This story originally appeared in our July 14th, 2011 e-magazine. Click here to download the pdf e-magazine.
While evaluating a start-up socent, what investors are really looking for is the ability of the entrepreneur to make the transition from founder to manager.
By Noshir Colah
As a member of a leading venture capital management company that focuses on early stage companies, I have the pleasure of reviewing business plans and meeting with entrepreneurs and promoters. By definition, since our investments are “early stage”, there is usually little or no track record by which to evaluate the proposals.
The available tools are often restricted to an idea, the manner in which the idea is proposed to be converted to a viable and scalable business, perhaps a limited demonstration of the feasibility of realizing the objectives, and an evaluation of the entrepreneur.
Evaluating the “Idea” is reasonably straightforward. It requires an affirmative answer to a single question: “There may be a niche in the market, but is there a market in the niche?” Overestimation of the market size is one certain way of writing off an investment.
New businesses are established on the strength and personality of the entrepreneur. But there comes a time when the business has outgrown the ability of one person to run it. This is a defining moment. Can the entrepreneur reinvent himself or herself to transition from the Founder to a CEO?
I find it necessary to pay a great deal of attention to understanding the potential for the entrepreneur to make this critical transition. Two areas often provide a good indication: the organizational section of the business plan and the manner in which decisions are taken where there are more than, say, five employees.
The organizational planning offers keys to the promoter’s vision. Does s/he plan on hiring senior level managers at the right time? Is s/he planning to continue in roles, which may not be strengths? Is the remuneration for senior management adequate to enable independent decision-making? Or is s/he likely to hire only “Yes men”?
It is not enough for an organizational plan to have a chart with designations. Right from the planning stage it is necessary for detailed job descriptions. A venture must know what key resources will be required. And top management is a key resource. While down-the-line delegation can and should come as the venture advances, it is important to understand early the level of delegation of authority and responsibility for top management.
Assuming the first two criteria have been met, the next question is: Does that provide enough comfort that a successful transition from Entrepreneur to Manager will be made, thus providing the structure to facilitate growth? Not quite. There could be a big gap between intentions and ability. The key to bridging this gap are systems and SoPs (standard operating procedures).
I recently evaluated an investment opportunity where the promoters had proven only about 20% of a high-risk business model. The market was huge, as were the challenges.
After several months, we concluded that the promoter team had the right approach and ability. The determining factors were four: one, the founder had made an effort to bring co-promoters with strong professional management experience; two, all the promoter-managers had worked in professionally-managed firms and were grounded in strong systems and SoPs; three, with as few as eight managerial employees, the firm had SoPs and reporting systems in all functional areas; and four, even at this stage the promoters ensured that procedures were strictly followed, including by themselves.
Thus, the promoters were able to prove that their expertise had been passed down. This gives confidence in the ability of the company to grow beyond the promoters, and its strength to manage growth internally. This, then, is proof that the Entrepreneur has transitioned to a Manager, and that the firm can become larger than its founder.
Noshir Colah is Executive Director of Aavishkaar Venture Management Services, which provides micro equity investments to social enterprises.