A word of warning: VC’s and CEO’s may hate this post, though more the former than the latter unless you’re the New CEO replacing the Old CEO.  I must also say that the Valley has gotten better in recent years as it has realized that replacing a CEO is no small thing.  Many now conceed that may be easier to train a good Founder to be a CEO than to get a CEO to understand what the Founder has hardwired into their DNA.  Nevertheless, replacing CEO’s is a very common thing in the Valley.  Young entrepreneurs have no idea how prepared their Board is to do so if they hit a rough spot.  I had a VC tell me one time, “Replacing people is what we do, that’s really how we add value.”  What the Young Entrepreneur may not know is that perhaps their Board made the decision to replace the Entrepreneur as long ago as the very first time they gave them money.  I guarantee any smart investor will have thought about it and decided how far they think the Founding CEO can take the company.  A clock may be ticking that the Founder doesn’t even know exists.

I will leave aside the discussion of what the replaced CEO/Founder ought to do.  They’re going to have to figure out how to make peace with the new arrangement and whether to stick with their company.  Ideally, everybody knew it was coming and the Founder didn’t even want to be the CEO.  Equally as ideally perhaps the New CEO and the Board will continue to see some value in keeping the Founder around and that value will be something the Founder is prepared to deliver.  In that case, maybe there is hope and you should disregard this post.  These are matters for the Founder to consider with regards to their career, but if you’re not a Founder, read on because your situation is different.  This is not about whether it’s possible to hire a better CEO or whether there aren’t companies that have done very well hiring new CEO’s.  It’s not about the fate of companies at all, it is about the fate of your personal career.  This is about some math and some personal experience that both speak loudly to my own calculations about career.

First thing is, I have a fair bit of experience with this process.  Out of 7 gigs so far, 3 have involved a CEO replacement and at the most recent one, I was the CEO that replaced the incumbent.  Based on the experiences of the first two I had decided that if the CEO was replaced in future gigs, I was moving on.  This is what I told the Board the first time they came to me and wanted to replace the CEO at the third gig.  What I hadn’t counted on was that they would ask me to step up to the position at a later date.  Somehow, when that happened, I forgot my old plan and launched into the CEO job with gusto.  We showed immediate strong growth and got the customer to where it should’ve been in terms of financial metrics for a SaaS company of our size.  It didn’t matter in the end and the company failed because it couldn’t raise a round (which is the cause of death for most startups).  I should have stuck with my original plan and moved on when the CEO was replaced.

I can walk you through the whole story and point to ample extenuating circumstances for why the company couldn’t raise a round–we needed to raise that round shortly after the 2008 Dinosaur-killing Sequoia memo went out, one of our two VC’s wouldn’t participate because they had investments in competing companies, yada, yada.  It’s all bullshit because these were symptoms and not the disease.  When Boards replace CEO’s they are fixing a Big Problem.  Typically it is a very big problem, although it may not be the problem you think it is.  You’re there, in the trenches, focused on winning at your startup.  Your Board is jaded, they have a lot of other investments, and they’re focused on minimizing their pain while they let their winners run with as much rope as possible.  They are far more subject to Deal Fatigue than you are, and they’ve heard so many presentations filled with facts and figures that they’re much more willing to go with their Gut.  They have the luxury of going from your Board Meeting, which is depressing as heck, to one at another portfolio company that is leaping over tall buildings in a single bound.  Only the very best Board Members can be objective and keep all these experiences separate.  Put your hand in cold water and then into lukewarm water and the lukewarm feels scalding hot.

That Big Problem will be described in rational terms like, “This company has never hit a target yet on Sales.”  But, the reality may simply be that not only are they tired of dealing with missed targets (which may have been overly optimistic, missed by just a little bit, or impacted by Outside Events out of the Company’s control), but they’ve also lost their optimism, and they don’t trust the Old CEO.  That’s a very dangerous Big Problem to try to solve because Deal Fatigue magnifies the scale of every problem.  You see, the VC’s never had the degree of Hope and Fanaticism that I hope you came into the deal with.  They can’t, they’ve seen too many fail and they’re totally bought into the Portfolio Effect.  They don’t have to fight every battle tooth and nail, they just have to know where to double down and where to cut their losses.  You can’t take it personally, it’s their job and their business and they are good at it.

