EVERY GREAT COMPANY is unique, but there are a few things that every business must get right at the beginning.
I stress this so often that friends have teasingly nicknamed it “Thiel’s law”: a startup messed up at
its foundation cannot be fixed.
Beginnings are special. They are qualitatively different from all that comes afterward. This was
true 13.8 billion years ago, at the founding of our cosmos: in the earliest microseconds of its
existence, the universe expanded by a factor of 1030—a million trillion trillion.
As cosmogonic epochs came and went in those first few moments, the very laws of physics were different from those we know today.
Companies are like countries in this way. Bad decisions made early on—if you choose the wrong
partners or hire the wrong people, for example—are very hard to correct after they are made.
It may take a crisis on the order of bankruptcy before anybody will even try to correct them. As a founder, your first job is to get the first things right, because you cannot build a great company on a flawed foundation.
When you start something, the first and most crucial decision you make is whom to start it with.
Choosing a co-founder is like getting married, and founder conflict is just as ugly as divorce.
Optimism abounds at the start of every relationship. It’s unromantic to think soberly about what could
go wrong, so people don’t. But if the founders develop irreconcilable differences, the company
becomes the victim.
It’s not just founders who need to get along. Everyone in your company needs to work well together.
Freud, Jung, and every other psychologist has a theory about how every individual mind is divided against itself, but in business at least, working for yourself guarantees alignment. Unfortunately, it also limits what kind of company you can build. It’s very hard to be monopolist entrepreneur without a team.
A Silicon Valley anarchist might say you could achieve perfect alignment as long as you hire just
the right people, who will flourish peacefully without any guiding structure. Serendipity and even
free-form chaos at the workplace are supposed to help “disrupt” all the old rules made and obeyed by
the rest of the world.
And indeed, “if men were angels, no government would be necessary.” But anarchic companies miss what James Madison saw: men aren’t angels. That’s why executives who manage companies and directors who govern them have separate roles to play; it’s also why founders’ and investors’ claims on a company are formally defined.
You need good people who get along, but you also need a structure to help keep everyone aligned for the long term.
To anticipate likely sources of misalignment in any company, it’s useful to distinguish between
three concepts:
• Ownership: who legally owns a company’s equity?
• Possession: who actually runs the company on a day-to-day basis?
• Control: who formally governs the company’s affairs?
A typical startup allocates ownership among founders, employees, and investors. The managers
and employees who operate the company enjoy possession. And a board of directors, usually
comprising founders and investors, exercises control.
In theory, this division works smoothly. Financial upside from part ownership attracts and rewards
investors and workers. Effective possession motivates and empowers founders and employees—it
means they can get stuff done.
Oversight from the board places managers’ plans in a broader perspective. In practice, distributing these functions among different people makes sense, but it also multiplies opportunities for misalignment.
Big corporations do better than the govt, but they’re still prone to misalignment, especially
between ownership and possession. The CEO of a huge company like General Motors, for example,
will own some of the company’s stock, but only a trivial portion of the total.
Therefore he’s incentivized to reward himself through the power of possession rather than the value of ownership. Posting good quarterly results will be enough for him to keep his high salary and corporate jet.
Misalignment can creep in even if he receives stock compensation in the name of “shareholder
value.” If that stock comes as a reward for short-term performance, he will find it more lucrative and
much easier to cut costs instead of investing in a plan that might create more value for all
shareholders far in the future.
Unlike corporate giants, early-stage startups are small enough that founders usually have both
ownership and possession. Most conflicts in a startup erupt between ownership and control—that is,
between founders and investors on the board.
The potential for conflict increases over time as interests diverge: a board member might want to take a company public as soon as possible to score a win for his venture firm, while the founders would prefer to stay private and grow the business.
In the boardroom, less is more. The smaller the board, the easier it is for the directors to
communicate, to reach consensus, and to exercise effective oversight. However, that very
effectiveness means that a small board can forcefully oppose management in any conflict.
This is why it’s crucial to choose wisely: every single member of your board matters. Even one problem director will cause you pain, and may even jeopardize your company’s future.
A board of three is ideal. Your board should never exceed five people, unless your company is
publicly held. By far the worst you can do is to make your board extra large.
When unsavvy observers see a nonprofit organization with dozens of people on its board, they think: “Look how many great people are committed to this organization! It must be extremely well run.”
Actually, a huge board will exercise no effective oversight at all; it merely provides cover for whatever microdictator actually runs the organization. If you want that kind of free rein from your board, blow it up to giant size. If you want an effective board, keep it small.
On the Board or Off the Board
As a general rule, everyone you involve with your company should be involved full-time. Sometimes
you’ll have to break this rule; it usually makes sense to hire outside lawyers and accountants, for
example.
However, anyone who doesn’t own stock options or draw a regular salary from your
company is fundamentally misaligned. At the margin, they’ll be biased to claim value in the near term, not help you create more in the future.
That’s why hiring consultants don’t work. Part-time employees don’t work. Even working remotely should be avoided (depend on startup type), because misalignment can creep in whenever colleagues aren’t together full-time, in the same place, every day. If you’re deciding whether to bring someone on board, the decision is binary. Ken Kesey was right: you’re either on the board or off the board.
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