Founder’s Dilemmas: Strategies to Anticipate and Avoid the Pitfalls that can Sink a Startup

Founding teams must align on three Rs: Relationships, Roles & Rewards. Startups that do have resilient founding teams but misalignment on any of these are hidden, ticking bombs that explode at the most inopportune moments. Here are six strategies to avoid cofounder pitfalls that can sink a startup.

As NGP Capital celebrates its 20th anniversary, we reflect on much for which we are thankful. Fewer than ten venture firms have consistently invested globally across North America, Europe and Asia as NGP Capital has over the past two decades. We appreciate the dozens of ambitious entrepreneurs who have shared their success with us and investors who have consistently supported us.

Above all, I appreciate the partnership that brought NGP Capital to this landmark milestone. Our early partners — John Garder, Bo Ilsoe, Upal Basu, David Tang, and I — grew the firm together for nearly two decades while operating across three continents and fifteen time zones. We assembled our diverse partnership from four countries and three professions while operating across three continents. Peers observing us from afar marveled at our compatibility. The whole was greater than the sum of the parts as we invested better together than we may have individually.

Narratives are neatly knit retrospectively: you can connect the dots looking backward but not forward. The idea of a global venture fund was audacious and perhaps foolhardy when John Gardner and I launched the fund. As we walked the shores of an isolated beach along the California coast, the scenery offered two versions of our contemplated endeavor: the mammoth waves crashed forbiddingly offshore while the late afternoon sun sparkled through the waves’ misty afterglow. Agreeing on a long-term vision for the fund, we took deep breaths and plunged in. Leaving established, well-regarded funds to launch a global venture fund was as bracing as the northern California ocean water. The odds of success were as formidable as the massive waves pounding offshore since China and India were technology newcomers and Europe had long underperformed the U.S. venture market.

John and I had traded sharp elbows on a basketball court for years but had never worked together before we committed to our partnership. Sharp elbows occasionally resurfaced as we navigated through a global financial crisis, a trade war, COVID and changing technology landscape. But our shared vision and aligned interests helped us survive these tempests.

Ultimately, I took the plunge with John on the beach long ago based on one comment from a mutual friend: “I would trust my son with John.” Our mutual friend was spot on. That shared trust and long experience guarding each other on the basketball court enabled us to execute plenty of no-look passes while we operated a continent and often a world away.

Founder’s Dilemmas: Relationships, Roles and Rewards

“If entrepreneurship is a battle, most casualties stem from friendly fire or self-inflicted wounds” as Noam Wasserman observed in Founder’s Dilemmas. Up to 65% of venture-backed failures, he notes, result from problems within startup management teams.

Iconic startups emerge when talented founding teams converge with lucrative markets. Talent and opportunity are prerequisites for startup success yet, if forced into a Faustian bargain to choose one or the other, venture investors prefer to back superb entrepreneurs. Great teams can pivot when fledgling markets sour, but troubled teams will fumble lucrative opportunities every time.

Thiel’s Law observes that “a startup messed up at its foundation cannot be fixed.” Peter Thiel, founder of PayPal and Founder’s Fund, has seen many founding teams flourish or flounder. Our experience at NGP Capital reinforces Thiel’s views. No NGP Capital portfolio company has ever flourished after founder departures due to internal rifts.

Common Pitfalls of Founding Teams

Ambitious entrepreneurs aspire to assemble a stellar, cohesive executive team that can scale and establish market leadership in a large, lucrative sector. All founding teams start with good intentions making significant personal sacrifices to bring their vision to fruition. Yet too often startups dissolve due to self-inflicted wounds.

Pressure creates diamonds or dust. Startups are pressure cookers, a marathon comprised of a series of 100-yard dashes. Decisions in any single dash can throw startups off course or put them out of the race altogether.

After reviewing 3500 venture-backed startups, Wasserman proposed that founding teams must get three Rs right from the outset: Relationships, Roles and Rewards. Startups that align interests on the three Rs typically have resilient founding teams. Misalignment on any of these three are ticking bombs hidden below the surface that explode at the most inopportune moments.

Relationships: Founding teams are typically assembled based on affinity and trust. These are good but insufficient criteria. Wasserman found that cofounders with prior shared work experience have the highest likelihood of success, but teams formed based on friendships are less stable than strangers. Homogenous teams breed more conflict due to overlapping skills. Friends and family are better seed investors than cofounders. Family cofounders, while laudable, rarely worked in our experience as close familial ties make it harder to attract and integrate top talent needed to scale the business. Family and friendships also delay and complicate hard decisions when organizational change is needed.