So if the CEO is being replaced, your business is probably facing the very biggest problem the Board can imagine plus a lot of subjective negative momentum that only the Board feels.  It’s both a numbers problem and a relationship problem.  Naturally there must be a relationship problem, because events are leading to a divorce.  Sure, maybe it’s all proactive and there’s no problem beyond a little growing pain.  Right.  And maybe that horse over there is really a unicorn that temporarily misplaced his horn.  There are two cases to replace the CEO:

1.  The incumbent was never going to take the whole trip and knows it and everyone has found a happy upgrade.  This is a Good CEO Transition.

– or –

2. That Big Problem is staring the Board in the face (numbers) and they don’t believe the incumbent can get through it (relationship).  This is a Bad CEO Transition.

This is the time to take a good hard look at the Old CEO and ask yourself whether they were the sort that never planned to finish the job and they welcome an incumbent.  You can tell if you’re any kind of judge of character at all.  The signs will have been there all along.  The Old CEO will be too young and inexperienced.  They will lack ultimate leadership potential and CEO gravitas.  The new guy, meanwhile, will be much more experienced and will carry much more gravitas.  They’ll be exceedingly smooth and confident.  There will be at least an initial sense that the old and new CEO’s like each other.  Those are some of the signs of a good CEO transition.

In a bad transition, the new guy may be a little more experienced at being a CEO or they may be the same or less CEO experience.  They often have a totally different background, “Hey, all we need to do is replace this Engineer with a Sales Guy and we are Golden.”  They often have a track record that has little to do with Startups and everything to do with having been a lesser executive at a much bigger company.  It’s the first CEO gig for an SVP of Sales, for example.  When they’re together, which will be rare, the Old and New CEOs don’t talk to each other much and don’t make much eye contact.  The Old CEO is either completely absent or remarkably quiet compared to his old self.  He’ll have nothing to say about his plans going forward.  “I just want to take some time off to relax with my family and decide what I’ll do next.”  Lastly, if the New CEO has some kind of amazing comp package, that’s a sign that an otherwise talented exec is being asked to step in and do what the Board views as Mucking out the Stalls.  Those are some of the signs of a bad CEO transition.

If your company has had a tough time making its numbers, if it has been pivoting, if there is unusual pressure for progress, if you’ve either just raised or are about to raise a round, and you see the Bad CEO Transition Signs, get your resume in order.

Why move on if you’re dealing with a Bad CEO Transition?

First, let me direct you to Jason Lemkin’s missive about what the dilutive effects of a new CEO will be.  What he has to say is absolutely true and I’ve seen it from both sides of the table (as the New CEO and as an exec greeting the New CEO).  Virtually everyone except the New CEO and VC’s will be taking a significant equity haircut.  It’s got to come from somewhere and the New CEO is the savior while the Board doesn’t consider itself part of the problem.

Second, consider what happens after the New CEO is hired.  For starters, you know something ugly is out there in the Board’s purview, whether or not you’ve been told what’s going on.  If you don’t already know, nobody is going to let you in on the secret just because there is a new CEO–quite the contrary.  Publicly, there are no Bad CEO Transitions, there are only Good CEO’s brought in amicably for the continued maturation of the company.  Besides realizing there is a Big Problem, you also have to come to terms with the challenges New CEO faces in overcoming that problem.  No matter what anyone may think, CEO’s are punished way too much for failure and rewarded way too much for success.  In other words, New CEO is going to have to make a lot more changes because just changing the CEO doesn’t go very far to solving the Real Problem.  New CEO can’t do it alone.  They are going to need a lot more capital (hence the dilution Jason writes about) and talent.  Unless your problem is one of simple execution, New CEO also faces the problem of educating themselves enough on your company and space so they can begin to formulate a solution.  Once they arrive at a solution, it will nearly always require still more time to hire the right people to help facilitate that solution.

Translation:  There will be no progress on your Company’s Big Problem during the CEO’s first six months and still no progress for probably much longer.

