any lawyer who wants to move from being a “worker bee” to leading client relationships needs to self-critically assess and devote serious attention to her/his communication skills: reading people for their pain points/values and adjusting your message, building rapport with diverse people, speaking crisply and confidently, etc. And the exact same can be said about a founder who wants to be and stay CEO.

Everything is Selling

When investors want to discuss investment, when employees want to discuss employment, or when key early customers want to discuss the product/business, whom do they ask for? The company’s technological savant? No. They want to talk to the CEO. The 3 core jobs of a founder CEO are to find customers, recruit employees, and close on investment. All three of those require strong sales and communication skills, because 90% of the work is deep, serious conversation. As the company scales, those tasks become more segmented, but at early-stage the CEO, and only the CEO, can get them done effectively.

All the time I see founder teams full of MIT, Stanford, etc. technical degrees, and a CEO who went to an unremarkable school. But 5 minutes into a conversation with them you know exactly why he/she is CEO. They can sell. And I’ll see VCs who are fine keeping X founder as CEO, but insist that Y step aside for an outside CEO. Why? Because Y can’t sell. Sure, I may be over-simplifying a bit, but not by much. Assuming you aren’t dealing with a VC who always replaces founders purely for control purposes, whether or not a VC trusts you in the CEO seat often boils down to whether you can look them straight in the eye and convince them, through well-articulated conversation, that you are ‘CEO material.’

Sales Skills ≠ Extrovert. Find a Coach.

Like any other skill, sales skills can be learned, practiced, and taught, but it takes honest self-criticism and time. And they do not even remotely boil down to whether or not you are an extrovert. Shyness/social anxiety/bad communication are dysfunctions. Introversion is not a dysfunction; it’s just a personality orientation. Sales/communication skills tend to come more naturally to extroverts, but there are extroverts who are terrible at sales (often because they are glad-hander loudmouths), and there are introverts who are fantastic at it. Apart from self-practice, there are excellent executive coaches who can be engaged to help founders improve their ‘presence’ in conversation.

By no means should the above be interpreted by smart, technical founders as that they absolutely need to go out and find a schmoozer MBA to put on their team. The best lawyers (and executives) are extremely technically smart and know how to communicate. It should, however, be read to mean that you should rid yourself of the delusion that your technical skills/intelligence alone will ensure your position on your company’s executive team. ‘Soft skills’ are at least as important as ‘hard’ ones, and the faster you improve yours, the greater chances you’ll have of getting customers, employees, and investors to not only ‘buy’ your product and company, but ‘buy’ you as an executive as well.

Rich v. King: The (Core) Founder’s Dilemma

TL;DR Nutshell: Much of the tension between founders and outside investors lies with one question, highlighted (years ago) by Noam Wasserman (HBS) as the core “founder dilemma”: do you want to be rich, or do you want to be king? When both founders and investors are honest with each other (and themselves) about their feelings about, and approach to, this dilemma, their relationship ends up running far more smoothly.

Background Reading:

Rich or King

In the majority of circumstances (statistically) the wealth accrued by entrepreneurs is inversely correlated with their percentage ownership stake in companies. In other words, founders who give away more equity and control in their companies (to other employees, investors, etc.) end up, on average, building larger, more valuable companies, and therefore become much richer than founders unwilling to give up control. That inverse relationship is the foundation of what Noam Wasserman, a professor at Harvard Business School, calls the “Founder’s Dilemma.”

Obviously, when any particular company (in isolation) is extremely successful, founders are able to maintain more control and ownership relative to companies that are less successful. We all know stories about the (rare) Facebooks of the world in which founders have maintained significant control through many rounds of funding and even IPO.  But overall the types (categories) of businesses in which entrepreneurs give up control in order to attract capital, talent, and other resources will grow much much larger (and enrich the founders) relative to the types of companies in which entrepreneurs maintain a tighter grip.

