Founders, Equity and Culture
It’s common in today’s start-up scene that early-stage investors lead with the question, “Who’s your co-founder?” So much so, that companies attend start-up speed-dates with incubators and VC networks, seeking the next Jobs-and-Wozniak partnership. But the jury is out on whether co-founders work so well as sole founders. MIT Sloan, the business school, says individual founders like Musk or Bezos are statistically more successful. They offer the idea that all sorts of “social frictions” eventually break co-founding teams. The data supports that idea, says MIT: “Solo founders are more than twice as likely to own an ongoing, for-profit venture than two or more founders.” [1]
Maybe the hunt to match co-founders by skill set, misses a deeper need to match co-founders by things they believe are important and help create hypergrowth.
Success comes from both what we do and the way we do it.
If co-founding a successful company with no social friction for ten years taught me something, it’s that the four of us amplified the same ethics and concerns. If we hadn’t valued the same things, CloudSense would have had rifts, and have been another MIT statistic. We had one clear ethos, and it was a recipe for long-term, sustained growth. As a co-founder, I would count myself lucky daily that our partnership worked. Reflection and hindsight have helped me shine a light on why it worked and there was more to it than luck.
Before I finally decided to go into business with Alex, Fawzi, and Davor, I’d given it plenty of thought, attempted as much open discussion with them, and tried to use good judgment. Of primary importance is partnering with good team members who have similar work ethics, who are empathetic and with low egos, and are prepared to listen and for give-and-take. They must be open to healthy and often intensive discussion and disputes, and then be able to come to a resolution, hold no grudges, agree who is right, and when necessary, admit to a mistake.
Finding people with courage and with their own genius is essential. Finding people with those traits and who also have small egos is a winning formula.
Fortunately for us, those positive traits came through as we had our company kick-off discussions, during which we created our first business plan. The final part of this document provided a record of our discussion about the way we wanted the company to run day to day—in other words, its ethos.
Trust
We wanted our business to be built around trust: trust between the four partners, mutual trust with customers, and using trusted technologies to deliver our solutions.
Accountability
We knew that we were holding each other to account by documenting our aims and the way we were going to achieve them. We strove for accountability to one another as colleagues and on teams, and in the commitments, we made to customers.
Empathy
Empathy was an important part of our ethos, we wanted to do a good job. We felt for our customer's needs because we’d walked a mile in their shoes, through our work in Industry. Customer empathy became a good filter for the people whom we were considering bringing into the business, and over time, empathy also led to a strong source of bonding with our customers.
Confidence
Our plan was built on confidence. We planned to grow into a big company and take it to exit in five to six years. Our confidence was born out of our belief in our market, one another, our customers, and our ability to serve them. Confidence needed to be a key part of our ethos because success in the rough-and-tough competitive environment of enterprise software relied upon it. If we didn’t have confidence, then we had no right to be in the market at all.
Innovation
The last trait that we talked about in the ethos of the company was innovation. We had experienced the level of change that we could bring about for customers with our problem-solving skills. It was this creativity and innovation that excited us all. Innovation in our DNA meant we were well-placed to meet the needs of demanding businesses in a tough competitive environment.
On Co-Founders
Let’s say you’re building your business on your own, and you have one or more employees but no equity partners. You own your business 100 per cent.
As your business grows, you’ll likely find that you simply cannot get the high-level expertise you need by hiring leadership talent at an early business stage. You conclude that to attract a heavyweight, you need to offer a share of ownership in the business. In other words, you need one or more partners.
The question is, how do you find good partners?
In my case, this question was answered for me: I was asked to become a partner in a business launch. The other three co-founders —Davor, Fawzi, and Alex—were software engineers. Whilst two of them had the experience of founding companies before, they all felt they needed a fourth partner with versatile managerial and business skills as well as customer-facing ones to run the company.
Could they have done my job? Probably not in the early years, maybe somewhat in the later years—everyone develops skills over time.
If the roles were reserved, could I have founded our business on my own and got the orders coming in? Probably.
Would it have become the fast growth, globally successful enterprise without them? Probably not.
Does that mean you must have a business partner? Only you know the answer.
Here’s my experience.
Starting and growing a company is hard work. It’s not off-the-scale frantic and all-consuming all of time, but it’ is exactly that a lot of the time. It’s in those brief lulls where you find a moment to think about the ever-so-essential work stack to which you are not naturally attracted, because most often, people gravitate to the things that energize them, that are familiar and are the reasons they started a company. My strong suit included being good on vision, strategy, coordinating, cajoling, convincing and generally leading people, being creative, and being an opportunist to get the best out of the circumstances that presented themselves. The rest of my hand included being an enthusiastic technologist but an inadequate engineer, a people person, and (at the time) a “slow-to-trust, its-faster-to-do-it-myself-than-rely- on- others- I’m- uncertain- of” sort of person.
