Start-up companies often focus on small, uncertain opportunities with large growth potential. Contrast this to the approach taken by larger established companies which lack the flexibility and innovation of start-up. By their very nature they have created lower risk environment and recruit people who ‘fit the culture’, reinforcing more structured approach.
Consequently, entrepreneurs tend to avoid the governance practices typical of larger companies even though governance is exactly what they need to achieve the aggressive growth sought in later stages of development.
Overcoming initial complacency
At the concept stage the entrepreneur is risking only his or her capital, time, and intellectual property. For instance US research shows that, on average, start-ups have remarkably low levels of initial investment with 26 percent having less than US$5000 and 60 percent with less than US$50,000. In New Zealand, start-up companies on average begin with approximately $50,000 in initial capital.
Nevertheless it is the early phases of start-up company that hold the greatest risk, and in particular those involving prototyping and product development. When the business appears to be creating real value, the entrepreneur increases the risk by pursuing growth strategy.
Growth brings the demand for extra capital which attracts investors who set aggressive targets, encouraging higher risk taking, greater costs by hiring experienced managers, and more formal planning, reporting and controls.
At this dynamic stage, proper governance can greatly assist senior management in fulfilling key responsibilities so that prototypes reach the production phase and beta models win customer support and positive testimony. And by providing access to sufficient capital and international marketing skills at board level, effective governance ensures the end products reach market with an installed base of successful client sites.
The need for experience
There is considerable debate about the need for the entrepreneur to have industry experience or proven track record in bringing product to market. This causes dilemma from governance point of view. To attract venture capital the new investor wants to see team with ‘industry experience’, however the innovation and flexibility that drives the initial discovery is not always result of experience.
Studies show that less than 40 percent of entrepreneurs have experience in their target industry and as many as 30 percent were not even in paid employment. These entrepreneurs display risk-taking approach focused on solving problem. Their responsiveness to customers and penchant for selling solutions works well in the concept and development phase, however it is in the prototyping and development phases that pressure is exerted by new investors to bring in experienced hires. This is one of the reasons entrepreneurs rely on the money of friends and family – to avoid the pressure from ‘outside’ investors.
These first pressures or frictions appear to be clashes of knowledge but often they are actually arguments for control of the business’ direction. They may manifest themselves as disagreements over minor decisions but sometimes they are precursors for more fundamental issues, ie, who is going to be in control of key business decisions such as growth, risk, research, investment and marketing strategies.
This issue of ‘need for experience’ is often really about the need for person who can be link between the entrepreneur’s specialist skills and the marketing expert, without upsetting the balance of power at the board table. This is increasingly available in the form of Industry NZ and incubators or accelerators such as Auckland University’s Icehouse or Massey University’s Centre for Innovation. These have the advantage of bringing valuable expertise to the table on neutral basis, as they are not investors.
Board skills
Each start-up company should set up board of directors, which includes the following individuals:
1. The entrepreneur, who brings innovation and prototyping skills.
2. The second board member who understands the development cycle of production, distribution, installation and customer support.
3. The third, who knows how to maximise the potential from each market, ie, promotion, negotiating commercial terms with users and, crucially, licensing distributors and protecting intellectual property.
4. And finally, the fourth person who represents the investors. He or she will have skills in raising further capital as well as ensuring appropriate governance, reporting, controls and management are in place to give confidence to other potential investors.
In addition, the board should make use of advisers in the financial and legal areas, as well as specialist groups such as accelerators, incubators, and Trade and Enterprise New Zealand.
The planning phase
As the business moves into the growth phases of production and market penetration, there is greater requirement for strategic and operational planning. For the original entrepreneur, the change can be traumatic given entrepreneurs have unusual traits. Studies have found that only 30 percent of entrepreneurs have rudimentary business plan. Significantly they have often experienced failure before and only succeeded on their second or third attempt. Contrast this with corporate executives who rarely have to recognise failure as being ‘theirs alone’ and who seldom leave the security of corporate role to take the risks associated with being an entrepreneur; the opportunity risks are too high.
Consider then the reaction of entrepreneurs who are required by investors to bring in ‘experienced executives’ with the skills and disciplines of business management learned in the relative safety of corporate management roles. Spontaneity and speedy adoption can be replaced by planning and innovation within the constraints of cooperative decision making.
While this can cause friction at governance level, the demand for growth prevalent in start-ups requires this more structured approach, which coincidentally comes at the most risky period of the venture’s development. Therefore it is essential that thorough business plan be presented to the board to identify key risks and build mitigation and risk monitoring strategies into governance procedures.
Evolving with the business
The key learning point from governance point of view is that the need for planning must evolve with the business. The very things that made the entrepreneur successful and created the business must change to meet new demands for shared decision making. This is counter-intuitive to the entrepreneur who must do more things in way that is the opposite of what has made them successful.
Knowledge of these phenomena at board level as well as mentoring and guidance for the entrepreneur are essential governance competences. Rifts and division involves behavioural issues that must be addressed by the board.
Again the answer is not always found in those experienced executives sought by investors. Such executives have spent corporate lifetime hiring and developing people with the right skills who fit the culture; arguably they are not always used to working with the ‘maverick’ behaviour of an entrepreneur.
Accordingly, the use of incubators or neutral advisers such as Trade and Enterprise NZ can provide more objective opinion. They facilitate behavioural issues by helping entrepreneurs transit from unstructured innovators to strategic risk takers who bring investors with them on the journey to success.
Growth challenges
The drive for growth and the demand for capital create significant challenges. High growth often involves international expansion which is costly, particularly for New Zealand ventures.
This requires new investors who demand influence and controls at board level which may cause friction. Furthermore, the goals and values of the original entrepreneur and the new investors may not always be c