This is why Mr. Wasserman says that if founders want to avoid significant headache and heartache in the course of building their business, one of the first questions they need to ask themselves, and be honest about, is: do you want to be rich, or do you want to be king? Because very very very rarely can you be both.

Some founders legitimately care less about money than about ensuring that their business stays in alignment with their long-term vision/mission. They certainly want to be successful, but a removal from the leadership position in their company would, in their mind, mean personal failure, no matter how much gold they can expect to line their pockets with.

Other founders want to retain control/influence in their company as long as they feel that doing so will increase their chances of becoming financially successful, but the true, primary end-goal is financial success, and they will willingly step down if they feel someone else can scale the company better and faster.

Kings and VCs Don’t Mix

If you are very heavily a “King” founder, you need to think very very carefully about whether you should take institutional venture capital at all. VCs fall along a spectrum in terms of how much deference/respect they give to founder CEOs. Some (the good ones) will assume a coaching perspective, respecting a founder CEO as the head of the company and pushing her/him to learn and become a great leader. Others (the bad ones) will move as fast as they can to undermine founders and fill management with their handpicked roster of outsiders. The best way to find out who the Coaches and Underminers are is to ask people (privately and off-the-record) who’ve worked with them, particularly other founder CEOs.

However, while the best VCs give founders real opportunities to learn and excel, every-single-one will replace a founder if/when it becomes clear that doing so is required to continue scaling the business. Why? Because VCs are profit-obsessed vultures? No, because they have bosses who hired them to make them money, by achieving big exits. It’s their job.  So even if you have the best, most respectful set of VCs on the planet, the clock is ticking once that money hits the bank. If you can’t handle the thought of not being CEO of your company, no matter how large it gets, don’t take VC money. Ever.

The Jungle, The Dirt Road, and The Highway

What many first-time founders don’t realize, though, is that as many startups scale and become large enterprises, there often comes a time when a founder CEO wants to be replaced. Jeff Bussgang’s three stages of companies: the jungle (earliest stages), the dirt road (early scaling), and the highway (mature company/late-stage growth) help explain why.

To be a successful founder, you usually need a personality that thrives in, or at least is highly capable of handling, chaos (the jungle). Meetings, committees, structure, process, reporting obligations, policies, policies on meetings, meetings on policies, etc. are often the exact kinds of things that founders are avoiding by starting up their own companies instead of taking jobs at BigCo. They thrive in following their intuition/judgments, tackling tough problems, and being on the ground strategizing about product and selling the Company’s vision.

But as companies become full-scale enterprises with hundreds of employees, all of that “structure” becomes necessary. You simply cannot run a 500 employee multi-national company like a Series A startup. Great founders often succeed in the jungle, and thrive on the dirt road (when the company is a startup), but start feeling suffocated, uninspired, and disengaged on the highway. And of course, professional CEOs are the reverse: they are trained to keep the rocketship steady and fueled once its cleared the roughest atmosphere, but their skillset breaks down if required to operate in the iterative, intuitive, grassroots environment of early-stage companies.

“Rich” founders who understand their strengths, and when those strengths are no longer optimal for the stage of their company, are able to actively participate in the executive succession planning of their companies, rather than putting up a fight with their Board.  Some decide to completely step away from the company they’ve built in order to go build something new. Others will take a role in their company that leverages their strengths – removed from the day-to-day processes and bureaucracy of the enterprise, and focused exclusively (as an example) on higher-level product and strategy.  Some founders will (happily) make the transition between jungle, dirt road, and highway without giving up the CEO title, but those are few and far between.

The important thing in all circumstances is that founders not fight the reality of what it means to take on institutional capital and build a large, scaled company. Work within that reality to achieve financial and personal success. Know yourself. 

Start Off With Transparency of Values and Vision

Control-freak founders are not alone to blame for the ‘founder’s dilemma’ dysfunctions of the VC-founder relationship. Certain VCs fail to be upfront with founders about their expectations and style of corporate governance. In order to “get the deal,” they’ll talk up how supportive and founder friendly they are, and once the cash is deposited immediately start running through the playbook described in How Founders Lose Control of Their Companies.  A founder who wants to be King and a VC who pretends (temporarily) to be OK with that is a perfect recipe for dysfunction at the Board level, which usually ends up destroying value.