For all my ability to chart a course, build momentum, and then take people towards an exciting destination, I wouldn’t have known if I’d got a team building great product or a terrible product, and lots of people would have run out of patience with my then, route-one-is-best approach to almost everything.
Now I’d be doing myself a disservice if I didn’t add that my ambitious, impatient, 35-year-old self-developed new skills over time, but businesses don’t get many shots at defining their modus operandi, their culture, and their motion. My business partners offered exceptional vision to design and develop our products. Their work ethic inspired our teams for over a decade. They repeatedly pulled out the stops and reliably conceived and delivered high quality product with a discipline to deadlines and a quality that kept customers very happy. They each brought soft skills in abundance to engage the team and empathize with them, which was settling and reassuring for the team as the business developed with a sense of fairness and constancy.
We realized what a strong team we made, and it felt good. We were lucky enough to have the right people with the right balance of skills to pull it off. I think my cofounders having previous start-up experience gave them a strong hand in making sure that we started out with the right people.
I recommend you reflect on whether you have the talent you need to shape, lead, and deliver across the disciplines of your company. Being a great entrepreneur requires brutal honesty, and you should start with making sure the pieces of the puzzle are all in place to grow your business. Think about the nagging doubts about those areas of your business that you know need more attention but which you can’t navigate effectively on your own.
If you ultimately decide you could do better with a partner, then it’s something to seriously consider. Undoubtedly your primary objection in your own mind is that a partner will dilute your equity. My response to that would be a smaller piece of something very significant is better than a bigger piece of something small that cannot get the momentum and scale.
In other words, would you rather have 100 per cent of $100, or 50 per cent of $1000?
Fortunately, my three partners and I found it easy to establish a common vision. We had been working together for a while, we knew who our ideal customers were, we had experience of serving these customers, and we knew how we could add value.
Having a shared ethos and the same vision was the single biggest reason our partnership worked over the long run. If you seek a co-founder or business partner, you mustn’t stop at the skill fit. Using intuition, testing the relationship, and doing due diligence on one another may be the most important things you do to ensure the long-term success of your business.
Co-founder Roles and Goals
After ethos and vision, I think for us the next most important factor in our success was giving each co-founder the space to do the role they were good at whilst not treading on one another’s toes. Although this insight applies equally well to a wider leadership team as to founders.
Once I agreed to join our start-up, we ran an initial two-day company kick-off. We started by learning more about one another, our backgrounds, our families, our hopes and dreams, and our motivations for the business.
We co-wrote a short business charter that stated we wanted to specialize in certain business domains, technologies and customer offerings. We set out a timeline to build a business with some growth aspirations and an idea of a common goal to exit the company.
Today, when we look back on this document it’s clear that it served an important purpose in creating an alignment. It allocated jobs to each of us, which we arrived at through a process of discussion and agreeing upon the roles each of us were best suited to do.
On Equity
As you build the foundation of a business that can thrive over the long run, it is important to think about company ownership. At incorporation, my co-founders and I decided the company would be divided four equal ways. My initial perspective was that starting with a quarter of the company was enough for me. Over time this changed a little, as I became anxious that my share of the business would dwindle as we raised venture capital, and my share capital became diluted.
Gradually I realised that we were building a far greater and more successful enterprise because of this partnership structure. We had four strong leaders who worked hard, both individually and collectively. It was creating momentum to the power of four. My grasp of maths told me that the power of four did something exponential to performance. The value of your equity rather than the proportion of the company that you own is in the end far more important. If by partnering with others you can drive exponential value, then it’s clearly worth it.
After we had sold the business, one of the new owners remarked to me, “I think you guys did it just right. You are generous with equity. Never underestimate the power of ownership.”
Since then, I’ve thought more about what he said and how it fitted with the patterns that I saw. Being an owner in a business creates an unrivalled sense of commitment and pride for that person and unleashes a drive and determination like nothing else. Imagine if everyone put in the effort and had a focus on success in the way founders do. I have first-hand experience that this really happens. This is something well-known to venture capitalists, and they will typically ask during your first venture round that you set aside a portion of the company equity as a share incentive for staff. In the UK, this figure is often around 10 per cent of the company but it is not uncommon for that to rise to 20% or more.
When we begin our venture journey, the co-owners created a pool of 12 per cent of equity for staff.
When as company owners we were hiring or looking to bring through talent in our business, we would initiate a conversation about equity, and for those who received it there was always an air of excitement as well as gratitude. They were considered worthy of joining an owners’ club.
They also understood the direct link between productivity and future wealth potential and that excited them. People who were part of the plan worked notably harder and were notably more committed to the culture and the vision of the business than other people. That’s not to say other people didn’t work hard; they most certainly did, but successful businesses are probably only 1 or 2 per cent better in the way they market and sell, and innovate and deliver, than the businesses that don’t make it.