In fact, there may be no measurable progress for more than a year, although a smart New CEO will find something to declare victory on within 6 months.  Meg Whitman wants five years to show much progress at behemoth HP.  The reason it’ll take much longer is that even after the CEO formulates a new plan (what they’re doing the first six months), they must then get all the rowers in the boat moving in that direction and doing so with enough force that it has some measurable impact.  During that time, at least another six months, all sorts of unpleasantness will surface.  Anyone in the organization with a political bone in their body will be trying to romance the New CEO either to advance their own personal position, get New CEO to embrace their agenda for how to make it all better, or often both.  All those battles Old CEO fought to get the troops aligned and moving in one direction are suddenly undone, and the Old Combatants will be back to thinking they were right in the first place and the fact that Old CEO lost his job just proves it.

There is a tiny bit of good news in that if New CEO has been around the block and is smart, he knows darned right well the politicians are out in force and he is taking notes.  When he has a good idea who the worst offenders are, he will replace them with his own Trusted Lieutenants.  That’s good news assuming the Trusted Lieutenants are less political and are genuinely stand-up people who will help the Company succeed.  New CEO will probably also replace whoever runs the part of the company perceived as being the biggest part of the Big Problem.  Of course determining the truth of that is also ripe for political discord.  Sales will argue the Product sucked or that Marketing never got them enough leads.  Marketing will argue Product didn’t listen to their Product Managers, didn’t build enough product, or that Sales didn’t follow up the leads they were given.  Product will argue there’s been Sales Execution problems or that Marketing never really understood their product and wasn’t able to present their beautiful baby in a good enough light.  Finance will skewer anyone that was off budget by even a little bit.  This will all slow down the ability of New CEO to figure out what is happening considerably.  The smart ones may just choose to ignore all the history, focus on the Big Problem, and just start implementing their idea of Best Practices in whatever parts of the organization are most likely to improve on the Big Problem.  This is scary to all concerned because the changes are not motivated by anything in the Company’s history–they’re motivated by New CEO’s history and experience, which is not yet well known or understood withing the Company.  That’s why it will seem like there is no rhyme or reason to the decisions being made–you won’t have the right background to understand them.

If you are unfortunate enough to be in one of the organizations affected by these changes, life will be tough.  Progress in your area will be delayed while this cycle of learning, renewal, and execution winds it way down through various org charts until it has gotten sufficiently far from the source of the pain (the Board is the source) and sufficient time has passed that we can’t afford to keep rearranging the Deck Chairs on every deck.  A lot of the changes will make no sense to you at all, and you may wake up one day to find yourself in a company that bears little resemblance to the one you were so committed to not very long ago.  Whatever your motivations–money, a chance to work on something really cool, belief in the dream, etc.–it may no longer be possible to pursue them.  At best, a lot of time will pass and you’ll look ahead and still wonder when things will get back to “normal”.

Does all of this really have to happen?

If you have a Bad CEO Transition, in other words, one to fix a Big Problem, then I’m afraid the answer is, “Yes, that’s pretty much how things play out.”  Whatever happens, it will take a lot longer than anyone hopes to fix things.  Often, things will not play out and the company will be in permanent decline.  None of the three CEO replacements I’ve participated in resulted in a company that was ultimately better off.  Two of the companies are dead (Borland was a $500M a year high flyer and it is still dead having fallen inexorably with Philippe Kahn’s departure), and one still has a chance to get there, but at least from a shareholder value perspective, their high point is a long time back.

What do you do in these cases?

If you are in the right position, likely an executive reporting to the CEO and someone who at least sits in the Board Meetings, you are in a position to see it coming.  Watch for what I call the Three Deadly Sins of a CEO:

1.  They’ve missed their numbers.

2.  The Board is not confident in their plan to fix #1.

3.  They are not taking coaching from the Board.

In every one of the Bad CEO Transitions I have witnessed, these three sins have been allowed to go on for too long.  That is a surefire way for a CEO to get themselves fired.  Make no mistake, every CEO will break all 3 deadly sins at some point.  Many will break 2 at a time.  Some will break all 3.  That latter group has a very limited time in which to show results before the Board will take action.  I would say 6 to 12 months depending on the level of Deal Fatigue the Board is fighting to maintain perspective against.  For startup CEO’s, Deal Fatigue is charged directly against Political Capital and when you run out of PC, you’re toast.  Unfortunately, Deal Fatigue carries on like any other debt, and even the New CEO inherits the Deal Fatigue which is charged against their PC from the outset.