As trite as it sounds, honesty and transparency go a very long way here. Founders should be open about their vision for the Company, their expectations for how they’ll interact with their Board, and their attitude towards when and how to recruit outside management.  VCs shouldn’t beat around the bush about what the job of a venture capitalist is, and their approach to Board governance and executive recruitment.

The narrative of the founder CEO pushed out by VCs he now hates isn’t the only narrative out there. There are plenty of success stories of founders who built strong, trusting relationships with investors who still did their jobs as VCs and ensured professional management (that the founders can trust) was brought in at the right time. It just depends on the people.  Building and maintaining trust is hard. But so is building and scaling a company. Cut the BS, communicate like adults, and then focus on building something awesome and getting rich, together. 

When LLCs Make Sense for Startups

TL;DR Nutshell: In the vast majority of instances, tech startups are best served by starting out as Corporations (C or S-corps, but usually C-Corps) on Day 1, and lawyers suggesting otherwise are usually generalists who lack tech/vc-specific domain expertise to understand why. However, there is a narrow set of circumstances in which LLCs make sense for a startup.

Background Reading:

This post is about the “almost” part of that tweet. But to get there, it’s important to address the “simpler” and “tax efficient” aspects, because those are the two core reasons that I often hear pushed onto founders for why they should be LLCs.

LLCs may be simpler generally, but Tech Startup LLCs with investor capital and equity compensation never are.

Here’s a hypothetical: Imagine you’re an athlete who’s signed up for a football camp held in Boston in the middle of February. Your general knowledge of Boston weather tells you that it is going to be a** cold. You ask a few other people with knowledge of Boston, including me (I went to law school there), and receive confirmation that Boston is a** cold in February. So you show up to the camp with only your winter gear… but it turns out the camp is entirely indoors in a heated facility. Whoops. Should’ve asked someone with true domain-specific knowledge of that camp, not just people with general knowledge. 

That, in a nutshell, is what happens when lawyers and other business people tell tech founders to use LLCs. LLCs are extremely common in the general legal world. For simple operations with one or a small number of owners, they are by far the dominant legal structure, because they usually are simpler. However, for tech startups, who very often (i) use equity as a significant part of their compensation for employees/service providers, and (ii) often raise capital with multiple equity classes, complex preferences/rights, etc., things get extremely complex under an LLC structure, much more so than with corporations. The amount of tax and legal analysis that has to be done to issue equity compensation and/or raise capital in an LLC is (without exaggerating) 10x that of a corporation.

So, if your plan is to raise capital and use equity as a form of compensation for employees and contractors (which is usually a hallmark of a tech startup), do not delude yourself for a second that an LLC will be simpler than a corporation. 

The “Double Tax” issue usually only matters if your startup is a “cash cow.”

Yes, in a general sense LLCs have one layer of tax and C-corps have two. That is another reason why (as stated above), LLCs have become a very dominant legal structure, not just for simple companies but also for many large businesses as well. Again, though, context is key. The “additional layer” of tax that corporations face is on net profits; after accounting for expenses, including salaries. No net profits, no corporate tax. So if a startup is going to be generating substantial profits (taxed once) with the end-goal of distributing those profits to shareholders (taxed again at individual level) as a dividend, the two layers are a problem.

But how many high-growth tech startups do you know that, instead of reinvesting profits for growth, pay profits out as dividends? Not many; certainly not in the first 5-10 years of the company’s life. Most high-growth tech startups deliberately operate at a net loss for a very long period of time, and therefore (i) aren’t worrying about taxes on net profits, and also (ii) are taking advantage of those losses at the corporate level in a way that may not be even use-able on the individual level. This, btw, is also why S-corps are usually not very helpful for tech startups either.