Ownership is the way that you get the extra 2 per cent out of your team.
In terms of the distribution of your staff equity, I’d encourage you to think about the roles and the seniority level that can bring the biggest multiplier effect to your company. There is a balance to be struck between spreading ownership broadly and creating sufficient depth of opportunity for key people to make them, as I liked to say, “get the company tattoo.”
Ownership can mean different things, and the way you think about structuring your equity is important. As a founder, you are the original owner. Employees who come into your business and you wish them to stay, may not do so, and your structure needs to recognise this more transient nature and not have them leave and retain the upside without your consent.
Then there are your investors, and they have specific needs. They have their own targets and their own investors who have funded them, so there are several interests they bring to an equity discussion.
Here are my thoughts on equity structure.
Partner and co-founder Equity
We set quite a high bar when selecting people with whom we wish to be in business as partners. Any business partner or co-founder who is on the journey with you from the start should probably have the same class of share as you. They are not an employee but a vital keystone to the company and they, like you, are the key talent, taking the risk to get the company started and committing all to grow it. With the help of a legal advisor, you will need to put together a shareholder agreement which will detail specific responsibilities of your class of shares. This will include appointing directors to the company, and there may be other specific consent matters that require your agreement if you choose to add them.
Staff Equity
When you set aside equity for your staff, my advice is to use an alternative share vehicle. This is because the share class you and your partners have will be independent of your employment in the company and therefore not reversible should you leave. You’re going on a long journey with your business, and even the best staff may choose to move on and do other things. It would be impractical and unfair for staff leavers to automatically retain ownership of shares given to them as part of their role.
In different jurisdictions there are different ways of incentivising staff with shares. One common way is a shadow equity scheme, which is an option to own part of the company at a future defined event. This is a simple way of running a scheme because it doesn’t constantly change the ownership of the business during your journey as employees come and go. It only does so at a given point in time, most likely the exit.
The alternative to shadow equity is a share class with different and reduced rights associated to it, including a default position that the shares be handed back to the company should the employee leave.
Both have their merits, and often different tax implications in different jurisdictions. An options or shadow equity scheme I found the most simple and effective want to use is this:
In a start-up headed towards an exit event, all equity incentives should be designed to pay out only on the event of the majority of shares in the company being sold to a new buyer. This is the exit. This is distinct from a share plan that may be in place at a large public company where the shares can be sold on the public market, yielding return to the employee share owner.
You should consider how you allocate shares in the first place. Allocating shares to staff based on achievement of goals in the annual plan and over a multi-year period is a great way of keeping ownership as a front-of-mind motivator for your team. You should probably take professional advice as you set the price of the equity given to staff.
The financial reward comes from the gain in value between the price at the point they are given or sold the shares, and the exit value of the business when it’s sold. The tax authorities will be interested in the difference between these values because that is where they apply capital gains tax, and as such you must get the issue price correct. This is best done with a justified price and a paper trail from your accountant that can be relied upon later at the point of exit.
Investor Equity
Finally, I want to mention the shares that an investor will take upon investing in your business. You can expect there to be a negotiation around the value and rights associated to the class of share they are taking.
In summary, your investors will be looking to protect against the downside scenario where the business is sold for a lower valuation than when they invested, and they will also price in a premium for the risk that they’re taking by investing in your business.
In other words, if your company is extremely successful, with many investors vying to give you money, you will get a higher valuation and less dilution than if the sole investor thinks they alone are taking significant risk.
[1] https://mitsloan.mit.edu/ideas-made-to-matter/2-founders-are-not-always-better-1
Final Thoughts:
In this note, I reflect on the foundational principles that guided CloudSense's formation, emphasising the importance of aligning co-founders on core values to foster a cohesive and resilient company culture.
Key Takeaways:
Align on Core Values: Ensure that co-founders share fundamental beliefs and work ethics, such as trust, accountability, empathy, confidence, and innovation, to create a unified company ethos.
Prioritize Character Traits: Seek partners who demonstrate empathy, low ego, openness to healthy debate, and the ability to admit mistakes, as these qualities contribute to effective collaboration and long-term success.
Document Shared Ethos: During initial planning, explicitly discuss and record the desired daily operational principles to establish a clear cultural framework for the company.
Foster Mutual Trust: Build a business environment where trust among partners, with customers, and in chosen technologies forms the foundation of all interactions and decisions.
Embrace Innovation: Cultivate a culture that values creativity and problem-solving, positioning the company to meet the evolving needs of demanding markets.
By aligning co-founders on these core values and character traits, startups can establish a strong, cohesive culture that supports sustainable growth and resilience in the face of challenges.