If you are not in a position to judge the subtle nuances of the Three Deadly Sins of a CEO, you may have to wait until the deed is done and the Old CEO is out before you know what’s happening.  In either case, once you know what’s coming, it’s time to prepare your parachute because the plane is going to lose altitude quickly and may very well crash.  If you’re lucky, the Outside World can’t tell there is a Big Problem.  The Board and everyone else will try to put forward the face that it is all a logical progression.  Find your next position on the strength of whatever positive sentiment remains around the deal.  If you ultimately believe the deal will be a success, buy out your options as cheap insurance that you will still profit to a degree.

Perhaps the best way to look at it, if you can be so objective, is to consider whether you would take the job with the company as it stands with New CEO and knowing everything you know about it.  Forget the old Dream that taints your soul and judgement.  Do you want to work at a turnaround?  One way to do that is to assume you have to start vesting your options all over again with a 1 year cliff.  The dilution, confusion, delays, and added risk associated with New CEO are going to amount to the same result anyway.  If you’re like me, and you’ve seen how the movie ends a couple of times, you’ll regretfully move on to find something new and less tarnished.  Unless of course it’s you they’re asking to step up and be the CEO.  My advice if that happens is to only consider that job if you’re a corporate ladder climber at heart anyway.  If you’re an entrepreneur, you won’t be happy and there are easier ways to get to be a CEO with none of the downsides.

What happens if you stay?

There are two winning strategies in turnarounds–you either want to be the first to leave or the last.  The last to leave gets to reap any benefits of the turnaround and having been part of it, may be rewarded more.  But there is the certainty that at best, the Company will wind up back on whatever Dream Success Track you had imagined, but it will happen much much later than you’d expected.  Alternatively, you can go find a new opportunity that doesn’t have the Deal Fatigue and Political Shuffling needed before New CEO can be successful.  BTW, make sure your new opportunity’s CEO has been there for at least a year and tangible results are surfacing in your new company’s press releases lest you be jumping from the frying pan into the fire.

PS  Isn’t the Jobs-Sculley picture strangely prophetic?  Sculley is leaning on the Lisa, which was the more buttoned-down-and-business-like computer and Jobs is leaning on the upstart Macintosh.  That’s not unlike their styles, personalities, and even their track records.  Today there is no sign of Sculley or Lisa anywhere and the Mac is stronger than ever.  Also, the transition from Jobs to Sculley was a Good CEO Transition and the one back to Jobs was a Bad CEO Transition.  One put the company into a funk for years–so much for ignoring this advice to move on when it’s a Good CEO Transition.  Steve Ballmer represents another Good CEO Transition and an argument to have moved on from Microsoft when Gates left.

The Bad CEO Transition (back to Jobs) brought Apple back to life as one of the World’s Greatest Companies, but even that last miraculous transformation took quite a while–years.  If we look at the Return of Jobs as the Best Possible Bad CEO Transition, that’s another way to get the measure of how such things may matter for your career.

Jason and I don’t always agree, but Jason is a prolific blogger and a very bright executive you can learn from, so there’ll be a chance to agree somewhere down the road.  This latest post of his is one I loved.  He’s basically describing the problem of hiring your first Sales Rep if you don’t have an experienced VP of Sales to do the hiring.  The advice is simple:

If you only hire one rep, you won’t learn anything.  You’ll have no idea why they succeeded or failed.  If you hire two, you can look at the differences in style and results as well as benefit from the sum of both of their experience sets.

The analogy to A/B testing for marketing seems clear to me.  If you just make a change and roll it out, you have no idea how that change affected your subsequent results.  You can speculate that it drove them, but you really need to have the placebo in your testing to compare it against.  That’s why A/B testing is so important and I was tickled to see it applied to this problem.  It’s very smart advice.

I have known excellent VP’s of Sales who do essentially the same thing.  There is an old saw about how at any given time 1/3 of the sales reps are making their numbers, 1/3 are not, and 1/3 are so new it is too soon to tell.  Every year they fire the group that didn’t make the number so they can hire a new 1/3 and continue the process of Darwinian selection.  If the company overall misses, nobody fires the whole sales team, at least not if they had been making numbers in prior periods.

