Does It Help Startups for Founders to Cede Control?

The Wall Street Journal reports on a study finding that startups that have a founder staying on as chief executive or chairman past the first two years following inception have a significantly lower valuation, on average, than companies who replace their leadership during that period. The study’s author attempts to explain the difference in valuation by focusing on the relative attributes of founders versus executives that are brought on later. In other words, founders may have the inspiration to get the startup conceptualized and off the ground, but professional executives have a different and necessary skill set that the company needs at a later stage.

Should vendors provide services in exchange for equity?This may be part of the explanation, but it seems to me to be confusing correlation and causation. There may be a reason other than the qualities of the founders themselves that account for the different performance. One possible alternate factor is the manner in which startups are funded. Startups that receive venture capital funding are, in my experience, more likely to see a change in leadership, sometimes imposed by the venture fund as a condition to investment. On the other hand, startups that are funded by less heavy-handed capital sources (friends and family money, bank loans, etc.) are more likely to have the founders continue in their role indefinitely.

Venture capital firms can contribute far more to a company’s success other than providing new executives to replace the founders. Particularly if the firm focuses on a specific industry, the firm will have seen and invested in many similar companies and will be able to provide useful advice that would not be available to startups that rely on non-VC funding. Such expert guidance from investors could account for significant differences in company valuation. In addition, VC firms generally invest more than a startup needs to spend immediately, so the simple fact of there being more cash in the bank could lead a VC-backed startup to have a higher valuation than one that isn’t VC-funded.

So, I wouldn’t necessarily conclude from this study that startup founders should immediately start seeking their own replacements on the theory that they’re terrible managers. It may be that they should instead position themselves for VC funding to make long term success more likely, though that may have the ultimate effect of shortening their tenure with the company.