Diverse, balanced cofounding teams are best. Startups with dominant CEOs have 19% lower performance, but consensus-based teams move too slowly. Finding an appropriate balance is hard to achieve and harder still to maintain.

Roles: Division of labor is a major source of tension unless skillsets are diverse and roles are clear. If founders focus on control, then roles are the source of greatest tension. The desire of multiple founders to be CEO is cancerous but rarely visible externally. Control tendencies tend to backfire as venture investors expect unalloyed focus on wealth creation. Only 62% of founding CEOs retain their CEO role after Series B, 48% after Series C and just 39% after Series D according to Wasserman. Replacing founding CEOs is nonetheless done reluctantly as hired guns are tourists and tend to move on when startups falter, often when their experience is most needed.

High growth startups require flexibility to attract talent and scale the business. Purview may expand but roles typically narrow during periods of rapid expansion. A sense of entitlement is a hindrance to growth or, heaven forbid, contraction. Overtitling of founders early in the startup is a challenge later as it risks having to demote or replace founders, which can be disruptive.

Rewards: The purpose of equity allocations and compensation structure is to align interests, yet when founders focus on wealth as they should in venture-backed startups, then rewards are the source of greatest tension. Self-interest is normal but greed is lethal. Compensation codifies pecking orders, which may alter team dynamics and undermine flexibility needed as the startup evolves.

Entrepreneurs are preternaturally overoptimistic: 95% think their venture-backed startup has more than a 50% likelihood of succeeding and fully 30% think there is no risk of failure. Overoptimism becomes a source of friction when startups run headlong into market fortresses. Many top executives that were vital to our initial investment decision have subsequently left for greener pastures when growth languishes below lofty expectations.

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“All happy families are alike; each unhappy family is unhappy in its own way” as Leo Tolstoy remarked in Anna Karenina. Forgive me then for the many cofounder pitfalls I have overlooked. In 35 years of investing in and cofounding startups, I have surely forgotten more startup challenges than I care to remember in the interest of health and well-being. Nonetheless, I trust Figure 1 is useful as a fair summary of the common challenges that cofounding teams face. My next task is happier and, as Tolstoy suggests, more manageable in offering a few practical steps aspiring entrepreneurs may take to survive and thrive as a startup team.

Figure 1: Founder’s Dilemmas on Relationships, Roles and Rewards

Practices to Thrive as a Startup Team

If founding teams are so hard, why not go it alone? Solo entrepreneurs can avoid challenges on shared roles and rewards, yet cofounding teams generally perform better than single founders in complex, fast moving situations. Teams of two or three cofounders generally perform best as complexity increases exponentially with more cofounders. In my review, 70% of 75 successful technology IPOs from 2019–21 had multiple founders with an overall average of 2.1 cofounders.

I first learned about Wasserman’s Founder’s Dilemmas from a fellow climber on our trek to Everest base camp. The climber, also a Silicon Valley entrepreneur, observed that cofounding a startup is akin to sharing the ‘bond of the rope’ on mountain climbing expeditions. When alpine climbers are tied into the same rope, their lives are literally in each other’s hands. The rope becomes a symbol of connection, mutual dependence, trust, responsibility and solidarity. Roping with an alpine partner commits both climbers to a shared fate and rescuing each other in the event of a fall. The bond of the rope increases the risk of falling, but with the benefits of a belay, may lower consequences of a fall.

Cofounding a startup is not a life-or-death decision as the bond of the rope is in climbing, but the shared commitment of trust, mutual reliance and responsibility should be no less weighty. Cofounders commit to spend much of their lives together for years ahead with professional reputations and financial wellbeing at stake. With so much at risk, here are six practical steps any founder can take when considering a startup partnership:

1. Networking and Mentorship: Network widely in industries relevant to your contemplated startup to understand the available talent pool and key success factors for your business. Evaluate your Founder Fit and do a gap analysis on how your skills align with requirements for startup success. Cultivate mentors among entrepreneurs and investors who have previously built successful startups. They can help you assess the pros and cons of including cofounders and review cofounders you are considering.

2. Try Before You Buy: You never really know someone until you have been together in the trenches under fire. Prior shared work experience is the best test of compatibility. In my review of successful technology IPOs, 77% of startup cofounders had previously worked together and 12% were university classmates. Absent prior experience together, take a try before you buy approach. Work together on a project as a prelude to the startup to test your partnership. Assuming all goes well, the project will inform ongoing cofounder discussions on roles and rewards. There is no shame in parting ways after the trial period. If you mutually decide to move on, then consider the project as worthy endeavor and make best efforts to sustain the mutual respect that led you to consider cofounding a company together. After all, technology innovation is a surprisingly small world.