And to add an additional wrinkle: in an acquisition, corporations often have the ability to do tax-deferred stock swaps, whereas LLCs don’t. So, in short, the “LLCs save a lot of taxes” perspective, while generally correct, is usually misapplied to tech startups by people who simply don’t do enough startup/vc work to give sound advice. Yes, VCs often push companies to be C-Corps (read the background articles), but VCs are hardly the only reason why the C-Corp structure is used in tech. 

LLCs therefore make sense for tech startups that:
(i) expect substantial net profits very early on;
(ii) aren’t planning on raising institutional venture capital, and/or
(iii) aren’t planning on using equity to compensate a lot of people.

Lots of net profits early on (rare)? The single layer of tax may be worth it, and even institutional VCs sometimes are willing to accept the complexity of an LLC to take advantage of the tax savings.  Not planning on raising VC money any time soon? Other types of non-tech investors are usually more comfortable with LLCs than VCs are. Not planning on paying your employees with equity? Then you’ll avoid the tax nightmare of issuing LLC equity to dozens/hundreds of people.

Few tech startups fit the above scenario, and that’s why few are LLCs. The classic tech startups that operate (rationally) as LLCs are bootstrapped/self-funded software and app companies with no plans to scale very quickly with outside capital, and large “marketplace” startups for which the actual investment in the technology is minimal relative to the large amount of revenue/profit pushed through the marketplace. For almost everyone else, C-corps are king, and for good reason.

p.s. I am not your tax lawyer, and am not pretending to know the right answer for your specific company. The above is just general knowledge; not legal advice. If you rely exclusively on a blog post to determine your legal structure, without talking to a professional to understand your context, you’ve taken on the risk of screwing it up.

Early Hires: Options or Stock?

Nutshell:  While the conventional equity path of a startup is to issue (i) common stock to founders and (ii) options to employees, early hires concerned about taxes will often insist on receiving stock as well. Voting power, along with other political factors, present a few tradeoffs for founders to consider in that scenario.

Vocabulary:

  • “Option Pool” – a portion of the company’s capitalization set aside (after founder stock is issued) for equity issuances to employees, consultants, advisors, etc., and subject to a special “plan” designed to comply with complex tax rules.  Even though it’s referred to as an “option” pool, properly designed equity plans will allow for direct stock issuances under the pool as well; not just options.
  • “ISO“ – Incentive Stock Option – a tax-favored type of option issuable only to employees, if certain requirements are met. The main benefit is that upon exercise, the difference between the exercise price and the fair market value on the stock at the time of exercise is not taxed as ordinary income. However, it is subject to the Alternative Minimum Tax (AMT), which can hit certain people depending on their tax situation.
  • “Restricted Stock” – For purposes of a private startup, just another way of saying Common Stock. The same security that founders get, except for non-founder employees it’s usually issued from the “pool” (under the Plan) using different form documents.
  • “Early Exercise Options” – Conventional options issued to employees are not exercisable until they vest; meaning until the recipient has worked long enough to “earn” the right to exercise them.  Early exercise options have modified vesting/exercise provisions so that they can be exercised from Day 1 – with the underlying shares becoming subject to the vesting schedule.  From the Company’s perspective, early exercise options are very similar to restricted stock issuances. The only real difference is that the recipient has the option to exercise and receive the Stock on Day 1, or sit on it and exercise later.

Convention.

The conventional path of a Company’s equity issuances goes something like this:

  • Founders receive direct issuances of Common Stock (not options)
  • Non-Founder employees receive ISOs (options)
  • Consultants, advisors, etc. receive NSOs (options)
  • Investors receive Preferred Stock, or SAFEs/Convertible Notes that convert into Preferred Stock

Backround:  

  •  The value of restricted stock is taxable as ordinary income on the date of issuance, unless its fair market value (FMV) is paid in cash.
  • Options, both ISOs and NSOs, however, are generally not taxable on the date of grant, as long as their exercise price is equal to the FMV.
  • So, you would normally expect employees to prefer receiving options over stock. No tax > Tax. And this is the case when the stock’s FMV is relatively high. That’s why later hires (usually after a Series A) almost always receive options, without question.
  • Stock gets to vote on stockholder approvals. Options do not (until they’re exercised for stock).

