From Founder-CEO to CTO or CSO: Key Protections in Succession Planning when you face the Founder’s Dilemma

Are you the founder or co-founder of a successful startup in tech, e-commerce, life science or other areas of the innovation economy? Chances are that at some point, you may become a victim of your own success.  You may be asked and even pressured to let a “professional” CEO take your place at the helm, and you would then step aside to fall back to take a CTO or CSO position in what had been your company.

A well-known Harvard study showed that by the time ventures were three years old, 50% of founders were no longer the CEO; in year four, only 40% were still in the corner office; and fewer than 25% led their companies to IPOs. (See Noam Wasserman, “The Founder’s Dilemma”, Harvard Business Review). 

This article discusses how and why this situation that Wasserman has called (and I, in this article, also call) the “Founder’s Dilemma” occurs, and then goes on to offer advice to the founder CEO who will transition to the CTO or CSO role:  what key protections to seek for yourself and for the company you built. 

“Founder’s Dilemma”:  You can be a victim of your own successful launch

This Founder’s Dilemma only arises for successful founders. You’ve had a successful launch.  You’ve attracted angel or VC investors which is not easy to do.  Now the question comes – who will lead the company in the scale up to the next level? 

There are famous founder CEOs who led the launch and were able to lead the scale up and IPO as well, Mark Zuckerberg, Bill Gates, Steve Jobs and others. Yet, famous as they are, these founders who could successfully transition to lead the scale up are the exception, not the rule.  

Why?

As the founder who conceived of the idea and began developing it into a product, you have the passion of a true believer to build the startup team, to make those first sales, and to not only sell employees, customers and suppliers on your product, concept or technology, but to sell investors as well. You were the best person to lead the company’s launch right through to hitting the first milestone of completing initial product development. But once that milestone is reached, the company’s challenge changes to selling the product to the market. The CEO’s priority now is scale-up:  to create and manage a growing organization, with marketing, sales, HR, production, legal, regulatory and other functions, and to manage not only your executive suite, but also the Board, investor relations and new capital raises as well.

Many founder CEOs, whose passion, vision and willingness to take risks have brought initial success to their startups, are not equipped with the required skills for this stage of the company’s growth. As a result, when you seek funding from venture capital investors at this stage, they often condition funding on commitment to hire a professional CEO who has a track record in scaling ventures to liquidity.

You can lose your position as CEO and many of your rights as founder. You can become a victim of your own successful launch. The next sections of this article discuss managing the process so that it does not happen to you.

Protect the Company with Board, Investors and Successor CEO

The first level of protection when facing the Founder’s Dilemma is protection of the company.  You do that in three ways – smart selection of the Board of Directors, selection of the right investors and “owning” the selection process for the successor CEO.

When you step down from the CEO role, you are letting go of much control of the company. To ensure the continued success of the company, you should build a strong board that includes independent directors who are knowledgeable in your company’s industry and market. Even as investors’ preferred stock terms exert a level of control, it’s best to have an independent majority of industry representatives who can empathize with you, the founder CEO, and a minority of VC members of the board who can offer input but not control the direction of the firm.

When deciding to take investment from venture capital investors, you should not focus only on valuation, but spend time evaluating past investments in the field, experience and judgment. Even if the investors want a professional CEO, what input will the founder have? What will be the composition of the board? You should read the signs to be assured of mutual respect.

Investors usually recognize that the founder is very central to the company and losing him or her completely could be very disruptive for the company. So, the founder usually remains on the board, or may even be Chairman, to continue his/her influence on corporate strategy. When the founder CEO’s technical expertise is needed, he or she may also take on the role of CSO or CTO. This can put the new CEO in the difficult position of both “reporting” to the founder-chairman and having that same founder-CTO as a direct report. If you are in this situation, you will need to carefully manage the relationship to avoid disruption to the company.

As founder CEO, the third area of Company protection when you face the “Founder’s Dilemma”, after building the Board and wise choices of investors, is making sure you have a key role in the choice of the successor CEO, the “professional CEO”.  

The professional CEO should have proven ability to sustain infrastructure and organizational growth, to communicate, interface, harmonize and energize investors, directors, the media and other parties.  As the founder CEO, you want to be a big part of the selection process and feel a sense of confidence that you can work with the person chosen and that the person chosen has a realistic understanding of where the company is now, and shares with you and the Board a vision of where he or she wants to take the company and again conveys to you the ability and experience that he or she can take you there.  

Thus, even though you are very attached to the company you created (it’s your baby!) and probably enjoy much respect and influence there, it is in your interest and all the other stakeholders to embrace this succession process, to be part of it, rather than fight it, and if you can get the right successor, by all means bring him or her in to the benefit of all concerned.

Protect Your Interests with Key Contractual Terms

The other level of protection when facing the Founder’s Dilemma, is protection of yourself.  You also need to protect yourself – to assure legal and contractual protections for your post-CEO position as CSO or CTO. When should you seek protections? As soon in this process as possible. When the Series A or Series B investors condition funding on hiring a successor CEO, you need to set the executive employment terms for your own protection.

The basic protections to seek with succession include the following;

• Minority shareholder protections including for information, against dilution and cash-out rights;
• Exercise rights over options, vesting of shares;
• Role in successor CEO selection and transition (discussed above);
• Back licenses of technology, office support;
• Board representation or observer rights
• Severance pay, post-termination benefits and coverages
• Post-employment paid consulting
• Negotiation of non-compete, non-solicitation, other restrictions

When you bring in outside investors, your shares are diluted. To protect your own equity position in the company and to stay on top and be involved in company direction and strategy, you should seek to retain a seat on the board. If that cannot be accommodated, you could seek observer status on the board.  

With new investors coming in who will seek a professional CEO, you should arrange to have an employment contract for your new CTO or CSO position that provides basic protections in case the new CEO does seek to clean house and you face termination. Your CSO or CTO employment agreement should have protections in the case of termination by the employer and give you the right to quit for good reason and trigger your severance. Founders are frequently underpaid during the early stage of the startup. The employment terms should also include salary and benefits compensation to address this underpayment.

After working as CSO or CTO for some time, you may choose to leave the company but continue to contribute your expertise on a part-time basis. Such post-employment paid consulting can be written into your employment contract as well.
When you seek investment to help grow your company to its full potential, you share power and control to maximize everyone’s financial gain. At the same time, you should protect your own stake in the gain as you step down from CEO to the new role for you as CSO or CTO.  To address the “Founder’s Dilemma”, both careful succession planning to protect the company and ensure its continued success, as well as strong contractual terms to protect your own interests are needed in this endeavor. Don’t let others take over your company and leave you with next to nothing! An executive employment lawyer with experience working with startups can help you to better assure you keep the benefits of all the hard work and cash that you’ve put into your startup you’ve successfully launched and want to see go to the next level.

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