3. Shared Vision and Priorities: Startups are stressful and often all consuming. A shared vision helps align interests amid the din of daily events. The two most common founder motivations are wealth and control. These objectives are often incompatible, so founders should agree on priorities at the outset. Startups driven by wealth have better outcomes, while those driven by control often end in founder fits. Mission driven startups, though rare, enjoy a virtuous cycle of attracting and motivating talent who share the firm’s vision.

4. Complementarity and Compatibility: High performing founding teams share two characteristics: they are culturally compatible yet have diverse skillsets that augment startup success. Cofounders should agree on core principles that will guide the firm and inform its culture. But homogenous teams tend to be less resilient and breed more conflict due to overlapping skills. Half of the firms in my tech IPO review recruited a founder to fill a skill gap on the founding team. Complementary skills that broaden team capacity to cover key success factors needed to scale the business.

5. Clarify Roles and Responsibilities: Honeymoon periods are to be savored so conflict avoidance in the early days is normal among cofounders. But postponed problems are harder and costlier to fix later. Prior shared experience and agreement on vision and priorities should enable cofounders to address hard questions up front. Clarifying roles and expectations can occur while reinforcing team culture to pitch in as needed. Clear roles help ensure the team can operate effectively without duplicating efforts. Diverse teams with different skillsets facilitate division of labor.

6. Fairness and Flexibility: Equity may be split equally among founders or based on roles and expected contributions. But cofounders should not get locked in either in their roles or equity allocations. Startups need flexibility to adjust roles as the business grows. Overtitling of founders early in the startup is a challenge later due to the risk of having to demote or replace founders, which can be disruptive. Similarly, startup incentives are best aligned when stock options reflect ongoing contributions. Investors can alleviate management overhead and dead weight on the cap table by buying vested options of former employees who have left the company.

Founder’s Dilemmas: A Perspective from a Twenty-Year Partnership

Last week, John Gardner and I co-hosted a case study on Pubmatic, an investment made early in our shared history at NGP Capital. Pubmatic grew rapidly at first on the tailwinds of a shift in ad spending from traditional media to digital publishers. But Google and Facebook entered the space, and few firms survived the ‘adtech nuclear winter’ that ensued. Pubmatic survived as a resilient, adaptable founding team cut costs and pivoted from a transaction-based services to subscription software model. Following this five-year transitional saga, Pubmatic was well positioned when digital media and ad spend rose during COVID. Pubmatic went public in 2020 and continues to grow profitably.

Reliving the Pubmatic saga rekindled memories of our own shared journey at NGP Capital. The global financial crisis in 2007 battered global venture markets putting the survival of our fund at risk while still in its infancy. Our fund got a fever when our limited partners caught a cold. When COVID struck, a third of our companies saw revenues plunge to zero and several did not survive a shock that fundamentally altered their long-term business prospects. Global trade wars forced a reorganization of our global investment model. Crises like these would challenge any local partnership. Our global model required partners to reach consensus and coordinate responses across three continents. Though never easy, rational minds generally prevailed.

Much as the Pubmatic founding team demonstrated impressive fortitude to survive the ‘adtech nuclear winter’, their saga lends perspective on our own partnership journey. John and I foresaw none of the tempests we would endure together when we plunged into the bracing ocean water along the California coast two decades ago. But our shared vision and complementary personalities enabled the partnership to muddle through both the external shocks and internal stresses of managing a global fund. For this, I thank all my partners for their rigor, adaptability and persistence.

As they say in greetings and toasts in India, may you live ‘one hundred years.’

Related Concepts

Founder’s Dilemmas are closely tied to Founder Fit as cofounders complement each other and fill gaps in experience and skills needed for startup success. Choosing a cofounder is a One-Way-Door Decision with high Opportunity Costs of emotional energy, valuable time and equity, and professional reputations so careful consideration must be given before plunging in. The Who Scorecard can help identify Founder Fit gaps among Key Success Factors required to scale the business. The Who Scorecard can also help assess where cofounder complementarity and compatibility. An Outsiders Perspective from mentors and/or friends is vital when considering cofounders as Liking Bias, Loss Aversion, Deal Fever, Blind Spots, Wishful Thinking, Tunnel Vision commonly intrude on partner decisions. You may consider taking Myers Briggs or OCEAN personality tests as a foundation for understanding founder compatibility. Having done your homework and affirmed your partnership, it is best to Align Incentives so that you can Assume Positive Intent when disagreements invariably arise.

Most of all, have fun and be Exothermic! It is a blessing to share your journey of a lifetime with a trusted partner!