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Article 6 Common Ground and Another Real-Life Situation March 12, 2010

Posted by Lawrence Lenihan in Uncategorized.
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The common ground on these transactions is always based on communication.  Communication of goals, communication of objectives, communication of metrics and communication of feedback.  Even communication of something as basic as how you feel about each other!  Without communication based on mutually agreed goals, nothing positive can happen.  Either the CEO feels unjustly persecuted by the capricious whim of the investor, or the VC feels like he/she cannot get anything done without a wholesale change of leadership.

The CEO needs to be able to run his/her business.  We as VC’s can help, but we can’t (nor should we) run it for him/her.  VC’s stink at running companies because what makes us good investors (ability to do a ridiculous amount of multi-tasking, assimilate incomplete information and make the best decision in the shortest amount of time, be able to change on a dime to a position 180 degrees opposite based on incoming data, lots of responsibility but little accountability, etc) do not make for focused, well-executing operating business leaders (yes, some of these traits are positive in any leader, but not to the extreme that is embodied by how a VC has to function).  If a VC is running your business, you are in trouble! I think a good VC realizes that and understands that if you grab the steering wheel from the back seat, the car is probably going to hit a tree!

While we are not any good at running your business, we are pretty good at assessing whether you are any good at running your business.  When we made the investment, we were confident enough that you could run it that we wrote you a check.  But after that, you will prove it by running your company successfully.  If you can’t, we VC’s will weigh our options: coach you, bolster you with better people, sell the company or fire you.  Hopefully we have been doing the first two actions all along.  Frankly, I’d rather just sell the company if we can – replacing the CEO is bloody, not fun and is not a high likelihood for success if the business is really struggling.

The CEO can resist and often does.  At the end, we don’t have any recourse if the CEO has the share votes or the board votes to stop us from firing him.  At least not in the near-term.   In the longer term, if he is losing money, we can block a financing or use other contractual controls that we might have, but the CEO can be like a bank robber with dynamite strapped to his chest.  In the end, he can pull the firing pin and blow himself up, but the one who is always certainly killed in this situation is the CEO: he loses everything including his reputation.

That is not to say the VC’s haven’t been idiotic in replacing CEO’s.  I am sure we have on occasion.  Maybe many occasions in the industry.  But both sides really have to look at this situation as one where total value has to be maximized irrespective of hurt feelings, damaged egos or desire for vengeance and retribution.  A CEO with a large ownership position at some point has to realize that he is hurting himself the most by not making a change, provided, of course, that the assessment of failure is based on these objective measurements and not a personality clash.

I was in a situation with one of my companies where the company did not execute well for the first 18 mos of our investment.  After many meetings offering help, guidance, admonition, chastisement and ultimately, frustration, we told the CEO that we were forced to step-in.  We sent in one of our venture partners to work with him to gain an understanding of the situation and to determine where we were going wrong.  Our venture partner did a magnificent job sorting through the issues and putting us in a position where we could clearly and unemotionally understand where the business actually stood (Venture Partners are great operators – they help in the evaluation of investment ideas but they are real operators who often are working on their next business while with us.).

The CEO did not make all of the changes we suggested but he did make several.  He hired an excellent executive who helped turn performance around on the customer acquisition front.  Our Venture Partner, working with the a new CFO, created metrics around which we could determine what was going on in the business.  But, at the end of the day, we told the CEO that we were going to start a search for a leader with better skills for the strategy we were trying to execute.  He disagreed with the conclusion (he had a right – the company’s performance had improved notably).  Later we the management team created a strategy (because now we had better visibility into the business due to our efforts) that showed an opportunity for incredible growth.  The business started executing even more and turned profitable.

So, should we still replace the CEO?  After all, the business was doing much better.  In fact, was doing well.  But, I contend that, even more than before, we needed to replace him because, ironically, the strategy that the CEO and his team uncovered showed the potential for this business to be even greater than before.  With the right leader with deep experience in this new strategy (sorry I am being opaque, but I can’t discuss further), we could build something truly special.  This decision was not based on a judgment of incompetence – the CEO was a very talented executive with deep industry skills.  Moreover, we wanted him to stay since the CEO was a very critical part of the valuable assets of this business who had built the platform that now gave us this opportunity.  We just thought that a change would accelerate our development in the short window of opportunity we had.

The CEO disagreed with this decision, but he went along with the search process.  Several months into it, he came to my office and asked that we stop the CEO recruiting process. The humiliation, anguish and uncertainty of a CEO search was too distracting for him and the company.  The company was in a vulnerable position at this point and the recent success was tenuous.  We both knew that if he left, the company and our investment would go to Hell.  On the other hand, I still strongly felt that, without a new CEO with different skills, we would not have the same chance to build the 10x opportunity that we had hoped.

To his credit, he was a gentleman about it.  He did not storm into my office and make wild threats.  He simply stated that he could not stand by and hand over the reins.  He disagreed with my assessment about his abilities and the company’s future not being as bright as it could be with an executive more skilled in the areas that represented our new opportunity.  On the other hand, I disagreed with his assessment about his capability to achieve all the potential this company given this lack of experience in certain areas and I wondered why he, as a significant investor, would not want to build this company to the level it could achieve with talent better suited for the wonderful opportunity we have.

We were at an impasse, so the only common ground we could find was to agree for him to continue to execute on the current year’s plan with him at the helm and begin to explore a process to sell the company at some point in the future.  We will make money, but in my judgement not nearly as much as we could have.

Who’s right?  I don’t know – I hope its me.  I have certainly been proven wrong before.  Maybe we can execute on the rest of the year and we will both sit down and review the objective metrics achieved and, given this evidence I will change my mind. I hope so.  I’d like to think that my decision making and the actions I have taken were completely objective.  Given that I am human, probably not though!  I think one of the best traits that a person can have is to be able to recognize when you have made an error and admit it.  I hope that I am wrong here.  It’s not about who is right and who is wrong – it is about building something that is great.  I think that is why VC’s who are any good like what they do – we are builders and building something great is a lot of fun!  The CEO had gotten the company back on track.  Didn’t he deserve a chance to continue to run the company?  Seems so.  Did I want to continue this search because of our historical bias against him?  Maybe.  We’ll see how it turns out.

So you see, its easy to write about how it should be.  It just doesn’t happen that way all the time.  The only advice I have is to do the best you can with what you got…

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