15 Aug 2005  Research & Ideas

The Founding CEO’s Dilemma: Stay or Go?

Bill Gates and Larry Ellison are rare birds. In this interview by HBS senior lecturer Mike Roberts for New Business, professor Noam Wasserman explains how and why many founding chief executives find themselves replaced.

 

Editor's Note— Noam Wasserman is an assistant professor and MBA Class of 1961 Fellow in the entrepreneurial management unit at Harvard Business School. His paper "Founder-CEO Succession and the Paradox of Entrepreneurial Success," published in Organization Science in March-April 2003, won Harvard's 2003 Aage Sorensen Memorial Award for sociological research. With his coauthor, Rock Center Entrepreneur-in-Residence Henry McCance of Greylock Partners, professor Wasserman recently completed a case study about founder-CEO succession at Wily Technology. New Business publisher Mike Roberts met with professor Wasserman to learn more about his research.

New Business: Tell us about your research.

Noam Wasserman: My research focuses on founder frustrations in entrepreneurial firms, with a particular emphasis on the core issues of organization building that cause problems for founders' abilities to achieve their goals. I've been especially interested in the pattern of succession in many entrepreneurial firms—specifically, that many founders are replaced by "professional" CEOs early in the life of the venture. My data shows that the percentage of founder-CEOs who "go the distance" is extremely low, especially in high-potential ventures. People like Bill Gates and Larry Ellison, who are able to lead their companies for quite a while, get all the attention because they are rare, not because they are typical.

NB: What do we know about why this happens?

Wasserman: In large companies, when the CEO doesn't do well, the CEO gets replaced. When the CEO does do well, there is almost no chance that person will be replaced. If he or she has led the company to success, that person is about as solid in the position as one can get.

The interesting paradox is that when founder-CEOs do really well, that also increases the chances that they're going to be replaced.

My research shows that in small companies, it's still true that when founder-CEOs do badly, they are replaced. But the interesting paradox is that when founder-CEOs do really well, that also increases the chances that they're going to be replaced. Typically, early in the life of a company—when it is developing its first product or service—the founder who conceived of the idea and began developing it is the perfect person to lead the company, to ensure that it will be able to succeed at hitting the core milestone of completing initial development. However, when that milestone is reached—when the founder-CEO has successfully led the company in its most important task—the chances that that founder-CEO will be replaced also increase dramatically. The challenges within the company change so dramatically that the person who was best suited to lead the early stage of company development is no longer the best person to continue leading the company. Now, the product has to be sold: You have to create a sales organization, manage multiple functions, deal with customers, handle more complex financial issues, and deal with a very different set of challenges for which many founder-CEOs are not equipped. Objectively, many founders might agree that the CEO's job will require skills they don't have, but emotionally, they are very attached to the companies they started, they've grown to like the CEO position, and the success that they have enjoyed so far makes it much harder for others to convince the founders that they need to be replaced. However, it is precisely their success that has increased the need to replace them at this point.

This pattern is exacerbated when the founder-CEO brings in outside investors. VCs, in particular, often make the assumption that the person who started the company is going to have to be replaced along the way, and may therefore have a quicker "trigger finger" than the founder-CEO wants. But once the founders bring in those outsiders, the decision about who gets to be CEO is no longer up to the founders alone. My results show that whenever founders raise a new round of financing, the chances that they'll be replaced as CEO go up dramatically. It's precisely at this point that the founders are very susceptible to the VCs making demands on them as terms for that capital. That's one of the factors that Henry McCance and I examine in the "Wily" case.

NB: Is it inevitable that founders will not be able to go the distance?

Wasserman: Not inevitable, but probable. We teach a case in our first-year entrepreneurship course on a Silicon Valley VC firm called Onset Ventures, which lays out a "test" for all entrepreneurs it considers backing. It's called the "Rich versus King" test. It gets to this essential trade-off around what drives an entrepreneur: Is it the need to control the company (that is, to be King), or is it the drive for success, particularly financial success, which may require that the entrepreneur step aside once certain business milestones have been reached? Onset does not like to invest in founders who "want to be King" out of concern that they will not want to be replaced if such a step is required in order for the company to be successful. Once the company's product is defined and the business model has been developed, Onset—and indeed most VC firms—wants to be able to bring in a new CEO if required. Thus, the only founders who can assure their ability to continue as CEOs are those who don't raise outside money from Onset and its peers. Of course, that outside money is often necessary to build a valuable company, so King-motivated founders usually have to give up a lot of potential growth to remain King. In the entrepreneurship class, I push students to think hard about why they are choosing to be founders to begin with, and then to make conscious choices that are consistent with those motivations. The founders who get into trouble are often the ones who make decisions without regard for "Rich versus King," and who therefore decrease the chances that they will achieve their goals because they haven't made choices consistent with their motivations.

Objectively, many founders might agree that the CEO's job will require skills they don't have, but emotionally, they are very attached to the companies they started...

NB: For those founders who do give up the CEO role, do they often stay around in some capacity? Does that generally work?

Wasserman: This is another way that founder-CEO succession can differ dramatically from large-company CEO succession. In large companies, after the CEO is replaced, that person almost always leaves the company. However, in entrepreneurial companies, the board often tries to find ways the founder can remain within the company in a different role, such as remaining on the board or taking a lower-ranking executive role. Because those founders are so central to their companies, losing them completely could be very disruptive for the company. The ideal situation is where the board and the founder can craft an appropriate non-CEO role, one that the founder willingly takes on. However, given how hard it is to convince many founders that they should step down, there is also a big cost to keeping a disgruntled founder active in the company.

From the new CEO's perspective, it can be very hard to come into the company while your predecessor—the founder who used to be CEO—is still around. This is particularly true if the founder's new role is chairman of the board, looking over the shoulder of the new CEO. It gets even more interesting if, in addition to becoming chairman, the founder has taken an executive position below the CEO, for instance, as chief technical officer. In that case, the new CEO is both "reporting" to the founder-chairman and having that same founder-CTO as a direct report. Taking over a company is quite a challenge for any new CEO, but doing it in that kind of situation brings the challenge to a very different level.

About the author

Michael J. Roberts is a senior lecturer at Harvard Business School.

Reproduced with permission from "The Challenge of Letting Go: Founder-CEO Succession in Entrepreneurial Firms," New Business, Spring 2005.

See the current issue of New Business.