The Issues: Early employees want to minimize tax. Companies want to avoid giving away voting rights/complicating stockholder votes too early.

  • However, in the very early days of a startup’s life, avoiding tax on restricted stock is easy because of how low the FMV of the stock is (fractions of a penny): write a check for a few dollars (the full FMV), or just pay the tax on the few dollars of ordinary income.  You therefore get the “no tax on grant” benefit of options, without worrying about paying tax later on an exercise date.  Receiving stock also gets the clock running on long-term capital gains treatment.
  • Therefore, very early hires, when they do their homework, tend to insist on receiving restricted stock (or early exercise options) over conventional options. Better to deal with tax when the stock is worth (at least to the IRS) virtually nothing, instead of years later upon exercising the option when the tax bill could be much greater (ordinary income for NSOs, or AMT (for some people) for ISOs).
    • Sidenote: Conventional equity plans also have a 90-day post-termination exercise period, meaning, when an employees leaves a company (voluntarily or involuntarily) they have to exercise their options within 90 days, or they then get terminated – even if vested. Paying the exercise price isn’t an issue for an early hire in that scenario, because it’s very low (the fractions of a penny FMV), but if the AMT comes into play it can hit them with a tax bill.  This doesn’t come up in a Restricted Stock scenario.
  • The tradeoff from the Company’s perspective is that, just like founders, those hires that receive restricted stock will have full voting rights (including seeing whatever is submitted for stockholder votes) for all of their stock on Day 1, before they’ve vested in anything.  When only one or two people are in question, this may not be a big deal. It can be a way of making early employees feel like a part of the core team, because their equity is being treated just like founders.  When there are more than a handful of hires, however, it can get unwieldy fast. The number of people to consult for stockholder votes can go from 2-3 to 10, 15, 20. If there are consultants and advisors in the picture, they may start to ask why they aren’t getting the same tax benefits as early hires. And then at some point you have to draw a line and start granting options. Is the first optionee not as special as the restricted stock people? Politics. 

Generally speaking, the decision to give restricted stock v. options to very early hires is a practical/political one.  While the tax-favored nature of ISOs means that most early employees won’t see much of a tax difference between receiving ISOs v. restricted stock, the prospect of an AMT hit in the ISO scenario does make restricted stock, on net, better for recipients.  That needs to be balanced, on the company’s side, against the early voting power/information rights given away when an employee receives stock instead of options, and how it will play out with all of the company’s other hires.  

My general advice to founders is to be aware of the tradeoffs, and to consciously treat the early voting power and tax benefits associated with restricted stock as currency not to be wasted.  If there’s a very early superstar that you deliberately want to single out as a key player, use the currency.  If not, then make the decision based on all the other factors. Company culture will likely factor greatly into the calculus.  Many, many founders prefer to avoid the politics/complications and simply draw a line at the founder (stock)/non-founder (option) division.  Others are more selective. There’s no magic formula.

A few separate issues worth addressing:

  • The 90-day post-termination exercise period (after which unexercised options, vested or not, are terminated) often gets criticized as being unfair to employees, and there’s some justification for that criticism. The view is that the employee shouldn’t be forced to “use it or lose it” if they did their time (their option vested) and are now moving on to a new company.
    • The actual 90-day number comes from tax rules requiring that ISOs be exercisable only within 90 days of termination.  If an option is exercisable after that, it automatically becomes an NSO for tax purposes. But there’s nothing in the tax rules requiring that the option be terminated at 90 days. That’s largely meant (i) as a deterrent (frankly) to people quitting, and (ii) a way to clean up the cap table for people who didn’t want to pay their exercise price, allowing that portion of the pool to then be re-used for new hires.
    • While the 90-day period is still convention, key executives/hires will often either negotiate for an extended exercise period for their own grants, or the Company will as a gesture of good will, decide on its own to selectively extend the period when someone leaves on good terms.

