Why do venture capitalists focus so much on the management of startup companies? Why do VCs want experienced CEOs over great ideas and marketability, even? It’s the leadership factor. I recently wrote a blog touching on the topic of how choosing the wrong CEO can lead to a funding roadblock. I’m going to give some examples from my own investment experience that illustrate why VCs want experienced CEOs.
VCs Want Experienced CEOs Because It Takes Leadership Experience to Run a Company Effectively
So, why do VCs pay so much attention to investing in experienced CEOs? Because they have the management skills needed to accomplish a startup company’s objectives.
A classic example, which is not from my personal experience, of why VCs want experienced CEOs is Don Valentine’s insertion of John Morgridge as the President and CEO of Cisco Systems in 1988. It wasn’t until Mordgridge became CEO that Cisco exploded to become the successful company we know today.
Another example is FRS, Inc. FRS was a drive repair company in the 1980s. Its business model was to accept broken computer hard drives and repair them to sell them at a profit. In his first few years, the founding CEO had difficulty attracting customers and driving down repair costs. The board of directors brought in a new CEO, who was much more effective at both. Unfortunately, however, the company’s business model failed as the cost of disc drives became so low that it was not worthwhile to repair them. Better leadership from the beginning could have made a difference.
Investors Don’t Want to Gamble on Ideas Over Experience
VCs want experienced CEOs because bright ideas only get you so far.
What’s the logic? No matter how genius a startup company’s idea and business model are, it still takes effective management to build a successful company. Are there some successful first-time CEOs? Yes, of course. However, most Venture Capitalists have learned that the background and previous successes of the CEO can be critical.
In addition to being the focal point for executing the startup company’s strategies, the CEO is also the point man for interface to the venture capital firm. Almost all of the venture capitalist’s interaction with the company will be through the CEO, so VCs are relying on the strength of the CEO as a manager and as a communicator to keep them up-to-date with the company’s activities.
What I’ve Learned About Why VCs Want an Experienced CEO
One example from my own experience proving that VCs want an experienced CEO is NovaDigm Therapeutics. They developed a vaccine for both candida and staph (MRSA) infections. The founders were outstanding researchers at Los Angeles Biomedical Research Institute. Yet none would have qualified as the CEO of a startup company according to investor’s standards.
So, I helped organize the company’s formation, strategic plans, and fundraising documents. We successfully raised eighteen million from Domain Associates but only on the condition that, once the company was funded we would use one of the executive search firms to find an experienced CEO.
Lack of Effective Leadership Can Stifle Outstanding Potential
Because VCs want experienced CEOs, some brilliant companies with outstanding potential fail, despite their potential, with the wrong leadership.
For instance, Speech Systems was a voice recognition company with technology similar to what we know today, such as Dragons Systems or the voice-to-text technology on an iPhone. This was in the early 1980s, and its software was robust, but computer power was not nearly what it is today. So the system’s performance was marginal.
The founding CEO was an outstanding scientist and did a good job of starting the company and getting initial funding. Despite this, he was not able to raise the additional capital the company required to either further develop the technology or even take it to market.
Why? Because the directors felt it was necessary to bring in a new CEO to raise significant capital. After doing so, the company raised five million. Unfortunately, the new investors insisted on pushing the company into the marketplace prematurely, and it ran out of capital.
VCs Want Experienced CEOs Already In Place. Otherwise, Time is Wasted
DRC was a supercomputer accelerator company founded by a brilliant hardware scientist whose first company failed because he was unable to raise capital. Again, this happened because VCs want experienced CEOs and they did not see him as having the necessary management skills.
After the first company failed, I suggested that he bring in an experienced CEO to start a second company, which he did. This resulted in six million dollars of financing. Ultimately, the company was successful and was acquired by one of its largest customers. This isn’t always the case, however. VCs want experienced CEOs to already be in place so their investment is less of a gamble.
Be Willing to Adapt to the Company’s Changing Needs
Yet another example of placing the right CEO at the right time is LivesSafe (originally Crimepush). LifeSafe was the invention of two brothers seeking a way for people to use their cell phones to report a crime via a text message, voice message, or video to the local 911 center.
They did a great job of using equity to attract a technical team capable of implementing the first product. And they got invaluable national publicity from a couple of early successes.
Wisely, when they began to approach angel investors, they realized they would need a more experienced CEO to raise capital. Fortunately, they met an individual who could serve as both an angel investor and the CEO. Subsequently, this founding CEO was replaced by a still more experienced CEO, and the company raised an additional ten million.
Another example is IC Sensors. This company was founded by a superb technical team who knew how to build microdevices by applying semiconductor manufacturing techniques to silicon. For their initial venture capital financing, they brought in a CEO who had some prior CEO experience. One of the conditions for the initial financing was that some accounting and operational problems needed to be resolved.
After some months, the board decided that the company was not performing well and the conditions for investment had not been satisfied. So, it recruited a new CEO who did an excellent job of sorting through various commercial opportunities for the technology. They even ended up creating two very successful product lines and selling the company at an attractive profit.
So there are two lessons here:
1) It helps fundraising if you have an experienced CEO already in place because time is wasted finding a more fitting CEO.
2) Sometimes, when a company enters its growth stages, a new CEO is necessary because they are a better fit for that stage of growth.
VCs Want Experienced CEOs Because of Their Skill Sets
Everything mentioned above is just a small sample of situations, but these are not isolated examples. Venture capitalists appreciate the importance of having competent management at the helm of a startup more than anything else.
Of course, having an experienced CEO is not a guarantee of success, but VCs want experienced CEOs because this at least assures that they have hands-on knowledge of some of the most critical management tasks.
VC’s Look For CEOs Who Have Experience In:
- strategic planning
- negotiating
- fundraising
- hiring
- firing
- building and motivating a team
- accounting
- fundraising
- dealing with a board of directors
- coordinating activities
- forecasting
- resolving conflicts
For the first time, CEOs who frequently have most of their experience in a laboratory, or an engineering or marketing group, often do not have this experience. So it’s not surprising that seasoned investors will lean in the direction of experienced managers instead.
Ideas and marketability will only get you so far because experienced leadership is more valuable in the long run. This is why VCs want experienced CEOs. And your company is much more likely to get funding if you have one in place.
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