Happy New Year’s all!

I’m waking up well-rested this first day of the New Year and my blog reader is full of more of the same as regards how to fix our ailing economy and what our nation should do going forward.  There’s quite a lot of hand wringing about how the Fiscal Cliff deal was too weak because it didn’t address spending, how we’re going to have to learn to get by as a nation with fewer and fewer jobs, and a bunch of other malarkey   I use the word “malarkey”, because I have come to believe that as a nation and a culture (both naturally and in the sub-culture that is high tech startups), we consistently bet on the wrong things for long term success.

In no particular order, let me use this post to tell you what I mean:

–  We’re focused on the Fiscal Cliff, raising taxes on the rich, and cutting our deficit.  Nothing wrong with any of those possibilities except that not one of them will help the biggest problem our economy faces right now, which is that unemployment is way too high.  In fact, a lot of it, actually makes that problem worse.  Instead, we seem content with the idea that if we tax the rich more and slash the deficit enough, that will somehow fix the problem.  Paul Krugman, love him or hate him, is a Nobel prize-winning economist.  I don’t much care for his politics, but one thing I’ll say for him is that whatever proposition he puts forth, he provides data to support it.  One thing he’s been saying since the mess started is more spending, not less is what’s needed.  He’s gone on to show vast amounts of historical data on why this is so and we have the very convincing benefit of a double blind test where Europe went heavily down the austerity path while the US went with a (not quite big enough) stimulus plan.  Guess what?  We’re much better off economically and you can see that in black and white.  Fred Wilson writes that we’re now going to have to endure a “Death by a Thousand Cuts“, and I think his sentiment is totally wrong.  If Keynesian economics is write, and the data continues to show it is, that those “Thousand Cuts” represent forestalling real spending cuts to a time when they can be better afforded and we don’t need the extra propping up.  Sure, the money could be better spent, but none of the proposals are about how to do that.  Bottom line is there is a ton of data on this stuff, the path is clear (spend when the chips are down and cut when times are booming), but we’re so focused on the wrong targets and so politicized this is ignored.

–  We allow ourselves to believe that the job problems are structural, that there will simply be fewer jobs going forward, and there is nothing we can do about it.  Fred Wilson’s partner, Albert, says as much in his New Year blog post, “Starting 2013 with a whimper“.  Krugman will give you link after link where he suggests it isn’t structural at all.  Heck, I have seen it myself.  I recently visited family in Houston, Texas.  The place is absolutely booming.  There’s so many jobs there is a danger of overheating.  At one point in the Presidential debates it was pointed out that 1/2 of all the jobs created during the Great Recession where in this one state:  Texas.  For a real eye opener, use Zillow to compare real estate prices there versus Northern California.  They basically never felt the crunch the rest of the nation is experiencing.  Why?  Because of the Oil Business.  It is a business that creates real jobs.  It is an industry that spends on expensive machinery that wears out quickly.  Machinery and technologies that were developed here, where we are the world’s foremost experts.  Machinery that operates under conditions of extreme stress and breaks a lot.  It’s an industry where we can’t afford to wait for a container of parts to come from overseas from the low-cost bidder because that is too expensive and the low cost parts just break again even sooner.  It’s an industry that can’t outsource itself overseas and keep all of its profits overseas to the degree Apple has.  Imagine what it would do for the economy if we were more focused on job creating industries like this one than on building the next advertising driven social network.

–  We’re completely focused on the need for ever more progressive taxes on individuals while having let the real horse, corporate taxes get well out of the barn.  All that chit chat about how great the economy was when individuals were much more highly taxed goes double for corporations.  In fact, the difference in historical taxation for corporations is much larger than for individuals.  We hear that raising taxes on corporations destroys jobs, but as far as any logic goes, it is quite the opposite.  The most profitable company on the planet, Apple, has vast hoards of cash sitting in the bank and what few jobs they do create are all overseas.  If their profits were taxed like crazy, two things would happen.  First, they’d have a much higher incentive to raise their expenses (e.g. hire more people) and invest rather than salting it away and paying taxes on it.  Second, it would result in indirect progressive taxation because it would be far less attractive to pay huge earnings multiples for a share of stock and it would be far less attractive to distribute profits as dividends.  Making capital more expensive wouldn’t matter though because Apple is clearly not a particularly capital intensive company else they’d be investing and not salting away all that cash.  Why aren’t we making corporate income tax hugely progressive just like individual taxes.  Leave small businesses alone and tax the heck out of the Apple’s?