Obligatory Disclaimer: This post contains a lot of fundamentals and generalizations on tax rules, but it’s obviously not intended to be an exhaustive statement of those rules. Circumstances vary, and you should absolutely not rely on this post without consulting your own attorney and/or tax advisors.  If you do, don’t blame me when it blows up in your face.  You’ve been warned.

Contracts are for the Divorce; Not the Honeymoon.

Principles:

  1. Small holes have a way of widening when you push a few zeros through them; and
  2. When a contract is being negotiated, founders are focused on the marriage. Their lawyer is (or should be) focused on the divorce.

Founders, for personality reasons, often pride themselves on being “closers” and able to accept levels of risk that others aren’t willing to tolerate.  They’re “upside” people. That’s generally a great thing, but seasoned negotiators know how to play off that tendency to their advantage.  This happens all the time:

Background: A draft’s been delivered and negotiated back and forth a bit. Then, right before signing, the other side’s counsel drops in a provision that they say should be uncontroversial – and casually includes a signed signature page, ready to close.

Company Counsel: (speaking to Founder) This provision is problematic.  It could lead to X, Y, or Z. I’ve seen it happen before.

Founder: (speaking to lawyer) Ugh, seriously? I just want to close this deal.

:: after discussion, Founder calls Investor to discuss ::

Investor: Your lawyer is being paranoid. There’s no way we’d do that. We’re all aligned here.

Founder: Yeah, you’re right. Damn lawyers.

:: Docs get signed ::

When the Company becomes more valuable, X, Y, or Z ends up happening.

Founder: F***ing S****!@#

Paranoid? No, Experienced. 

Why do good startup lawyers see red flags where founders just see corner cases holding up deals? The answer is simple, and it’s not risk-tolerance. It’s volume.  This is often the founders’  first VC deal, or at least they’ve never dealt with a fall-out with investors or business partners.  This likely isn’t even the lawyer’s 50th rodeo. The lawyer knows that contracts are drafted during the honeymoon, but enforced during the divorce. And holes in contracts have a way of getting bigger when there’s 7+ figures ($) waiting to be pushed through them.

Granted, there are a lot of lawyers who do in fact make mountains out of molehills.  See ‘When it’s time for your startup lawyer to shut up.‘   But that doesn’t mean that a good lawyer will simply gloss over all issues to keep the business parties happy. Founders need to be prepared when experienced negotiators push the “let’s just get this closed, we’re all aligned here” button to discredit a lawyer’s advice. It’s an old-school tactic.

Good Cop, Bad Cop.

So my advice to founders stuck in this scenario is to go with another oldie-but-goodie: good cop, bad cop. In other words, ask, but blame your lawyer.  It goes something like this:

Investor: Your lawyer is being paranoid. There’s no way we’d do that. We’re all aligned here. (replay)

Founder: Yeah, you’re right. He is paranoid.  I know you’d never do X, Y, or Z. Lawyers are such a pain in the ass. But can we just make the change so that we don’t have to discuss things with him again?  We’re ready to close if you are.

Sidenote: I’ve found joint lawyer bashing to be an essential part of the founder-investor bonding experience. Don’t miss out.

Deal lawyers don’t mind being the bad cop at all. They’re used to it. It works.  Well, only if they’re actually your lawyer. See ‘Don’t Use Your Lead Investor’s Lawyers.’ You preserve your image as a closer, but still avoid the landmine pointed out by your “damn lawyer.”

If you don’t trust your lawyer, you should get a new one. And if you say you trust him, you should pay attention when he says that there is a serious problem in a contract.  We’re not all risk-averse pedants. We’ve just seen enough divorces to know what “we’re all aligned here” really means.