Grow the Pie (not Your Slice)

It’s incredibly common to hear the following as a seed stage VC: “I decided to hire [junior employee X / outsourced software development firm Y] because I don’t want to give away a big chunk of equity to hire a true [CTO / key business role]. Once we raise another couple rounds of funding, we’ll bring in someone more senior.” Here’s why that’s a gamble I usually don’t recommend.

When startups begin hiring, they generally offer less cash compensation and stability, while requiring more work-life balance sacrifices, than later stage companies. There are many motivations to join anyway: the opportunity to build something meaningful, the adrenaline of being there at the foundation of an exciting business, the lack of rules, bureaucracy and reporting structures, the people, the idea, and the culture.

But from a strictly financial point of view, the only reason to join an early stage company is the equity upside. That means, to attract the very best team members, equity (usually in the form of options) is the best recruiting tool that early companies have. While it’s painful for founders to give up a large portion of their baby to someone who wasn’t there for the conception of the idea or those first few months of sleepless nights, it won’t matter anyway unless the startup has a long, successful life.

An incredible technical cofounder for a technology startup cannot single-handedly make the company succeed. But a bad technical cofounder, or no technical cofounder, can single-handedly take it down. Years ago, I personally invested in a great idea with a talented CEO who signed some great enterprise contracts and then had to hit pause because the back end couldn’t handle a large volume of users. Poor architecture can bring a site down as soon as a company starts to scale. A clunky interface is hard to overcome, even for a product that offers great value. Most importantly, the ability to test and ship product quickly is critical to a company’s success, particularly in software. Without a great engineering team, or with an outsourced team that doesn’t sit in the office late at night to make a big release date, companies can’t move quickly enough to compete.

Even so, I constantly see, speak to, and even have invested in non-technical founders that bring on mid-level engineering hires rather than a CTO early on. Sometimes it’s out of necessity, as hiring great technical talent is hard. However, it’s often because founders don’t want to give up more than 1-2% of the founder equity. The problem is, great junior engineers want to join companies with great engineering leadership. Having the wrong person, or no person, at the top can make future hiring much more challenging.

Key technical talent is important for software and hardware businesses, but the same goes for critical roles in other organizations. For instance, an outstanding credit person with deep experience in underwriting can be a huge boon for an alternative lending business. Someone with deep retail experience and relationships can make a big difference for a new food company. And while it requires dilution to bring on those hires, they can often result in better valuations that reduce dilution from VC investment going forward.

Of course, one of the toughest things for a business is to have a co-founder who comes on for only 8 months and then leaves with a big chunk of ownership and control in the company. So next up: a post about using vesting and cliffs to ensure that doesn’t happen!