–  As a complete aside from taxes, we are too focused on Big Companies and not nearly focused enough on Small Business.  It’s been shown time and again that Small Business creates jobs while Big Companies destroy jobs.  Yes, when Obama came to Silicon Valley, who did he meet with?

–  As a country, a culture, and in the Digital Technology Microcosm, we have focused far too much on price and not nearly enough on building the best there is.  It has become popular to say that because companies like Facebook have ad-driven models, “we are the product”, and that’s why we are not treated well even though we think of ourselves as customers.  This goes a lot further when we focus entirely on price (where ad-driven is the ultimate price focus).  Pricing focus destroys a disproportionate number of jobs while quality focus creates a disproportionate number of jobs.  There have been some articles that point this out.  A focus on efficiency can only free up capital.  A focus on doing fundamentally new things that haven’t been done before might create some jobs.

–  We are too focused on investing in endless get rich quick schemes.  The Darwinian model of throwing out a tiny bit of seed and waiting to see what takes off with little capital is just too appealing when you have a big portfolio to help balance the risks.  Unfortunately, it self selects temporary fashion hits and things that are easy to do (they have to be) and creates few jobs and very little lasting value.  Compare and contrast creating the world’s best system for frac-ing oil reservoirs versus reinventing a better system for restaurant menus and ask yourself which one is going to do more to buoy our economy and create good jobs?  Here’s the list of food-related startups the same VC mentions in his article on reinventing menus:

 E la Carte, and other food-tech startups like Blissmo, Chewse, ClubW, CraftCoffee, CultureKitchen,DailyGobble, EcoMom, Farmeron, FoodA, FoodSpotting, KitchIt,GoSpotCheck, LoveWithFood, MileHighOrganics, NetPlenish, Ordr.in,ShopTouch, TeaLet, Ven.io, WholeShare.

I just look at the list and see more of the same, no real companies, no real jobs.  What could have been done in terms of creating the next real software company if all the seed money that went to the long list of food-related startups from the same VC had been focused?  Half the stuff Dave bemoans as being missing I can get pretty close to with Yelp already.  Do we really need to divide that pie to finer and finer degrees?  And just because it is a popular meme for bashing, do we need any more photo startups?  Which among the ranks of the unemployed have the inclination to do all the dining out and photo taking to grow those markets?  It kills me to admit it, but it is enough to make me want to agree with Arrington–not only is this ineffective, it’s downright boring.

The worst iteration of this has been Wall Street, which successfully sold the doozy that a “Free Market” is the same as a “Competitive Market’, and that therefore we should deregulate them as much as possible.  It’s only the competitive markets where the invisible hand is strong enough to do the right thing.  Anything else is a monopoly of one kind or another.  Monopolies can come about in industry, and they can also come about when the leverage inherent in exotic derivatives and deregulation puts control of too much in the hands of too few who are then willing to make a profit no matter what the cost.

–  We are too focused on riding the bubble rather than on building lasting value.  I will refer you to my post on Riding the Bubble for more.  Just do a search on this blog for Bubble and you’ll see it isn’t a new theme.  The Bubble Riders are all Momentum investors because there seems to be very little Value Investing at all in the Venture World.  It’s a shame because the most successful investor of all time, Warren Buffet, is a value investor, not a momentum investor.  But, we live with a monoculture when it comes to investment thesis.

If all this is what passes for how it will be done in the future, we shouldn’t wonder if the economy continues to suffer.

Meanwhile, it’s a New Year.  We don’t have to keep doing things the old way.  Selfishly, we can realize that ultimately you have to be a Contrarian at some level in order to have an edge.  I hear the VC’s are ready to switch to Enterprise for a while.  Let’s all turn over a New Year’s resolution to look at a bigger picture, see a longer term, and consider a change.

We’re due for it.  This other stuff has been failing us for a long time.